No doubt many readers of this site are of the libertarian persuasion after reading scholarly tomes by Ayn Rand, or Karl Popper.
Not me, though. I simply observed governments in action, and compared them to the workings of the free market.
One interesting thing I have observed over the years is that even governments who present themselves as ‘friends’ of the free market get the political urge to regulate, with the purest of motives, to ‘help’ the market along.
Markets aren’t like that, though. Even the best intentioned meddling by governments have consequences that are undesirable. Consider the Australian government’s well intentioned meddling in the Australian property market… Australians, it must be said, have a long standing tradition of investing in property, rather then equities in private companies. It is a bit of a chicken-and-egg riddle as to whether or not investors were reacting to the tax code, or the tax code evolved to suit property investment.
The tax code in Australia has a provision known as ‘negative gearing’. What this basically means is that if I go to the bank and borrow money to invest, the interest on that loan is tax deductible.
In practice, banks much prefer to lend to people who use that money to invest on property rather then shares.
Hillary Bray takes up the story
Negative gearing is not being driven by the investment return on rental property. Returns are better in both the share market, and also in sticking the money in an investment bank account. Rental property investment is entirely driven by its beneficial tax treatment.
Having some method to encourage investment in housing is a good thing. However, the problem in Australia at the moment is that rental property investment is a consequence of the high rates of tax elsewhere in the system. The existence of a housing price bubble is evidence that the market is being driven by tax returns – not investment returns.
Negative gearing is tax effective because it allows people to lower their income to get below the top rate of tax threshold at the same time as they benefit from a capital gains tax levied at only half the top marginal rate.
The current housing price surge began almost as soon as the capital gains tax was lowered three years ago. …
As the Reserve Bank pointed out, these two incentives are being made even more extravagant by the treatment of depreciation for rental housing. As the bank asked out loud, why are there depreciation allowances for appreciating assets?
The Reserve Bank’s submission to the Productivity Commission’s inquiry into house prices is basically saying that the extraordinary increases in house prices are in fact being driven by the Government’s fiscal policy – by the current structure of the taxation system.
So as a result of successive Australian governments tinkering to help the property market along, the result has been to send housing prices through the roof; to the point where it is now difficult for ordinary wage and salary earners (read voters) to afford a house in Melbourne and Sydney.
No doubt if the government had abolished the negative gearing provisions of the tax code when it halved the capital gains tax there still would have been substantial rises in the property market; that is the natural result of cutting the taxation of appreciating assets. The effect of leaving negative gearing intact is the market’s self correcting mechanisms aren’t able to kick in.
I would quibble, though, with Hillary Bray’s contention that “Having some method to encourage investment in housing is a good thing.” I do not believe that the state should favour one form of investment over another- all it should do is provide a climate suitable for all sort of investment and let the market decide the best place for capital to go.
The State is NOT your friend, even when it’s trying to help you.