This article first appeared on The Guardian website at this link: https://www.theguardian.com/commentisfree/2016/feb/19/labors-negative-gearing-reform-proposal-is-economically-responsible-and-fair 

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Labor’s negative gearing reform proposal is economically responsible and fair

Labor’s reform proposal for negative gearing is well founded in fairness and economics. But like most reforms, particularly ones which remove a well-entrenched and significant market distortion, there are likely to be some consequences for the housing market and the economy as the reforms take effect.

The policy proposal would restrict negative gearing to investment in new dwellings from 1 July 2017, if Labor wins the election. Given the policy has now been well telegraphed and will take effect about nine months after the election, there will be a temptation for some investors to bring forward their purchase so they have an established dwelling in their property portfolio that is negatively geared.

This would likely force up the price of established dwellings. Louis Christopher, director of SQM Research, thinks there is a risk of a surge in investor demand for existing property as they scramble to take advantage of the grandfathering provisions. What happens after that is also important and Christopher notes that after 1 July 2017, “a subsequent slump could occur via the drop off in demand from investors”. Of course, this assumes several issues which will have to be clarified if the proposal becomes law.

Importantly, for a significant bring-forward to occur, the banks would have to remain enthusiastic providers of capital for investors. If the banks don’t play that game, the price impact would be muted. Add to that some probable guidance from regulators to the banks on their lending for investment properties and it is possible if not probable that credit would not be easily forthcoming. The banks already take a more cautious approach to lending than they did prior to the GFC, partly of their own accord and partly from the lending guidelines already in place.

The other aim of the policy is to direct investment dollars into the construction of new dwellings. The hope is this would make houses more affordable and end the phenomenon where investors bid up the price of existing dwellings, squeezing first-home buyers out of the market.

After 1 July 2017, Christopher reckons there will likely be a surge in demand for new properties.

After all, negative gearing will remain in place, but as noted, only for new dwellings. It is likely this fresh and previously untapped demand for new properties will underpin more construction. The share price of several construction companies, Boral and CSR for example, are up around 10% since Labor announced their plan. The reform could therefore boost GDP, at the margin, as the dwelling supply builds over time. If Christopher is correct, there could be financial risks for investors who do bring forward their purchase of established dwellings. If there is enough of a herd approach to “beat the change” and the price of established dwellings gets a boost, investors risk paying an artificially high price.

The risk comes after the rule change when demand for established dwellings from investors falls away sharply, as the tax distortion ends. Prices could be dampened but other issues such as interest rates, the overall health of the economy, unemployment and wages will have an influence on prices over and above this change.

For those looking to get into the property market and who have been held back by high prices, the reforms are good news with a pipeline of new supply likely to flow over time. Housing is like most other markets – extra supply relative to demand will dampen prices which, for housing, means improved affordability.

The proposed changes to negative gearing rules are economically responsible and fair. It is the sort of policy change that has been needed for many decades and the good news is it probably means the risks for house price booms in the future are greatly diminished and housing affordability, in time, will improve and home ownership rates, which have been falling, should again pick up.

It also means $30bn is available to the budget bottom line over the next decade which at the moment is something much needed in the quest to deliver a budget surplus.