From: c.oneill@trl.oz.au (Chris O'Neill)
Subject: Re: Negative Gearing
Organization: Telecom Australia Research Laboratories
Date: Sun, 22 Nov 1992 05:37:40 GMT

In article <1992Nov20.055253.28190@cs.su.oz.au> yar@cs.su.oz.au (Ray Loyzaga)
writes:
>In article <1992Nov19.084457.23632@trl.oz.au> c.oneill@trl.oz.au (Chris
O'Neill) writes:
>>In article <1992Nov19.033826.19190@cs.su.oz.au> yar@cs.su.oz.au (Ray Loyzaga)
>>writes:
>>>In article <1992Nov18.005443.8650@trl.oz.au> c.oneill@trl.oz.au (Chris
>>O'Neill) writes:
>>>>In article <BxusMp.29n@bunyip.cc.uq.oz.au> kerry@citr.uq.oz.au (Kerry
>>Raymond)
>>>>writes:
>>>>>Negative gearing and making a gain are not possible simultaneously!
>>>>
>>>>They are!!
>>>
>>>What the guy actually meant to say was that "negative gearing"
>>>is a term used to describe the situation where the costs of funding
>>>a project outweigh the returns, 
>>
>>when you don't consider capital gain (inflationary or otherwise)
>
>Yes, exactly that is the definition, so if you don't like the
>definition why not write an earth shatterring economics text
>and revolutionise the terminolgy.

The term "negative gearing" was not the only one used in that sentence.  The
term "gain" was also used but you're not observant enough to notice that.

What the guy actually meant to say is that negative gearing and making some
sort of gain (after all sources of financial benefit are considered including
capital gain) along the lines that I suggested in the article that he was
replying to, are not possible simultaneously.

>>>since the most popular example is
>>>property it means that the sum of (mortgage interest, rates, insurance,
>>>utilities, legal and agents fees and various other duties) is more than
>>>the rental income of the property. This property is said to be
>>>negatively geared.  A property is positively geared if the reverse is true.
>>
>>Thank you for reminding us what negative gearing is.  My point was about more
>>than just the definition of negative gearing.
>
>Your point is a mish-mash of ideas, you at some point raise the bogey
>of "negative gearing" when in effect it is the fact that interest costs
>are tax deductable that is making these effects. Negative gearing has
>nothing to do with it, GEARING does, both positive and negative.

Thanks for your mish-mash.

>>>>Negative gearing does not view the inflationary part of capital gain as
>>taxable
>>>>whereas it does view the inflationary part of interest on borrowings as tax
>>>>deductable.  This is how you make a gain while fobbing the loss on to the
tax
>>>>office:
>>>
>>>Under the present capital gains tax legislation, nothing views the
>>>infaltionary part of the capital gain, it is the same whether the
>>>asset is negatively geared, positively geared or purchased outright.
>>
>>That was part of my point.
>
>No it wasn't, you only talk about negative gearing. 

I said "negative gearing does not view the inflationary part of capital gain as
taxable", i.e. I was talking about capital gain as well.

>I guess
>it is because it is a nice emotive term like multinationals and
>refugees.

I can't help it if it's emotional to you.

>>>>If the real interest rate on borrowings is 10%, the rate of inflation is 8%
>>>>(thus the nominal interest rate is 18%), the real rate of return on the
>>>>investment is 6% and the tax rate is 48.5%, then the negatively gearable
loss
>>>>is
>>>
>>>What you really mean to say is, you pay an interest rate of 18%,
>>>inflation is 8%, therefor the "real" interest rate is 10%. 
>>
>>Thanks for the re-iteration.
>
>No, I happen to state it according to how most people will understand
>it, 

You can't see the equivalence, can you?  Or are you trying to make something
out of nothing?

>after all the term "real interest rate" has also been used to refer
>to the difference between the average cost of funds and the interest
>charged on bank loans, I an remember many instances of people
>complaining that Australia has very high "real interest rates" because
>you could typically get 3-6% on your savings but you pay 10-16% on
>your loans.

