Saul Eslake on Fixing Housing Without Hurting Investors

We spend a lot of time on this show stress testing advice from people with a financial stake in the outcome. So it's worth being honest when we're the ones with skin in the game. The government's proposed changes to negative gearing and the CGT discount are bad for property investors.

We've said that clearly and we stand by it. But we've also largely been hearing that argument made by buyers, agents, accountants and mortgage brokers whose business models depend on investors staying active in the market.

Saul Eslake is an independent economist who has been arguing for these reforms for years, and his recent Senate submission presented, as expected, a rigorous case. He's looking at this through a very different lens than we are.

Productivity data, distributional equity, the long run effects of the 1999 CGT changes, and the honest truth is that our expertise in the property market doesn't automatically give us a view on a lot of these questions. Today, we're going to let him make the strongest version of the case, push back

where we think the property market consequences are being underweighted and see where that leaves us. Welcome to the elephant in the room. This is the podcast where we love to talk about the big things in property that never usually get talked about.

I'm Veronica Morgan, real estate agent, buyer's agent and buyer's agent mentor, co-host of Foxtel's Location Location Location Australia, author of Auction Ready and co-host of Your First Home Buyer Guide.

Hi, I'm Chris Bates, ex-financial planner and mortgage broker, currently ranked number three in the annual MPA Top 100 Mortgage Broker Awards. Before we get started, everything we talk about today is not personal advice, and we recommend you engage the services of a licensed and experienced professional.

So Saul, it is great to see you again. It's been a while since we've met. We always respect you and what you say and the work that you do, but we know we're sort of on opposite sides of the fence here.

So I think it's a great conversation that we expect to have today with you. Thanks for joining us. Thank you for having me, especially given that you think our views may diverge on some of the questions we're going to talk about.

Not everyone with different views is as open-minded and respectful as you always are. Thank you.

Yeah, absolutely. I think that's... And to be honest, I'm not sure what I'm feeling, to be honest. I'm all over the place with it all. I'm trying to, you know, understand the society, individuals' needs, current people in the market, future buyers, you know, from a property point of view.

I mean, your sort of take, I mean, obviously you went to the Senate committee yesterday or you were part of it. Obviously, there's another one today. By the time this is released, a lot will be sort of...

But your sort of overall take, you know, with the policy and what the government sort of tried to or has released on budget night, you know, is it right? Is there anything that you think that they've missed? Is there anything that you would prefer they changed? And or you just really...

gung-ho and believe in what they're doing? Well, no, I wouldn't describe myself as gung-ho. Some others may, and that's up to them.

But let me start by making an observation I didn't make yesterday, which is that I'm interested in good public policy, what I think is good for the nation and a majority of its people as a whole.

So, for example, I will be adversely affected by the government's proposal to tax discretionary trusts.

at a minimum rate of 30%, because since I stopped working for banks 11 years ago, I've run my business through a trust and a company, which allows me and my family to pay less tax than we otherwise would. Despite the fact that that will make me worse off,

I nonetheless think it's the right thing to do. I think there's a fundamental question which I began my remarks to the Senate committee in Canberra this week with, which is why should people earning the same income

be asked to make different contributions to the cost of providing services by paying tax on that income at different rates because they have earned it in different ways or to personalize it.

Assuming for the sake of this argument that I'm earning the same money as I used to when I worked for Merrill Lynch, which let me assure you I'm not, why should I pay less tax on that

because I can now run it through a trust and a company than I would have had to when I was being paid a salary by Merrill Lynch. And that's what the questions that what the reforms that the government has instituted are seeking to address. Now,

As I said to the committee, I don't dogmatically believe that there are no circumstances in which some types of income should be treated differently by the tax system from others.

It's legitimate to use the income tax system to encourage some kinds of economic behaviour and discourage others, just as we used indirect taxes, for example, to discourage smoking and the excessive consumption of alcohol.

