From: c.oneill@trl.oz.au (Chris O'Neill)
Subject: Re: Taxation distorting investment
Organization: Telecom Australia Research Laboratories
Date: Tue, 17 Nov 1992 06:27:37 GMT

In article <Bxszyq.LsJ@bunyip.cc.uq.oz.au> kerry@citr.uq.oz.au (Kerry Raymond)
writes:
>c.oneill@trl.oz.au (Chris O'Neill) writes:
>
>>The overall effect is that (during times of sufficient inflation) there were
>>massive amounts of investments that were making a real loss that was paid for
>>by the tax office (or more precisely, genuine taxpayers such as PAYE
>>taxpayers).
>
>Speaking as a genuine PAYE taxpayer and negative gearer, I'd like to
>point out that negative gearing is not in itself a terrible thing.
>When deciding to borrow for any purpose, one has to weigh up the costs
>of borrowing (the interest etc) against the benefits (having the thing
>now, deriving income, obtaining capital growth). For example, most people
>borrow to buy their first home because their capacity to save up the
>entire purchase price is less than their capacity to pay off a mortgage
>which dwindles in proportion to the value of the house due to capital
>growth.
>
>In short, you only gear (borrow) whether positively or negatively because
>you expect to make money from the investment at some time, through
>regular income and/or capital growth. Both of these forms of income
>can be taxed when they occur in the lifetime of the investment.

The capital growth is only taxed on the real part.

>The tax deductions on the interest repayments don't exceed the
>interest payments so therefore the investment must be intended to
>make money eventually or there is no point in doing it.

It makes money for the owner, eventually, but only because the tax deductions
on the inflationary part of the interest change the investment from loss making
(for the owner) to profit making (for the owner).

You have not understood the technical detail of my argument or at the very
least you don't want to tackle it.

You may be trying to make the point that negatively geared investments make a
real profit eventually (when the negative gearing gets low enough) and that the
tax office starts to re-coup some of its losses when tax is paid on this real
profit.  Well, this is not necessarily true for a start and it also ignores the
fact that an investor can maintain his level of negative gearing by further
borrowing and thus continue to extract tax deductions indefinitely.  Another
point is that the tax office should stick to the business of taxing.  It should
not be involved in any schemes that involve trading off less tax now for the
hope of more tax in the future.

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.

>The well-publicized losses in the 80s have (IMHO) two causes.
>
>Firstly, the loans were out of proportion to the real value of the asset.
>Businesses (e.g. Channel 9) were bought at an artificially high price 

because negative gearing was initially so lucrative

>and
>thus there wasn't the asset base to generate the income/growth that was
>needed to sustain the payments on the loans

after the interest rates were increased because the Government had to control
the excessive amount of money being borrowed to finance negative gearing.

>The banks and financiers
>have to accept a share of the blame for permitting such high levels
>of borrowing.

I just wish the Federal Government and its Treasury would accept their share of
the blame for the tax system that has wasted hundreds of billions of dollars.

>Secondly, some of the loans were done purely for tax reasons because
>it was believed that the income or growth of the investment would not
>be subject to taxation because of various shady dealings (involving
>South Pacific islands) and tax loopholes. Not surprising that these
>arrangements went bust when the taxman caught onto them.

The vast majority of the well-publicized losses in the 80s occurred in legal
activities.  Some illegal activities occurred, but they only involved a small
fraction of the losses.

>In conclusion, negative gearing itself isn't bad but, like cars and any
>other tool, it can be misused.

In conclusion, there is no economic justification for negative gearing unless
the loss making activity must exist for the profit making activity to make its
profit.

For example, negative gearing is one example of the tax deductability of costs
in a business.  A business can deduct costs such as rent in calculating its
profit because it would not earn that profit unless it used the property that
it pays rent on.

For an opposite example, if a salary earner negatively gears a rental property,
there is no justification for negatively gearing against his salary because he
gets his salary regardless of whether he has the rental property or not.

Chris O'Neill
Telecom Research Labs
Newsgroups: aus.politics