From: c.oneill@trl.oz.au (Chris O'Neill)
Subject: Re: Negative Gearing
Organization: Telecom Australia Research Laboratories
Date: Fri, 20 Nov 1992 00:01:00 GMT

In article <1992Nov19.071027.16215@cs.su.oz.au> yar@cs.su.oz.au (Ray Loyzaga)
writes:
>In article <1992Nov19.034509.11169@trl.oz.au> c.oneill@trl.oz.au (Chris
O'Neill) writes:
>>In response to a suggestion that I provide an example of how the tax office
can
>>usually be expected to make a loss because of negative gearing, I have worked
>>out the following.  The suggestion was in response to the comment I made in
the
>>article <1992Nov18.005443.8650@trl.oz.au>:
>>
>>> See if you can make a
>>>realistic example that includes interest on the tax office losses.
>>
>>Suppose we have 8% inflation, 18% (nominal) interest rate, 6% rate of return
on
>>investment, 48.25% tax rate and an interest only loan.  Under these
conditions
>>the proportion of negative gearing decreases as time goes by and eventually
the
>>return exceeds the interest.  For the sake of clarity suppose the original
>>amount borrowed and invested is $100,000.  Interest is fixed at $18,000 per
>>year.  Rental return is $6,000 the first year and increases with inflation
>>after that so we have:
>>
>>year  rent       loss or gain  loss or gain absorbed   present value of A
>>                                   by tax office(A)
>>1     $6000      $12000          $5790                 $5790
>>2     $6480      $11520          $5558.40              $4710.51
>>3     $6998.40   $11001.60       $5308.27              $3812.32
>>4     $7558.27   $10441.73       $5038.13              $3066.36
>>
>>16   $19033.01    $1033.01(gain)  $498.43(gain)          $41.63(gain)
>
>If you are trying to make it realistic, maybe you should assume that
>the bank would expect you to pay back some of the principal each year,
>this would accellerate the movement to positive gearing. 

Yes, I can do that for you (groan), if you really think it makes that much
difference.

>There are
>very few interest only loans out there.

There were a lot of businesses in the eighties that had steadily increasing
debt.  The interest only loan example was chosen as being more conservative
than these.

>This stuff is still based on the belief that interest payments are
>not a genuine business expense, which is not the law and hence there
>is no loss by the tax office, they aren't entitled to it.

Look, all I did was show the difference it made to the tax office when someone
made this investment.  You tell me how the tax office is better off.  I said
absolutely nothing about believing that interest payments are not a genuine
interest expense.  Any conclusions regarding the tax deductability of the whole
of interest payments came later.  So far there has only been a calculation of
the effect on the tax office.

>You are picking on negative gearing, but the same effects occur
>with positive gearing, just in smaller amounts, what you are
>arguing for is that interest payments should not be tax deductable,

I am not arguing that interest payments should not be tax deductable.

I am arguing that negative gearing should not be allowed against income which
is independent of the loss.

>which has very little to do with negative gearing, it being just
>one instance of interest payments being a genuine business expense.
>
>>You can do this on a spread sheet if you like but I just wanted to calculate
>>the total present value loss absorbed by the tax office if this situation
>>continues forever.  This gives the least loss absorbed by the tax office
>>because it makes a gain every year after year 15.  I used the geometric
series
>>summation formula to get the result.
>>
>>The total present value loss absorbed by the tax office is
>>
>>[$18000/(1-1/1.18) - $6000/(1-1.08/1.18)] 0.4825   (*)
>>
>> = $22774
>
>I don't remember, is it 48.5% before or after the medicare levy?

48.25% including Medicare levy.

>I still don't get your drift, you still don't say how the tax office
>gets richer by the investment not occurring at all?

I said that the tax office gets poorer if the investment occurs (by $22774
present total value).  If the investor had have used his money to buy shares
say instead of financing the above investment then the tax office would have
been $22774 better off plus whatever tax was generated by the shares.  Can you
show what benefit the tax office gets from the above negatively geared
investment?

>>The derivation of (*) is left as an exercise to the reader :-).
>>
>>I hope we all now realize why this country was going down the tube so fast. 
We
>>have been given a temporary respite from out-of-control negative gearing by a
>>massive recession that has stopped inflation.  But inflation only needs to be
a
>>few percent before negative gearing is once again worth doing on high return
>>investments such as shares and only needs to be 5% before its worth doing on
>>rental property returning 6%.
>
>I have stated it in another article, the inflation rate only affects
>the ability of the investor to pay the debt off, i.e. in a high inflation
>environment $1000/month this in year 1 is a lot more than $1000/month
>on 5 years time. It has nothing to do with ripping off the tax office
>since the inflation discount on capital gain is only a fair thing,
>after all if you buy something for $100 dollars this year and
>sell it for $110 next year, and there was 10% inflation how much
>money did you make??? ZERO. The rip off is that the tax office does not
>treat interest income the same way, they should
>be inflation discounted. 

Exactly, as should interest expense (on business borrowings).  If this was done
then the problem with negative gearing under inflation would not exist. 
Negative gearing causes a problem under inflation because it allows a business
to tax deduct the inflationary component of interest against any other income,
even though this component of interest is compensated for by the reduction in
the real value of the principal.  If negative gearing against independent
income is disallowed, we still have the undesirable fact that the inflationary
component of interest is deductable against dependent income but this severely
limits the damaging effects of such deductions.

Given that we haven't got a hope of implementing inflation adjustment of
taxation in this country, the next best thing is to disqualify negative gearing
against independent income.

> And yes I see your point about why we are
>going down the gurgler, 

Yes, you're good at seeing points.

>it is because most people can't understand
>the simplest of economic arguments, 

Some people don't realize when they are leaving themselves wide open to being
accused of the same thing that they are accusing others of.

>and even those that can get part
>of the maths right can't get the underlying argument right.

or have trouble getting it understood.

>>The horrible realization is that what happened in the eighties can happen all
>>over again, maybe not as severely but enough to ensure that Australias
>>distorted investment problem continues.
>
>Yup, and it has nothing to do with negative gearing.

HA HA HA HA HA HA

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