From: yar@cs.su.oz.au (Ray Loyzaga)
Subject: Re: Negative Gearing
Reply-To: yar@cluster.cs.su.oz (Ray Loyzaga)
Organization: Basser Dept of Computer Science, University of Sydney, Australia
Date: Thu, 19 Nov 1992 07:10:27 GMT

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. There are
very few interest only loans out there.
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.
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,
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?
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?

>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.  And yes I see your point about why we are
going down the gurgler, it is because most people can't understand
the simplest of economic arguments, and even those that can get part
of the maths right can't get the underlying argument right.

>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.

>Chris ONeill
>Telecom Research
>


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