Those who don’t know history are doomed to repeat it.” These words, from statesman Edmund Burke, came to mind when I read all the latest argy-bargy about possible changes to our tax system.
In April 2008 the Rudd government held a national think tank called the Australian 2020 Summit. One of its major recommendations was a total review of our tax system to make it more equitable. The Rudd government took up the challenge and commissioned the Henry Tax Review. The five members of that committee were highly respected, and represented a good cross-section of Australian institutions. The terms of reference, however, were farcical, as two major areas of tax policy were off limits – GST, and tax on superannuation payments for people aged 60 or over.
In late 2010 the committee handed down its report, which the Rudd government quickly consigned to the too hard basket. Only after intense pressure did they release its contents – just one week prior to the 2010 May Budget.
Politicians are great at floating ideas, but it’s a different matter when the challenges of implementation arise. As 2010 was an election year, they ducked for cover by specifically ruling out 26 of the most controversial recommendations. These no-go zones included alignment of superannuation preservation age with pension age, land tax on the family home, and the abolition of negative gearing.
They did accept a rise in compulsory employer superannuation to 12%, and a cut in company tax. The first of these was postponed by the Abbott government, and the second is back in the too hard basket.
So the Henry Tax Review was a total waste of time and money.
Five years later our tax system is still a mess, and Australia’s finances have deteriorated so badly that we are borrowing $100 million a day just to pay our bills. Now tax reform is back on the agenda with “nothing off the table”.
That’s an easy statement to make, but incredibly difficult to put into practice.
Let’s take a look at negative gearing – a hot topic whenever tax reform is discussed. Its critics claim that it’s a classic example of a tax break that benefits rich property investors at the expense of poor renters.
Gearing means borrowing. If the interest on an investment loan exceeds the net income from that investment, you have a negative cash flow and have to make up the shortfall from other resources.
It is a basic principle of taxation that losses from an income producing venture are tax deductible. So losses from negative gearing are subsidised by the tax office at the investor’s marginal tax rate. This applies to all income producing assets, such as commercial cooking equipment for a restaurant, or a bobcat for an earthmoving business.
Critics have been pushing for decades to have negative gearing curtailed, usually by requiring losses to be quarantined. This postpones deductibility until the particular asset is producing a positive cash flow. It was a spectacular failure when the Keating government tried it in 1985, but remains a perennially popular idea.
In any event, negative gearing is saving very little tax in today’s climate of low interest rates.
Let’s think about a typical property investor in the 32.5% tax bracket, who owns a single rental property worth $450,000, on which they owe $400,000 and which returns $18,000 net. If the interest rate was 5% their interest bill would be $20,000 a year, leaving a tax deductible shortfall of just $2000 a year. Tax saved by negative gearing would be just $650 a year – hardly the stuff that bottom of the harbour schemes are made of.
What changes to our tax system would make better sense? Well, some of the recommendations from the Henry Tax Review would make a great start, particularly if they were implemented, as recommended, in the context of a comprehensive overall reform.
Expect a lot of noise in coming months, as vested interests fight to protect their own patch while pointing the finger at everybody else to make sacrifices. If history is a guide we will see much more noise than action.