I have heard terms synonomous with interest rate margin or differential (I
can't recall the actual term) but I have never heard this described as "real
interest rates" in the economic litreature.

>>>(obviously
>>>you did your calculations in the late 80's).
>>
>>That's what we were talking about.
>
>So can you explain (after all it is your thesis that the cause of all
>our problems is negative gearing) why in the last 100 years, barring
>the short period 1987 to current, when there was ZERO capital gains tax
>and full tax deductability on interest we didn't have a late eighties
>style mess? Yet only in the late eighties (Sept 1987 onwards) we end
>up in a mess and the only change is the addition of inflation indexed
>capital gains tax. You would have thought this change would dampen
>the enthusiasm of this type of investment.
>Maybe there is something wrong with your theory ... I'll tell you what
>it is if you send me some money ...

Maybe there's something wrong with your knowledge, or lack thereof.  Ever heard
of financial deregulation?  It happened in 83 or 84.  Suddenly you could go to
some overseas bank, say "I want to borrow a billion dollars worth of your
currency", and if they thought you would make money they would lend it to you
and you could bring it back and change it for Australian dollars.  What bank do
you think Holmes a Court got his money from?

>>I have made calculations of the loss the tax office makes in two other
>>articles.  Make sure you read at least the second one (which includes a lot
of
>>the first one anyway).
>
>Sadly I must report that I have read all your articles, why not be more
>succinct, just post your theory, most of us understand the numbers but
>can't work out what you are trying to say, one minute it is

What happened to the next minute?

>"negative gearing is evil", "negative gearing caused the late eighties
>nightmare", "interest should be tax deductable", "interest shouldn't be
>tax deductable". 

Well first, just to make sure that you actually have followed this thread from
the beginning, it started under the title: Australia's Debt - IBIS view, where
a criticism was made of negative gearing (not by me in the original article)
then moved on to Taxation Distorting Investment (which negative gearing causes)
and finally onto Negative Gearing.  Have you followed all that?

>Just come out and say what your amendments to the
>current laws relating to investment are, and then we can see how they stand.

In the very first article of this thread (Australia's Debt - IBIS view), it was
stated:

>...the government should either scrap negative gearing and dividend
>imputation, both of which encourage borrowings, or stop taxing the interest 
>on savings.

This comment prompted my reply.  So if you read that, you would know what I am
arguing for: scrap negative gearing.

>>>>>Negative gearing is where the cost of borrowing exceeds the income
>>>>>produced. When there is a gain (i.e. when the income exceeds the
>>>>>interest payments), then it is *not* negative gearing.
>>>>>
>>>>>Suppose I borrow $100K at 10% 
>>>>
>>>>I presume you mean 10% nominal.  It is not clear that you understand the
>>>>difference between nominal and real.  The real interest rate is:
>>>
>>>Very few people talk about real interest rates, name one bank that
>>>quotes "real interest rates", 
>>
>>Their economists do, but not to plebeians like you.  It would be worthwhile
if
>>more people were familiar with the concept.
>
>As I have stated above, real interest has more than one meaning.

To you.

>>>I note that the real interest rate
>>>was completely irrelevant to your calculations, so why did you mention it?
>>
>>Well if you had been following the thread from earlier on you would have
>>noticed where I said:
>>
>>The fundamental point is that if I borrow money at say 10% real and use it to
>>finance an investment returning say 6% real then I am making a real loss
which
>>has to be abosrbed by someone somewhere or other.  If the tax system makes it
>>possible for an individual to profit in this situation then the tax system is
>>absorbing that loss.  It means that overall, our community is incurring a net
>>loss even though the individuals doing the negative gearing are making a gain
>>for themselves.
>
>And thats where we disagree, if you borrow money at 0% real, (lets say
>10% nominal 10% inflation) and make 6% real, then you are still making
>a tax loss, 

but not a real loss

>and it has ZERO to do with the "real" interest rate.
>So maybe now you will agree that "real" interest rates have NOTHING
>to do with what you are talking about 

You haven't disproved anything I said.  Try to understand what I said.

