Negative Gearing generates a tax-deductible loss. Interest paid on funds borrowed to acquire a rental property, shares or other income-generating assets exceeds the income received from those assets. That loss generated from investment in a capital asset is set off against salary income to lessen the PAYG tax liability. Since capital gains tax was introduced in 1985, negative gearing has been a popular device for acquiring rental properties. With banks very actively promoting marginal lending into equities, negative gearing on shares has now also grown massively.

The Democrats oppose the use of negative gearing as a tax avoidance practice. It costs Australia approximately $2 billion(1) a year. Losses should be claimable against income from the investment, but not against other earned income.

Negative gearing encourages tax-levered debt and tax schemes solely designed to minimise tax. Professor Krever(2) argues that because the tax-deductible loss is 100% but the taxable capital gain is only 50%, that "the incentive for tax avoidance by negative gearing must be enormous." This is known as the tax arbitrage effect – shifting from ordinary income to capital income to profit from unequal tax rates. Professor Krever says that the majority of overseas countries – including countries such as the USA, the UK, and Canada - do not allow negative gearing.

The United States, for example, allows negative gearing losses from investment to be claimed against income from that (and other investments), but not against PAYG earned income.

Negative gearing attacks the integrity of the tax system, and significantly reduces the tax revenue available for services. It is the tool that drives hundreds of tax planning schemes, many of which have trapped "mums and dads" investors into poor investment decisions through slick advertising and poor advice.

If the Government is not prepared to fix the tax system by moving to the US-style restrictions on negative gearing, it should at least restrict the losses that can be negatively geared against other earned income to 50%. That way, the negative gearing concession would match the new Capital Gains Tax system, which taxes only 50% of the capital gain. This would collect upwards of $500 million a year in extra revenue. Any changes should be phased in to minimise economic distortions.

The argument that attacking negative gearing would damage investment in low cost housing is not an argument that has been sustained overseas, where negative gearing has rightly been banned. Direct tax credits or grants are anyway a far more effective method of promoting low cost housing.#

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1 Associated Professor Chris Evans, ATAX University of New South Wales, in evidence to the Senate Finance and Public Administration Committee's Inquiry into Business Taxation Reform November 1999, estimated negative gearing cost the tax system in 1996/7 around $937 million in tax foregone on rental properties alone.

2 Professor Rick Krever, Director Taxation Policy Research Institute, in evidence to the Senate Finance and Public Administration Committee's Inquiry into Business Taxation Reform November 1999