To take one thing that I think is pretty simple, I think it's appropriate that the income tax system provide incentives for people to save for their retirement, which it does through the very generous taxation treatment of savings through superannuation funds.

The government has decided that it wants to continue to provide incentives for investment in new houses and apartments. And I support that because clearly we need more supply of houses and apartments.

And I think there is a case, and this is one area where I did encourage the committee to think about modifications to the government proposal. I think there is a legitimate public policy interest in encouraging startups.

And the problem there with the government's proposal is that indexation of the cost base for inflation, which is the model they want to reintroduce, doesn't work for assets whose initial cost base is zero, because indexing zero still leaves you with zero.

So my message to the Senate committee was that they should consider some kind of carve out, possibly similar to what they've offered for investors in new builds to provide an appropriate incentive for investment in startup businesses. On the other hand, given the plethora

of tax concessions that small businesses already enjoy. And let's lift them off. They pay 5% less in company tax than larger companies. They get concessions on capital gains tax if their turnover is less than $2 million and their assets are less than, I think, $10 million.

And yes, those figures haven't been indexed for a long time, but neither have the thresholds that apply to wages and salaries as they're taxed. The top tax threshold has only been increased once by $10,000 since it was set at $180,000 way back in 2008.

If that had been indexed, it would have been something like $280,000 today rather than $190,000. So small business is hardly being penalised by comparison with others because that threshold hasn't been indexed. Small businesses have been able to use trusts to reduce their taxes.

I said I've been able to do. They don't pay payroll tax and they're exempt from a whole lot of regulations that bigger businesses have to comply with.

As I said to the Senate this week in response to a question, one thing small businesses are really good at is not paying the tax that they're meant to.

The tax office runs a project each year, which they call tax gap, which tries to measure the amount of tax that they don't collect under all of the taxes that they administer because of noncompliance with the tax law and what the most recent

installment of the Tax Gap Project shows is that in 2022-23, 53% of the personal and corporate income tax that the ATO did not collect because of non-compliance was not collected from small business. And that's a much bigger share.

than the tax which the ATO doesn't collect because of non-compliance by large corporates or high net worth individuals. That's in part, of course, because the tax office puts a lot more resources into ensuring that large corporates and rich folk comply with the tax law, and it doesn't put as much effort into

ensuring that the much larger number of small businesses pay the tax that they're meant to. But that's something the small business is very good at. So I'm not in favour of any more concessions for small business just because they're small.

I think there is a legitimate case for some concessions for new businesses, because in contrast to the vast mass of small businesses, new businesses do tend to innovate. they do tend to create employment and invest.

And particularly, there's nothing a new business can do to stop itself from eventually becoming an old business and thus no longer eligible for the preferential tax treatment.

Whereas there's a lot of evidence to suggest that small businesses choose to stop growing just below the point at which they cease to be defined as small businesses for the purpose of being eligible for tax concessions.

So in that sense, I don't buy any of the arguments that are being put by purported representatives of small business, but the measures are unfair to them.

And in particular, I don't buy the argument that's been put by some that the changes to the capital gains tax regime and negative gearing should only apply to investors in housing. That's what happened between 85 and 87.

And one of the arguments that was used by real estate interests back then to get the original decision to abolish negative gearing reversed, which they succeeded in doing, was that change was unfair to property investors because they were the only ones who couldn't get negative gearing.

I'm sure that if the government succumbed to pressure to confine the changes it's wanting to make to investors in housing,

Just go on the, I mean, I sort of get you say carve out for startups, but no change to small business. Potentially they do a 50% discount or something for startups because, you know, they're investing, they're employing, they're growing, they're taking risks, they're investing, no cost base.

So for the share investing, you know, when someone, you know, is buying some shares and then they lose some money and then the losses, you know, should those losses get indexed? Because I don't think they do. Is there anything that like...

flaws with this model where, you know, potentially you take less risk because you're going to pay more gains if you, you know, and so you end up buying more index funds, you sort of like longer term investing, a lot of share investing and active management, spying and selling.

