New research underscores a surprising link between high personal income tax rates and the practice of negative gearing among property investors in Australia. According to a study conducted by the Australian National University’s Tax and Transfer Policy Institute, these elevated tax rates encourage middle-to-high-income earners to leverage their investments in rental properties, a finding that challenges the narrative often presented by the Greens regarding the exploitation of tax breaks by wealthier landlords.
The study, authored by Christian Gillitzer, a former economist at the Reserve Bank of Australia and current lecturer at the University of Sydney, reveals that high marginal income tax rates incentivize taxpayers to become property investors as a means to mitigate their tax burdens. This perspective shifts the blame from landlords profiting off housing tax breaks to government tax policies that may inadvertently encourage property investment.
Chalmers’ recent alterations to the Coalition’s stage three income tax cuts have further enhanced the appeal of negative gearing. Gillitzer’s working paper, which provides substantial evidence on taxpayer responses to rental property tax incentives, highlights that reductions in marginal income tax rates significantly decrease the likelihood of holding investment properties that generate negative net rental returns.
By analyzing taxpayer data from 2006-07 to 2010-11, Gillitzer observed that higher-income earners experienced a decline in their marginal tax rate from 45 percent to 37 percent, following adjustments to the income threshold for the top tax bracket. This eight-percentage-point reduction in their tax rate corresponded with a notable four-percentage-point decrease in the likelihood of reporting investment properties.
Gillitzer points out, “Ownership of debt-financed rental properties in Australia is concentrated among top earners and significantly decreases when marginal income tax rates fall.” His research indicates that those benefiting from tax rate reductions are less likely to hold loss-making rental properties compared to their peers who remain subject to higher tax rates.
Consider an employee earning $300,000 annually. This individual pays approximately $101,138 in income taxes, plus additional penalties and contributions, resulting in around $110,000 in total tax-related payments. With a net income of approximately $190,000 remaining, this person is likely to seek ways to reduce their tax liability, particularly if they do not have access to the same level of deductions as small business owners.
Australia’s unique tax system allows net rental losses to be fully deductible against labor income, making it an attractive strategy for high-income earners. The deductions available include mortgage interest and various property-related expenses, incentivizing individuals to invest in real estate to maximize tax benefits and capitalize on potential capital gains.
Gillitzer’s findings suggest that property investors often utilize debt to create tax losses, effectively shifting their income from the labor tax base to the more favorable capital gains tax base. Capital gains can be reduced by up to 50 percent and deferred until the property is sold, often during retirement when tax rates may be lower.
As the political landscape shifts, the Greens and Treasurer Jim Chalmers have turned their attention to negative gearing and capital gains tax (CGT) discounts. A Treasury review identified capital gains as one of the most significant tax concessions available to high-income earners, raising concerns about the impact of these policies on housing affordability.
Despite widespread belief that tax breaks for property investors inflate home prices, Gillitzer’s research suggests that the overall impact is relatively minor, estimating an increase of only 0.5 percent to 4.5 percent in property prices due to negative gearing and CGT discounts. The Prime Minister Anthony Albanese has also noted that eliminating tax breaks would not necessarily lead to an increase in housing supply.
While reviewing tax concessions, experts caution against implementing changes in isolation. Reducing property tax breaks could lower home prices slightly but might also exert upward pressure on rental costs. This is because diminished after-tax returns for investors may dissuade developers from supplying new housing.
Former senior Treasury official Geoff Francis expresses concern that Gillitzer’s paper might be misinterpreted as advocating for tighter restrictions on negative gearing. He notes that it could also be seen as an argument for a flatter income tax structure, a viewpoint echoed by former Labor Prime Minister Paul Keating and Labor veteran Bill Kelty, who have criticized high marginal tax rates as excessive.
Chalmers’ proposal to adjust the income tax thresholds has introduced a 37 percent rate for individuals earning between $135,000 and $190,000, while lowering the entry point for the top 45 percent bracket to $190,000. Critics argue that these adjustments fail to address how increased taxes on high earners may further encourage leveraged property investment.
As discussions on tax reform intensify, the possibility of a more equitable taxation system emerges. A proposal suggests taxing labor income at progressive rates while applying a flat rate of 20 percent to 25 percent on non-labor income, opening avenues for more effective fiscal policies that could alleviate the burden on labor income and promote a balanced approach to investment taxation.
