Tax Rules Drive Property Speculation and Housing Affordability Crisis
A comprehensive new report from the e61 Institute has uncovered how Australia's capital gains tax discount and negative gearing rules have artificially incentivised debt-fuelled property speculation, contributing significantly to rising house prices and a deepening housing affordability crisis. The analysis, which scrutinised hundreds of thousands of property transactions, reveals that these tax settings have created an extra artificial incentive for landlords to maximise borrowing against investment properties.
Distorted Investor Behaviour and Increased Leverage
Economist Nick Garvin, co-author of the report with Matt Nolan, explained that the current tax framework creates a disparity between how investment gains are taxed and how losses on interest costs are treated. Landlords can deduct all interest expenses from their incomes while only paying tax on 50% of capital gains for properties held over a year. This differential treatment means net rental losses are often outweighed by eventual sales profits, encouraging higher leverage.
The report found that among 900,000 investments purchased after 2007 and sold by mid-2025, approximately 46,000 were economically unprofitable but still generated returns due to the capital gains tax discount. The tax rules reduced the probability of an investment being unprofitable from 40% to 35%, a reduction of 5.1 percentage points or 13%.
Impact on Tax Rates and Housing Prices
The analysis demonstrated a clear correlation between leverage and tax rates. For investment properties with no debt, the typical tax on returns was 31%. However, this rate dropped progressively to 18.5% for properties with a 90% loan-to-value ratio, despite these highly leveraged investments yielding substantially higher pre-tax profits. In essence, the more investors borrow, the higher their profits and the lower their effective tax rate.
Garvin emphasised that this wedge between tax on asset-side gains and deductions for liability-side losses has distorted investor behaviour, boosting demand for housing and putting upward pressure on prices. While quantifying the exact impact on housing prices is challenging, the report suggests this has almost certainly exacerbated affordability issues for regular Australians.
Calls for Reform and Policy Implications
The e61 Institute advocates for an inflation-linked discount on capital gains or equal tax treatment of debt expenses and capital gains to remove the bias towards excessive borrowing. A Greens-led parliamentary inquiry recently concluded that the 50% discount skews housing ownership away from owner-occupiers and towards investors. Treasury is currently modelling potential changes, including reducing the discount to 33% for housing investors while maintaining current rates for shares and other assets, and possibly limiting negative gearing per investor.
Garvin highlighted that the design of the discount itself, rather than just the rate, is a key driver of the issue. As the federal budget approaches, with expected adjustments to tax breaks for investors, this report underscores the urgent need for reforms to rebalance the tax system and alleviate pressure on the housing market.