Is there any concerns with this? Well, I think people who are active investors, share market investors, that is buying and selling stocks in relatively high quantities every year. That's a form of income, right?

I mean, what's the difference between income that comes in that way and income that you get from working at a job which pays you a wage and salary?

I can't see any reason why people who make their income in that way should pay less tax on a given amount of income than people who earn a wage and salary, who, after all, are taking the risk that they might get sacked.

which can happen when you're in an employee, whether it's a big company or a large one, I don't see any argument for special treatment for that.

But the other point, Chris and Veronica, that I'd like to make about this that doesn't seem to have been well appreciated is that the shift from the 50% discount applied to nominal gains, that's been the rule since 1999,

to tax at full rates on real gains, which is what we had between 85 and 99 and what the government wants us to go back to, has actually been worse for investors in shares

What I mean by that is that as a matter of arithmetic, taxing nominal gains at half the marginal rate only results in investors paying less tax than the cost-based indexation system if the capital gain is more than double the inflation rate.

And as a matter of fact, although this wasn't necessarily the intention when the change was made, over the 26 years since that change was made, house prices in capital cities have risen at an average annual rate of 7.5%, which is more than double the inflation rate that's averaged 2.9%.

So investors in houses have benefited from the change to the CGT regime in 1999. But units have only risen at an average annual rate of 4.5%.

And shares, as measured by the All Ords Index, have only risen at an average annual rate of 4%. So investors in units and in shares would actually have been better off after tax if the system hadn't changed.

Now, as they always say in the fine print under financial products, past performance is no guarantee of future returns. Who knows whether shares will continue to underperform property? Probably not, given the changes that have been made.

But the point is that the change that's being proposed isn't necessarily going to make investors worse off, as is being alleged by those who don't want to pay more tax on their particular forms of income.

The other categories that have benefited apart from houses have been things like gold, Bitcoin, ETFs based on US shares. And it's not obvious to me that there is any Australian public policy interest served

by incentivizing people to buy Bitcoin or gold or SpaceX and other US listed shares. I mean, what we want incentives for people to invest in, I think, would be in adding to the supply of housing

Rather than just bidding up the price of the housing we've already got, which is where 80% of the money that's borrowed for housing investment currently goes into bidding up the price of housing that already exists.

We want more investment in new housing, and it would be a good thing to have more investment in startup businesses for the reasons that we've all agreed make sense.

So I've got a few things there I'd love to sort of pull apart. For starters, with the capital gains tax discount, I've long believed, even though it was also against my own personal interest here, that that's been too high.

Because it is, you know, it was set up to simplify things and it was set up to sort of... replace, if you like, that calculation or the indexation for inflation back in 1999. And our inflation has not been as high as it was back then, since then, correct?

So therefore, it was set up in an environment that is different to what has transpired. And I was saying that back in 2019, when Bill Shorten won the unlosable election. Thank you for explaining it that way as well, because I think that people don't understand that they're not necessarily automatically worse off.

I think that it's good for them to understand. But again, it's not simple. It's not as simple as going, well, okay, well, if I'm going to make 100 grand, I only pay tax on 50 grand.

That's very easy to calculate, whereas the indexing is very complicated and people are finding it difficult to sort of extrapolate that and basically planning around that. And I think the equalisation of income and interest rates, sorry, the income tax on income, I think that is fair, absolutely fair.

And I think what you're talking about is within the start-up community, if you want to call it that, the risk that they're taking, there's been no sort of incentive built into this budget for that, to account for that.

I will take a little bit of umbrage on the small business thing, only because I know as a small business owner who does pay my tax, I do pay my tax, um, If I'm not doing well, who pays my super?

Who pays my salary while I'm paying the salary and the super of all my staff? And there's been periods of time in my business where I haven't paid myself, you know, and I have been employing other people. And there's no fallback for that risk for small business owners.

