The Final Report of the Murray Financial System Inquiry (FSI), released to the public yesterday, explicitly highlights that the combination of high tax rates on savings, as well as tax generous concessions like negative gearing and capital gains tax discounts, has made investment into housing a relatively attractive proposition. In turn, Australia’s tax settings have created a level of demand for housing that is higher than it otherwise would be, resulting in too much of the nation’s capital being tied-up in housing at the expense of productive of the economy – a view articulated frequently by MacroBusiness.
Specifically, the Final Report warns on the excessive growth in Australia’s mortgage debt, and the risks posed for financial stability:
Since the Wallis Inquiry, higher housing debt has been accompanied by lenders having a greater exposure to mortgages. Housing is a potential source of systemic risk for the financial system and the economy…
Australia’s banks are heavily exposed to developments in the housing market. Since 1997, banks have allocated a greater proportion of their loan books to mortgages, and households’ mortgage indebtedness has risen. A sharp fall in dwelling prices would damage household balance sheets and weigh on consumption and broader economic growth. It would also reduce the quality of the banking sector’s balance sheets and the capacity of banks to extend new credit, which would compromise the speed of a subsequent economic recovery…
This concentration, combined with the predominance of similar business models focused on housing lending, exacerbates the risk that a problem at one institution could cause issues for the sector and financial system as a whole.
The Final Report also notes that the growth in mortgage debt has been driven, to a large extent, by the favourable tax treatment provided to housing, and recommends that the Abbott Government’s White Paper on tax explicitly seek to remove these tax concessions, specifically capital gains tax and negative gearing concessions:
A more neutral tax treatment of savings vehicles would reduce distortions in the composition of household balance sheets and the broader flow of funds in the economy. Across savings vehicles, after-tax returns differ markedly. For example, interest income is relatively heavily taxed. To the extent that distortions direct savings to less productive investments, a more neutral treatment would increase productivity…
Capital gains tax concessions for assets held longer than a year provide incentives to invest in assets for which anticipated capital gains are a larger component of returns. Reducing these concessions would lead to a more efficient allocation of funding in the economy…
For assets that generate capital gains, the tax treatment encourages leveraged investment, which is a potential source of financial system instability. Investors are attracted by the asymmetry in the tax treatment of expenses and capital gains, where individuals can deduct the full interest costs of borrowing (and other expenses) from taxable income, but only half of their long-term capital gains are taxed. The tax treatment of investor housing, in particular, tends to encourage leveraged and speculative investment in housing…
Overall, the Murray Inquiry’s Interim Report has done a good job highlighting the tax-related distortions fueling Australia’s housing obsession, which should help bolster the case for reform following the Government’s tax White Paper.
