The Government’s changes to the Stage 3 tax cuts have revealed just how massively the tax system benefits the richest. But what is less discussed is how it also affects the rest of the economy, and never is this more obvious than when it comes to housing.

As Richard Denniss reminded us at the Press Club, step one of reforming the tax system is to ‘do no harm’: “economics 101 says we should tax things we want less of and subsidise things we want more of”. Unfortunately when it comes to housing Australia’s economic policies do great harm.

Australia has hugely expensive tax expenditures which predominantly benefit high-income earners whilst distorting the housing market. A tax expenditure is when, instead of directly spending money on something, the government taxes something at a lower rate. This translates as the government foregoing tax received by allowing people or companies to reduce their tax either through discounts or deductions or by choosing not to tax something (such as placing the GST on private education costs)

The main housing-related tax expenditures are the capital gains tax discount and rental deductions, and capital gains tax main residence exemption.

Capital gains tax is paid when you buy an asset and then later sell it for a profit, the profit you make is taxed as income. The capital gains tax discount means that if you buy an asset (often a house), hold it for 12 months and then sell it, you only pay tax on half the profit you made. For example, if you bought a property for $400,000 and a year later sold it for $500,000, you have made a capital gain of $100,000. The discount means you only have to pay tax on $50,000.

Rental deductions refer to a range of tax concessions, including ‘negative gearing’, which means you can deduct expenses and losses from rental properties from your taxable income – so if the amount of money you receive from renting out a property is less than the amount you pay on the loan you record a rental loss and you are able to use this loss to reduce the amount of taxable income you have. For example, if the taxable income from your job is $130,000 and you made a rental loss on an investment property of $20,000 you would be able to use that loss to reduce your taxable income to just $110,000.

These two tax expenditures are hugely expensive, costing vastly more than all federal spending on housing and community amenities, including transfers to the states and territories, as well as Commonwealth Rent Assistance.

They are also highly regressive, in 2020-21 (the last time this was calculated by the Treasury) the top 10% received nearly $13 billion in benefits from these expenditures, more than the bottom 90% combined. Lastly, as explained by Alan Kohler, capital gains discount and negative gearing combined with Australia’s lack of inheritance tax have turned “property investing from a niche activity into … everybody’s tax avoidance scheme”.

This distorts the housing market because it provides incentives to speculators and tax avoiders that hampers the ability of those looking for a place to live to buy a home.

If Australia wants real tax reform, we could start with reforming these expensive, regressive, and distortionary tax expenditures.