But I'm saddened, and I looked at your charts too that you presented to the Senate committee, and I'm saddened to see that high degree of noncompliance on tax.

So let's talk about supply, though, because we've interviewed a number of people on this podcast who are in that space. In fact, just yesterday, we interviewed a town planner. That episode will come out maybe one or two weeks before this one.

And we're talking about New South Wales, for example, where he's saying that there's 100,000 dwellings that are approved in New South Wales, but they are not being built yet. And there's lots of reasons for them not being built.

And, you know, having investors willing to buy them is maybe one reason that you might add into why you would get this supply being built. We've also got a shortage of trades because we've got a lot of infrastructure projects, we've got an Olympics going on in Queensland.

So the capacity to build is constrained. What do you say to that? Like, how does this budget... sort of translate smoothly into making a meaningful difference with supply.

And then just one more thing before that, the Australian Institute came out with an article that I thought was ridiculous a couple of months ago, and it was talking about the fact that actually we've got more dwellings than we need anyway, that dwelling commencements and incompletions in Australia has actually outstripped population growth anyway.

It's just it's all in the wrong spot. Right. Their article wasn't about that, but their article was, you know, the investors are basically greedy and they're holding onto stock and that's why there's a supply problem. So clearly the supply is there, but it might not necessarily be where it's needed.

So how does this budget solve that? Well, the first point I'd make is that the changes to tax that were proposed in the budget aren't really intended to do anything about housing supply.

They are intended, although the government hasn't explicitly said this, to reduce the demand for housing, for established housing, from existing investors. You know, in a sense, and I do say this sometimes in interviews, that

when Angus Taylor and Tim Wilson say that if you tax something more, you will get less of it, they're right. But in this particular context, it means we will get less investment in established dwellings. Well, I would say that's a good thing because it doesn't serve any useful public policy purpose.

Number one, puts upward pressure on the prices of houses we've already got. But number two, and this has been understated, every time an investor says, succeeds in buying an established property, by definition, he or she is outbidding someone who was trying to buy it in order to live in it themselves.

And so they pat themselves on the back and say, I'm adding to the supply of rental housing by buying an existing dwelling and therefore I should get a tax break without, it seems, stopping to think that they're also adding to the demand for rental housing by by exactly the same amount.

Whereas if an investor buys a new dwelling, then that is genuinely adding both to the total stock of housing and to the stock of rental housing. And that investor should get some kind of tax incentive, which they will because they're continuing to get negative gearing and the CGT discount.

And it's possible, it's not guaranteed. And in fact, Treasury doesn't predict this. It's possible that having that distinction now between investment in established properties, which is where I said 80% or more of the money that's lent for investors. Yeah, that's a case stacker.

But retaining to that might actually skew investment towards new dwellings. No, it may not, because investors will also be conscious that if they invest in a new dwelling, when they come to sell it, it won't be a new dwelling. And so there won't be anyone who can get those...

So, you know, I'm not saying that that will definitely happen. I'm just saying it's a possibility that it will. And, you know, hopefully, even if, say,

investors switched from putting 80% of the money they borrow into established housing to say 60% so that the share going to new housing went up from less than 20 to about 40, that might help increase housing supply. But to go back to your other question, what is the budget doing?

I'm not here to spruik on behalf of the government, but they would say, they have said, the budget papers said that other measures that they are taking, including giving money to the states to speed up the development of the infrastructure that's required to support new housing estates,

will lead to an extra 65 000 dwellings being built and that's on top of some other measures that they have announced to sell up to a hundred thousand homes to first home buyers on disused government land and whatever the national australia housing for future fund ends up doing which so far has not been very much but the the primary responsibilities for speeding up housing supply

and reducing the obstacles that you referred to that developers face in bringing new product to the market. That's up to state and local governments to fix. The federal government doesn't have much power in this field except to bribe the states to do what they should be doing anyway.

