The curious incentives and consequences of negative gearing

Negative gearing was one of the federal election campaign’s fiercest battlegrounds.

While the Labor opposition claimed that the major beneficiaries of the tax policy were almost all in the very highest earnings bracket, the Coalition attacked any proposed changes, saying they would “smash” house prices and unfairly punish “mum and dad investors”.

The fact is, negative gearing can have surprising outcomes.

Using game theory, senior lecturer in mathematics Stephen Woodcock constructed four scenarios that demonstrate exactly who benefits from negative gearing.

At The Conversation, we decided to create a board game to show his modelling:

What happened

The game maximised the desirability of occupying the best house they could afford, whether this was by buying or renting.

If you’d like to see the cash-flow for each of the scenarios, click through below.

The ultimate outcome was that richer players used negative gearing to keep purchasing multiple houses – forcing others to buy progressively inferior houses and/or rent from others. Some missed out completely and were forced to rent.

At the end of the game, one buyer owned all the houses, with all other players forced to rent from them.

And interestingly, in this game, negative gearing increased prices.

What does the future hold?

“It is easy to see how curious (and less than ideal) ownership patterns can arise when tax policies incentivise speculation in the property market. What is less clear is what can, or should, be done now,” says Dr Woodcock.

Dr Woodcock points out that both Sydney and Melbourne rank in the world’s five least affordable cities to buy a house. Despite record low interest rates, first home buyers are at the lowest level in years. First home owner grants have done little to help this and, arguably, have only served to increase prices further.

Instantly scrapping negative gearing would almost certainly cause a huge drop in prices, which would be manifestly unfair to people who made investment choices assuming that tax advantage would be available.

Labor’s proposed restriction of the benefit to newly built properties only would provide some relief. It has been argued, though, that this would encourage speculation in certain areas.

“A tax policy which avoids incentivising curious outcomes for society, yet retains basic fairness for existing investors would require subtle measures and crossbench support. Albeit by the narrowest of margins, the Coalition’s retention of power might mean that any such reforms are several years away.”

Interestingly, it was noted earlier this year that federal politicians – from both major parties – averaged more than two investment properties each.