Richard Holden is a professor of economics at UNSW Business School. He received his PhD from Harvard University in 2006, where he was a Frank Knox scholar. Holden's research has featured in press articles internationally and he regularly contributes opinion pieces to Australian media. In 2015, he was co-author of Switching Gears, a McKell Institute report on reforming negative gearing to solve Australia's housing affordability crisis. Holden spoke to Julian Lorkin for BusinessThink.
An edited transcript of the interview follows.
BusinessThink: Is negative gearing changing housing affordability?
Richard Holden: I think it is, and in a negative way. It is creating a non-level playing field, between investors and owner-occupiers. It gives a tax incentive to investors to buy a property that is not available to people who are buying a house to live in for themselves, and that has contributed to the housing affordability crisis that we have in Australia.
It's important to understand that if you look at price to income ratios, Sydney is the second most expensive city in the world, and Melbourne is the fourth. We are more expensive than London and San Francisco. We have a housing affordability crisis.
BT: And how about price to rent ratios. That's often what really matters to people in the rental market.
Holden: The striking thing about rent ratios is that they are basically in the same direction. We are unfortunately topping the league tables on those measures as well.
BT: And how about the amount of money the government is losing or making. It seems that many people are reducing the amount of tax they are paying. Is the government getting any benefit at all from giving these big tax breaks?
Holden: What we do know is that about $4 billion a year is hitting the government's budget bottom line, as a tax break to people who utilise negative gearing. So it is a little bit tricky to think about taking that away immediately, and adding that back to the government bottom line.
But if you look at the report I wrote for the McKell Institute last year, it showed that over the course of about 10 years, if you transition sensibly away from negative gearing – by grandfathering existing properties that people negatively gear, and allowing it going forward for only new construction – that would add about $30 billion to the budget bottom line. And when the parliamentary budget office costed the Labor Party policy, which is broadly similar to the one I proposed, they found it would have a $32 billion impact over the same 10-year period.
‘Most countries that have had this kind of preferential tax treatment have done away with it, and none of the results of the scare campaign against it, such as rents spiking up, have occurred’ – richard holden
BT: So let's be clear. There is a lot of money that is being lost here, but you are not proposing to immediately just scrap negative gearing at all. We did have an experiment with this about 30 years ago when negative gearing was removed for a few years. What happened then?
Holden: During the mid to late 1980s, the Hawke-Keating government did abolish negative gearing for a roughly two-year period. And [none] of the dire predictions that some people are currently running as their scare campaign – against changes to negative gearing – happened. New housing construction did not drop anywhere in the country. And rents did not spike.
There was a modest rise in rents in Sydney and Perth which both had extremely low vacancy rates at the time, suggesting that those rents would have gone up in any event. And when we've seen this done around the world most countries that have had this kind of preferential tax treatment have done away with it, and none of the results of the scare campaign against it, such as rents spiking up, has occurred.
BT: But, playing devil's advocate, surely it's basic economics; that if you remove a big tax break – something that looks like a big perk – all those investors in the market will bail out. Isn't that going to mean that house prices will go down, and go down quite markedly?
Holden: There are two points. The great majority of investors in this market don't have access to negative gearing. If you look at foreign purchasers of new construction, they contribute between three and four times as much as domestic investors do. And so those people who don't have access to negative gearing will be unaffected by this.
Purchasers of properties after they have been new construction would be people who don't have access to negative gearing, under the Labor [Party] plan. And 76% of purchasers are owner-occupiers who don't have access to negative gearing anyway. So we are talking about a modest slice of the market.
Which brings me to my second point, which is very relevant to the point Prime Minister Turnbull has raised. He said if you take away 30% of people in the market, prices will plummet. What he is confusing here is who is actually important, in determining a housing price. It's not the valuation of the average person. It's the valuation of the second-highest person who is thinking of buying.
Imagine yourself in an auction and outbidding someone. So what's the price you are going to bid in an auction? And the same logic applies to private treaty sales. The price is determined by the valuation of the second-highest bidder. The first-highest bidder will win, and they will pay a small amount more than the second-highest bidder, and so it is their valuation that will affect things. Not the average bidder.
So then you ask yourself a question. Suppose, for the sake of argument, we take away 30% of the people in the market. It's not clear that would happen under changes to negative gearing but suppose it did. How much is that going to change the valuation of the second-highest bidder?
The way to think about that is to imagine you ask 40 male Australians to walk into a room. We arrange them from tallest to shortest, and you ask who is the second-tallest person and you measure them. And then perform the same experiment with 60 people in the room and measure the second-highest person. And you ask how different is the height of the second-highest person in the room with 40 people compared with the room with 60 people. And the answer is about half a centimetre.
‘When you already have quite a liquid market for residential property, changing the number of potential buyers by a modest amount isn’t going to effect the price by much at all’ – richard holden
So we are talking about half a centimetre out of a 180cm problem here. And the key point is, when you already have quite a liquid market for residential property, changing the number of potential buyers by a modest amount isn't going to effect the price by much at all.
BT: All right, it may not affect the price, but that number of buyers taking themselves away from the market may seem a little bit scary when we do have a problem with the rental market, not just in Sydney but in other cities around Australia. Maybe we should look at a different angle. Is the problem actually with the supply of housing in Australia and if so what can we do to increase it?
Holden: That's exactly right. The supply side is where the problem comes in. We have too few properties available for people, and that is what is driving up the price. It has been well recognised around the world. And so we've seen a shift, for instance, by every state and territory government during the past five years away from first home owner grants for people buying existing properties to providing those incentives only for people buying new properties. And that's basically a live experiment of what the Labor policy would be, and what it would do.
And have we seen a spike in rents? Absolutely not. A drop in new construction? Absolutely not. What we've seen is the power of the market transitioning people from buying existing properties to using those incentives to buy new properties. And it is the supply of new properties that will bring down rents and help make housing more affordable in Australia.