And the federal government is doing that on a small scale. But really, the pressure ought to be on state and local governments. to be removing these roadblocks and the red tape and the excessive charges that fall on people who are doing new builds.

And that's where the focus ought to be when it comes to matters of housing supply.

I do like how you've answered that, because you change the incentive, you do change the behavior. And I think the more that I've done digging into it, I mean, investor lending's gone for about 20 bill to 45 bill, you know, rolling quarters.

It's gone from, you know, 40% plus in some markets, well over 40% of new lending's been going to investors. It's been typically 600 to 700,000 where the affordable, where a lot of first-time buyers have been buying, And so it's priced out the next generation.

So there's, you know, I mean, a frustrating thing is they're doing it post-election, not pre-election. But when you look at all the stats, you know, prices have gone up enormously since 2019 when they had that, you know, back in the election. First home buyers are getting put into it.

Investor lending is out of control. You know, the buyers agency industry. So you can see why they had to do it. There are going to be some unintended consequences.

consequences there are going to be the winners and there's going to be losers right and so when you think about those losers in society like what do you see rental displacement you know do you see investors that got signed up into investor hot spots or high density apartments that are investment driven and not owner there's going to be people that

You know, you know, households every day, you know, Australians that, you know, are going to have to take a hit here. Like where, in a property sense, where do you think they're going to be? Obviously there's winners, you know, maybe first time buyers coming in. Yep. Potentially if they buy well.

Yeah, they're good questions. Let me make a couple of points on it.

I presented data to the Senate committee this week and I've used it in other presentations I've given on this topic before and they're all on my website and on my LinkedIn page that show that overwhelmingly the people who have benefited from the tax breaks that will be altered by the measures that are in this budget are A,

better off than the vast majority of Australians and B, older Australians. So one simple statistic I like to use is that while people in the top tax bracket represent about five and a quarter percent of all taxpayers,

they represent a much bigger proportion of the people who have negatively geared property investments.

Can I just check on that? Yes. Because my understanding is the dollar value that goes to the high income earners is greater. And of course it is because A, they pay the most amount of tax. But actually the number of people using negative gearing is much higher in lower income brackets.

Well, of course it is for two reasons. One, because there is a vastly greater number of people in the bottom income who are not in the top tax bracket. They are almost 95% of all taxpayers.

So inevitably, the number of people doing almost anything is going to be bigger in that group than in the... But isn't that important? No. Isn't that important? No, I don't think it is. The thing that I think he's telling, Veronica, is that if you are in the top tax bracket...

you are more than three times as likely to be a negatively geared property investor as if you are not in the top tax brackets. But you can still do that because you probably already own a property portfolio, which is giving you income.

And so then you can still go out there and negatively gear because you can offset that against the income from the property that you've already got because you benefited from this system that no longer is available to first homebuyers who want to rent first, for example.

Well, yeah, okay, but the number of first-time buyers who are rent-vesting is tiny. It's roughly 5%. So last year, that's sort of roughly a bit over 6%. That's a tiny number. That's a tiny number. Hang on.

So is the government's claim that this is going to bring 7,500 new home buyers over 10 years. That's 7,500 a year. So if, say, 6,500 are actually being rent-vesting to get into the market, that's a difference of only 1,000, right?

But why should people who choose to save up for a deposit by rent-vesting pay less tax on what they make than people who save up for a deposit in the traditional way by putting money in the financial institution that they hope will lend them a mortgage.

I'm not talking about capital gains tax discount here. I'm talking about negative gearing. I'm talking about for first-time buyers who need to, particularly in an expensive city such as Sydney, where they need to use the opportunity to rent first and they need to access negative gearing in order to get into the market.

And then now they actually don't have that opportunity at all. But Veronica, negative gearing only works. It only makes sense. It only helps you raise a deposit if you have a capital gain at the end of it, right? Because if you don't have a capital gain, then you're actually giving money away, right?