>other than an attempt to show that
>you might know one more psuedo-economic term that most on the net,
>I thought you could have thrown in "due diligence" it has been in the
>press quite a bit lately.

You haven't shown much diligence in getting my point above.

>>The real interest rate has fundamental importance.
>
>I agree, ZERO is a fundementally important concept, but sadly
>the "real" interest rate has nothing to do with this.

See, you don't realize the importance.

>>>For a large part of the eighties, there was no capital gains tax, this
>>>came in in late '85. Before that there was a speculative gains tax.
>>>Capital gain is available no matter what the gearing is, the real
>>>benefit to the investor of all this is that they can basically
>>>use capital gains to grow someone elses money, and reduce the cost
>>>of using that money.
>>
>>Thanks for this way of thinking about the situation.  This doesn't mean that
>>what I've said is wrong.
>
>Well actually it kind of does....

if you misunderstand what I've said.

>>>Like I said, show me how much money the tax office makes in a zero
>>>investment climate. 
>>
>>As I mentioned, I have calculated how much the tax office loses in another
>>article.  And contrary to your implication, it is not necessary for the tax
>>office to indiscriminately subsidize loss making investment for there to be
any
>>investment.
>
>It isn't indisriminant, it is quite explicit, the deduction is only
>permissible if the investment is made with the intent of producing a
>profit (even over time), 

a profit for the investor but not necessarily for the tax office and not
necessarily a good investment for the community overall.

>I believe that the Adelaide Steamship company
>had a ruling go against it last year because they had made investments
>purely to reduce their tax liability (they bought companies with large
>carried forward tax losses), they had to pay up a few hundred million.
>Removing negative gearing will slow down the investment cycle, simple as that.

On poorly productive investments that are based on non-depreciating assets
(property, shares).

>>>Or if you disallow interest payments as a deduction,
>>
>>I didn't say disallow interest payments as a deduction.  I just said disallow
>>negative gearing against unrelated income.
>
>Gosh, what a quaint idea, i guess you really mean removing the ability
>to write off loss making businesses against an unrelated area, negative
>gearing is not something that should be disallowed, if I want to invest
>in something that will make a loss for a few years it shouldn't be disallowed,

The tax deduction shouldn't be allowed.

>what you are trying to say (but can't because you want to keep raising the
>negative gearing monster) is that I should not be able to use those losses
>against my other income. Of course, contrary to what you say, this means
>that you must disallow interest payment deductions, 

to the degree that they cause negative gearing, but they should be allowed
against the rent from the assets they are financing.

>since by definition
>when negative gearing is happening, you only have other income.
>
>>>how much effect will the increased effective cost of funds have on
>>>investment.
>>
>>It won't have any effect on productive investment.
>
>Wrong.
>Many negatively geared investments are productive, they just don't make
>a profit to the owners YET.

Show that they are productive.  Productivity depends on rate of return on
investment.  Rental property returns 6-7% before tax.  This is not very
productive.

>>>>>Renting
>>>>>houses is a business! 
>>>>
>>>>but independent of earning a salary.
>>>
>>>who cares.
>>
>>Yes, I know you don't care about getting my point.
>
>You don't have a point.

Thanks for your opinion.

>>>>>The shop keeper can deduct expenses like rent of the
>>>>>shop and interest on the loan to pay for the fit-out. The landlord can
>>deduct
>>>>>expenses like rent of the purchase price (i.e. interest repayments) in
>>exactly
>>>>>the same way. 
>>>>
>>>>Sure, but why is he entitled to deduct them against some independent source
>>of
>>>>income?
>>>
>>>Ok, would you then allow the $5k tax free threshold on each independent
>>>business activity? Or will you treat income in one lump sum? Doesn't
>>>this lead to a bit of a problem???
>>
>>You'd better explain what the problem is.
>
>Well on the one hand you treat income as a lump some to levy taxes upon,
>but when it comes to losses incurred you treat it differently 

Losses should be treated differently in taxation.  As you said above,  Adelaide
Steamship had some of its losses treated differently.  There isn't a complete
open slather on deducting losses, but to a degree negative gearing is.  The tax
office is fundamentally supposed to tax profits and not subsidize losses. 
Negative gearing has been allowed because the loss is supposed to have some
influence on profits.

on some
>arbitrary division of types of business activity. Who makes these
>arbitrary delineations? Is a green grocer able to write off a loss
>on green beans against the profit he made with avocados?

