Claim: Negative gearing keeps rent prices low. Treasurer Joe Hockey recently defended the practice of negative gearing investment properties. “If you change negative gearing then there are significant flow-on consequences from people that rent homes and that needs to be properly considered,” he said. “There is a very strong argument that if you were to abolish negative gearing, you would see a significant increase in rents.” Is this true? Economies are complex organisms, with many moving parts, so you need to be careful before attributing change in one variable to change in another. To show one effect was the result of one cause, you need to control for potential omitted variables, or other influences that could have been the real reason. (For example, far fewer people die in the front of ambulances than in the back of them, but the policy solution is not to simply put injured passengers in the driver’s seat). Anecdotally, Australia’s memory of reform to negative gearing is coloured by the experiences of many in the mid-1980s, when the Hawke Government acknowledged negative gearing was driving up property prices and put a national quarantine in place. The results of this decision are typically cited as the reason why the system is working as intended, and cannot be amended without sizeable and costly adjustments. Negative gearing is a national policy that should, if working, have influence nationally. If all local rental markets are uniform and identical in terms of demand and supply, national changes should have uniform, national effects. But between 1985 and 1987, the period Mr. Hockey cites, we did not experience uniform effects. Rents grew quickly in Sydney and Perth, yes, but rents in Melbourne actually fell. This evidence should be cause to re-examine why things occurred as they did. The power of negative gearing to explain why rents rose in Sydney and Perth and not in the rest of the country is weak to non-existent. Thankfully, we have plenty of better explanations. One such explanation – though by no means the only one – is rental vacancy rates. Rental vacancy rates are important to the rental market in the same way that the number of used cars available is important to the used car market: supply and demand. When rental vacancy rates are historically above-trend, there are many landlords with homes available that are not generating an income – in other words, there is no point negative gearing. This pushes prices down and puts a dampener on rent growth in the short-term. In contrast, if there are many would-be tenants competing for a small, insufficient stock of rental properties, then they will bid against each other and raise the market-clearing price of rent in that city. In places where there are not enough rental properties to meet demand, there is the greatest incentive to negatively gear an investment property. This means; For cities with lower than average rental vacancy rates, we should see the highest gains in rental prices after quarantining negative gearing. For cities with rental vacancy rates above or matching their average rates, we should see no effect from quarantining negative gearing. Surprise, surprise, that’s exactly what we see. Prior to the negative gearing quarantine in 1985, both Sydney and Perth’s cities rental vacancy rates were incredibly low (in Sydney’s case, barely above 1 per cent). Perth had a rental vacancy rate of 1.4 per cent the year negative gearing was quarantined, down from 6.6 per cent six years earlier. In contrast, Brisbane had a rental vacancy rate of 3.9 per cent, which had been stable around four per cent for seven years. Melbourne’s rental vacancy rate was also stable at 1.9 per cent in 1985-86, which was higher than six years earlier. It is for this reason that the Hawke Government’s 1987 cabinet papers attribute the rent increases following the negative gearing quarantine in Sydney and Perth to “local influences rather than tax measures dominate in metropolitan rental markets”. The table below summarises the results: It’s worth mentioning that, in the period preceding the negative gearing quarantine, the presence of shortages of rental properties is evidence that the very purpose of the policy – namely, to stimulate supply of rental properties – was not being achieved. Today, little has changed to require us to reevaluate the merits of this costly and inefficient program. In June 2013, only 5 per cent of investment in housing was dedicated to constructing new dwellings. Vacancy rates are historically low. What did not work in 1985 is not working in 2015.