But the point is, therefore, you have to talk about the tax treatment of capital gains if you're going to be saying, if you're going to be talking about rent vesting, it makes no sense unless you get a capital gain. Agreed.

So my question then is, why should someone who chooses to save up for a deposit by rent vesting pay less tax on whatever they make by doing that than someone who saves up for a deposit by putting money in the bank or building society that they hope will grant them a mortgage when they've saved up enough of a deposit?

That's unfair, surely, isn't it? Have you done the numbers then to say that if somebody was to negatively gear on an investment property and with indexation in place, when they go to sell that, they use the indexation model in order to pay tax.

Have you done modeling to show that that just does not stack up? Well, it depends on whether the property they've reinvested in has risen in value by more than double the inflation rate. And if it has risen by more than double the inflation rate, then they will pay less tax

than someone who has built up a deposit by saving in a bank and earned interest. And my question is, why should one type of first home buyer saving up for a deposit pay less tax than another one who saved exactly the same amount of money in a different way?

But they might not pay this tax. That's the thing.

If we go forward 10 years, right, like I get these, I mean, I'm not that, personally, I'm not that bother-bother investor thing.

I think that's a, it's a good marketing tool that a lot of buyers agents, not you, Veronica, but the industry has been using to sell to people who potentially should buy a home, don't buy a home, buy a property elsewhere. And I think it's been a spruiking tactic. And I agree with that.

If you think 10 years time, you change this, it's a big change, right? These aren't little changes. Yeah. What will be the shift in overall, you know, 11 million households, what will they do? Will they pump as much money as they can into super? That makes sense.

Make sure you use your concessional limits. Make, particularly as you get close to retirement, because obviously it's tax-free. I mean, people are doing that anyway, but it's good for the super industry. They'll massively be incentive to upgrade their home. So while we wouldn't put our extra equity into investment properties,

We'll massively go into home because it grows tax-free and we'll find the lifestyle benefit from it. So you'll create a lot more homeowner. So housing prices will probably go up faster than they would under the old system. Do you buy shares, individual companies?

I don't know because outside of super, if I make some money and it goes up, I mean, I might buy an index fund. Yeah, hold it for 10, 20 years. That's fine.

But like, do I buy a stock or a young company that I think is going to go places when I know that if I lose money, I can't index my losses? So I feel like that, you know, in your coming 10 years time, you're like, oh, didn't really expect this.

But house prices went up a lot more than I expected. Not all, but you create this two-tier system. What are some of the unintended consequences you think that we're going to then have to correct for down the line?

Well, let me first say I don't give investment advice and I don't want to be doing that unintentionally by the way I answer your question. The second thing I'd say is I don't know.

And I have never been able to predict, I don't pretend to be able to predict, whether share prices are going to go up by more over the next 10 years than house prices are going to do.

My guess is they're all low over the last 25, in fact, over the last 40 years, house prices have risen at a faster rate than share prices. I think an important part of that has been the growing presence of investors in the property market.

and the tax changes will probably push in the other direction. So there is a chance that house prices will rise at a slower rate than shares, and we may see some investment, perhaps a lot of investment, redirected away from existing properties towards shares and other assets.

That might not be a bad thing if it enables companies to raise capital, which they can then use for productive investment, more than they have been able to.

And in particular, if the investment is directed towards Australian companies rather than SpaceX and Anthropic and US-based companies or a Bitcoin or gold, then there may well be, I'm not saying there absolutely will be, but there may well be benefits for the Australian economy.

I mean, the interesting thing, and again, this is something I said to the Senate committee this week,

is that when the change to the CGT regime was being proposed in 1999, it was in response to a recommendation from the review of business taxation chaired by John Ralph, who at the time was CEO of CRA and later went on to be head of the Commonwealth Bank, one of Australia's most distinguished business leaders at the time.

But he said that these changes would turn Australia into a nation of entrepreneurs and shareholders.

