Turnbull should follow Trump: trim deductions to fund tax cuts

12 Jan

Adam Creighton The Australian January 10, 2018

Forget Labor’s plan to curb negative gearing, the real sledgehammer to property has been wielded by US President Donald Trump, whose tax reforms have kneecapped tax concessions for home buyers. The changes, which hit high-income earners hardest, are to help pay for swingeing cuts to business tax the President signed into law last month.

This style of policy should appeal to the Turnbull government too. It cuts income taxes, makes homes more affordable, and could neutralise the appeal of Labor’s tax plan to limit deductibility of mortgage interest to “new” investment dwellings only. Under the new US rules, whichunlike Australia allow home­buyers, but not investors, to deduct mortgage interest against their wage/salary income, Americans can claim interest deductions on mortgages up to US$750,000 ($955,555) in value, down from US$1.1 million. And these limits won’t be indexed, ensuring they decline in effect by at least 2 per cent a year.

But that’s just the start. By almost doubling the “standard deduction” to US$12,000 — the US, sensibly, doesn’t have a tax-free threshold — there’s little point for most Americans to bother deducting their mortgage interest anyway. A couple, with a joint $US24,000 standard deduction, would need a mortgage of greater than US$600,000 to bother, given 30-year mortgages in the US are typically available for less than 4 per cent interest.

One analysis found 84 per cent of taxpayers will take the standard deduction (rather than “itemising” and summing specific deductions for charity and so on).

Current mortgage holders are grandfathered, but that won’t help the marginal investor, whose decisions are what effects house prices. The US National Association of Realtors, which estimates house prices will fall in every US state by between 5 per cent and 20 per cent, fought the changes hard. “Congressional estimates indicate that only 5-8 per cent of filers will now be eligible to claim these deductions by itemising, meaning there will be no tax differential between renting and owning for more than 90 per cent of taxpayers,” they concluded recently.

Third, the tax reform plan has reduced the maximum deduction for state and local taxes, which are based heavily on property ownership, to $US10,000 as part of a broader tax claim.

Finally, the new personal income tax provisions only last until 2027, when the old tax code springs back to life (including deductibility up to $US1.1m). So there will be an incentive to delay purchase until then, especially as that time draws nearer.

There was appetite for more. The US House of Representatives’ tax plan originally wanted to reduce the maximum mortgage to US$500,000 and limit the capital gains tax exemption only to those who had lived in the property for five years rather than two. The first $US250,000 of capital gains on the “family home” ($US500,000 if married) is exempt from taxation in the US provided such living requirements are met.

Republicans deserve credit for taking the cleaver to one of the great sacred cows of the US tax system. In 1984, then president Ronald Reagan said he “strongly agreed” with the “home mortgage interest deduction, which is so vital to millions of hardworking Americans”. It’s ironic this has happened under Trump, who made his fortune in real estate, a sector heavily dependent on political favours that hasn’t supplied any previous US presidents, perhaps given its higher propensity for corruption.

“Negative gearing” isn’t allowed in the US, where interest costs for investment properties can be written off only against other forms of “passive” income such as rent, dividends —not wages and salaries. The same goes for Britain and most other countries, which separate investment and labour income.

The Coalition has attacked Labor’s negative gearing policy as an assault on aspiration, a harbinger of a housing crash.

These attacks aren’t effective, given wages are stagnant and the number of people with five or more rental properties, for instance, has been rising at about 6.5 per cent a year, or four times as fast as the population. The government might be politically and economically smarter taking a leaf out of the Trump reform book and limit property deductions to fund across-the-board income tax cuts.

Of course, Trump is trimming deductions to lower tax rates. Bill Shorten’s Labor wants to use the additional revenue to increase the rate of spending growth on health and education from fast to even faster.

A property crash is unlikely. Treasury analysis revealed this week argues the impact on house prices would be small. Indeed, in the long run house and apartment prices always go up. That’s because the land they sit on becomes more valuable as the population increases and governments build nearby infrastructure. The value of land is affected by far more than tax rates and concessions: tax systems vary wildly across countries, yet land prices have risen more or less everywhere.

The Treasury memo says Labor’s negative gearing plan would raise $3.4 billion to $3.9bn a year. That’s good enough to make serious tax cuts, including cutting the 32.5 per cent rate to 30 per cent, which would save average earners more than $25 a week.

Now is a good time to phase out negative gearing too, given it’s hard to make a loss because of ultra-low mortgage rates. The number of taxpayers negatively gearing by claiming a net rental loss fell 1.8 per cent to 1.28 million in the 2016 financial year.

And why not consider limiting tax-free capital gains on the “family home” to say $250,000 — just as the US does — if dramatic cuts in income tax were made possible?

It would be good for the economy too. When people are undertaking an activity even partly “for tax reasons”, such as buying investment properties, it’s a distortion of savings. Far better to use savings to build and innovate than buy established houses.

We shouldn’t obsess about home ownership rates. Throughout the developed world home ownership rates soared after World War II. While inflation-adjusted income has increased since the mid-2000s, such rates in the US and Australia have fallen from about 69 per cent in the mid-2000s to around 65 per cent.

What is the natural rate? It’s impossible to know. But it’s hard to imagine a market more artificial than housing. The government and bureaucracy control land use and supply, and affect demand by adjusting credit standards and interest rates.