If he didn't sell green beans he might lose some customers who bought green
beans and who also bought avocados, thus affecting his profit on avocados.

>>>But you are arguing that they should be, you are arguing that
>>>the costs of the capital base (interest) should not be deductable,
>>
>>no, just that negative gearing of any cost against unrelated income should
not
>>be allowed.
>
>Like I said, with negatively geared investments, there is no related
>income.
>
>>>whereas I would be arguing that the inflation component of earning
>>>interest income should be deducted from the interest to bring it
>>>into line with the capital gains tax rules.
>>
>>Ah yes, inflation adjustment of taxation, that would also solve the problem
>>(seriously).  But as we know from bitter experience, there's a snowflake's
>>chance in hell that the government would implement inflation adjustment of
>>taxation.  I have tried to determine if there is another fundamental defect
in
>>the tax system that causes the problems with negative gearing and I have
found
>>that it is negative gearing against unrelated income.
>
>No, not tax indexation, 

Please try to read what I wrote.  I said inflation adjustment of taxation, not
tax indexation.

>sheesh, you should only be taxed on the
>non-inflation component on any investment which for most people
>is restricted to bank accounts.

Yes, I understood what you wrote.

>>The problem with negative gearing would not exist if inflation adjustment of
>>taxation occurred.  This is because the inflation adjustment would remove a
lot
>>of the tax deductability of interest and hence make unproductive investments
>>unprofitable to their owners.
>
>Que? I think someone turned the power off .... is any one home...

There's not very much at your home.  I'd better say it again.  What you said
above about

"the inflation component of earning interest income should be deducted from the
interest"

is called "inflation adjustment of taxation".  It can (and should) be applied
right through the tax system, not just on depositors interest.

>>However since there is no hope of inflation adjustment, I have studied the
>>fundamental defect in negative gearing.
>
>certainly fundemental defects have been revealed ....

Yes, fundamental defects in your ability to understand what you read.

>>>>>so do people who buy investment property.
>>>>>Both are risking their current income or savings because they believe that
>>>>>in the long term, they will make a profit -- a profit that will then be
>>taxed.
>>>>
>>>>After the tax office has lost vast amounts in lost interest.
>>>They haven't lost a thing, thats the law, 
>>
>>They lose, read my examples.
>
>They also lose because they give an tax free threshold to individuals,
>maybe you should argue against this to.

I'm only arguing about deductability (in the form of negative gearing).  I'm
not arguing about the appropriate tax on taxable income.

>>>>>Negative gearing makes it possible to start-up small businesses, 
>>>>
>>>>with the tax office as a loss-making shareholder
>>>
>>>Lets call it a "subsidy".
>>
>>Yes it's a subsidy of loss making enterprises.
>
>Lets call it a subsidy for starting an investment which by law
>requires you to be attempting to become profitable.

But the point is, the tax office is not too careful about checking whether they
would be better off without it.

>>>>I don't believe that it's evil to try to do better than bank interest but
>>that
>>>>doesn't mean that I think negative gearing is not evil.
>>>
>>>Funny, I think that in many circumstances, capital gains tax is evil.
>>
>>perhaps because you can avoid it so often.
>
>No, because I think that any realised capital gain should be untaxed
>if it is re-invested within a small period of time, as an example
>if a green-grocer decides to sell his shop to move to a better
>area, he should be able to re-invest the whole amount, no tax.
>If he decides to buy a boat instead, he should pay tax.

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