Well, he was wrong because after that change, the proportion of Australians who were direct investors in shares has gone down and the proportion of the employed workforce who are owners and managers of their own businesses, that is to say entrepreneurs, has fallen by more than five percentage points. It didn't work.

What he did do was turn us into even more of a nation of leveraged property speculators than we already were. So, you know, maybe... I'm not necessarily predicting this because there are obviously lots of other factors involved in all of these changes.

But maybe to removing some of the incentives that the tax system has provided for speculation on tax,

gains in properties we've already got, maybe removing some of those incentives might actually achieve what we didn't achieve as a result of the changes made in 1999, which is having more people starting up their own businesses if the government does the right thing by startups and more people owning shares.

that might be a good thing. Yeah. I think there's some people in the, some housing markets, housing and invest apartments are a bit different. And some housing markets, particularly in capital cities have gone past the point of any investors ever buying in them.

And you know, 99% of buyers in them are owner occupiers and every year the owner occupier rates getting bigger. And so you'd argue that maybe they're making investment returns elsewhere and they're putting that back into those housing. Like they're buying properties, they're making wealth and that's giving them the cash. Yeah.

So that could be true, but a lot of them are just owner occupiers upgrading and they're not sort of investor gains. I guess that's my sort of concern. I think also my other concern is the rental market. There's homelessness. We haven't built social housing.

We haven't built affordable housing for a long time. We've relied on the mom and dad investor to provide this rental stock. And all of a sudden, the people who buy the property often aren't the ones who are renting the property.

And so every year, I do feel that this rental pool is going to get tighter. Yes, there's going to be the winners, the first-time buyers, but vacancy rates are already where they are. Rental prices have already gone up a lot. Like, I just wonder, like... It already is hard enough to rent.

If you get kicked out of your rental and you're not, let's say 40% of the population have got maybe 20 grand in the bank account, if that, like they're running it pretty tight. And I just wonder if there's like a displacement, a homelessness issue, there's a transition.

And what do you think about all that, I guess? Well, I think you've raised some really important points, Chris, and let me try and do justice to them.

Number one, absolutely, governments have abrogated their responsibilities to provide social housing for people who would never be able to make it in the private rental market.

And that's been a failure by governments of both political persuasions at the federal and state level. And, you know, forgive the cynicism, but I've long believed that that's because both sides of politics perceive there are no votes in it.

That is to say, social housing, when it has been built, has usually been built in very safe labor electorates. So the Libs think there's not much point in spending money on them because they're never going to vote for us.

And the Labor Party thinks that there's not much point in spending money on it because they're always going to vote for us. And so they spend their housing budget on first homeowner grants and things like that, which of course are predominantly located in marginal electorates.

So, you know, I mean, in 45 years of trying to understand and predict what politicians will do, I've never found that cynicism about their motives has been a source of error. And so, you know, that's an important thing is that governments need to do more.

to provide social housing. The second thing I'd note is precisely because Australia is unusual among developed countries in that the rental housing stock is predominantly owned by what you like to call mum and dad investors, right?

In most other developed countries, the rental housing stock is owned by some combination of government authorities, charities, and companies specifically set up for the purpose of owning and managing rental housing. That's a model in the US and Canada in particular.

Now, the thing you need to know about those three things, that is government authorities, charities, and companies set up to own and manage rental housing is that they don't vote.

They're not on the electoral roll, whereas the mums and dads who own the rental housing stock in Australia do vote, and they vote against governments that want to introduce legislation that gives tenants better rights and protections.

That's why tenants in Australia have fewer rights to have pets, to put pictures on their wall, to have notice cards. of a reasonable time before they're evicted than they do in most other countries because that sort of thing costs votes and politicians know it.

Well, they've been putting a lot of legislation through in the States and certainly Victoria and New South Wales in particular have been putting a lot of that to redress that situation. I'm not... You're not criticising it? No, I'm not. But this is what I'm seeing.

And, you know, you've talked about the governments for decades now have stopped investment in social housing and affordable housing. And then they sort of seem to be attacking the mum and dad investor that's done the job in the meantime.

