Quarantining Interest Deductions for Negatively Geared Rental Property Investments

Negative gearing has become a popular tax shelter in Australia. Australia is one of few countries to generally allow interest deductions for negatively geared rental property investments. Although the tax benefits of negative gearing at the investor level are quite well known, the tax policy arguments for and against negative gearing have not been thoroughly examined. This is a paper about tax policy. It surveys the arguments for and against negative gearing. According to tax policy criteria, should negative gearing be allowed? Many commentators have speculated on what effect negative gearing has on the economy. Does it increase house prices and make home ownership less affordable? Or does it make accommodation more affordable by increasing the number of rental properties? Are there broader economic effects? Does it distort investment? Does it contribute jobs to the economy? Does it have an effect on interest rates? What is its impact on the tax revenue? A number of false assumptions have been made on both sides of the debate, undermining the arguments for and against negative gearing. Informed by quantitative and statistical analysis, this paper evaluates those assumptions and concludes that on balance there is a strong case for closing the tax shelter. The final part of this paper considers alternative vehicles for denying negative gearing. Drawing on overseas experience, this paper evaluates the tax policy implications of various options for quarantining interest deductions. One critical question for tax policy debate is to determine the appropriate level for quarantining measures. Should they be confined to real estate investments or broadly cover all types of investments? As with all tax reform, closing the tax shelter will necessarily have impact on other tax policy settings. Tax policy gains may be achieved in some areas but this might be at the expense of others. By examining the tax policy effect of alternative measures, this paper discusses which option for quarantining interest deductions and eliminating negative gearing would work best in the Australian tax system.