And yet, let's face it, they needed the tax incentive to do so because why would you do it otherwise? Right. But what I'm saying there, Veronica, is that all these mums and dads and we, I mean, this is why people say mums and dads, because who could be against mums and dads?

Well, it's also 72% of the investor population are only one investment property. So it's not institutionalised. I mean, most of the people who break the speed limit are mums and dads too.

Just because mums and, of course, people who break the speed limit and are trying to get ahead of the car in front of them.

Boom, boom. So whenever I hear people saying they're just mums and dads trying to get ahead, I always ask, well, a whom have they – a head of whom – No, my question wasn't around that. My question is, what about the stopgap?

You know, the government says it's all well and good to go, right, okay, no more investing in property, mums and dads.

We are not dovetailing this with an increase in investment. I mean, yes, there's an increase and whatever, but you're not actually fixing the problem with supply of affordable and social rental stock at the bottom of this, of the pile, if you want to call it that.

So there's this... It doesn't appear to be a managed exit. Put it that way. It appears that... Mum and dad investors are being shoved out of the markets and also it hasn't seemed to bother the state governments in terms of losing votes.

They're still pushing through a lot of very, very tough legislation for landlords and also for property managers, actually, incidentally. So let's unpick something. To reiterate, most of those mums and dads have bought properties that already exist. rather than new ones. Right.

So they haven't added to the stock of housing. What they have done is convert housing from what might otherwise have been lived in by owner-occupiers to housing that's lived in by renters. In other words, they have- Oh, hang on. Wait, wait, wait.

You can't just automatically assume that every investor has bought a house from an owner-occupier. No, not from-

But when an investor buys a property, they might be outbidding another investor, but ultimately they are taking a home that if investors weren't buying it, would be bought by an owner-occupier.

And so they are adding to the demand for rental housing by exactly the same amount as they are adding to the supply. Hang on a minute. Hang on a minute. You know that the compositional, so the household formation of rental properties is higher than it is for owner-occupier properties. Yes.

And so there is a number that's different, you know, and I wish I could pluck it out of the air. But if it's, say, it's four person per rental property per average and, you know, 3.6 per owner-occupier property per average, there's a differential there. So that is actually real.

And not every homebuyer is actually moving out of a rental property either. Some are moving out of mums and dads, yes. And there's a difference in stock.

The rental properties that are being sold, for example, there's a lot of the larger homes that are being sold out of the rental market and new investors coming in aren't buying that same type of property. And I agree, they are competing with first home buyers.

And that is actually a real benefit to first home buyers as a result of this budget announcement. So that's a good thing. But compositionally in terms of the rental market, it's a lot more nuanced than is being discussed.

It really is not as simple as one property gone from the rental pool, one property into their own occupied pool. Okay. So we've agreed that governments need to do more to invest in social housing. Governments...

also ought to provide incentives to investors to invest in new housing, which this budget seeks to do. It remains to be seen how effective it will be, but that's what they're trying to do.

The government has also been trying to encourage super funds and foreign companies with expertise in building and managing rental housing to invest in housing. And they are more likely to have the capacity to manage housing that's more suitable for people on low incomes.

Really? Yes. Yes, because they've had experience in doing it. But the bill-to-rent sector is really pitching at a much higher price point. And the super funds, I mean, look, I wish I could, again, I wish I could point to exactly where I got this information from.

But my understanding is super funds are saying that that's not their space. They might go in the higher end, but the returns for investors is not that great at the lower end. So if they are at the higher end, that will free up some existing stock to go for the lower end?

I mean, one of the reasons that people on lower incomes who are renters have been squeezed – is because there's now a much bigger cohort of people who 30 years ago would have been able to buy their own homes, but haven't been able to because of the deterioration in housing affordability.

People on, say, around or just below middle incomes 40 years ago, they would have been able to buy their own homes. They can't now, so they have to rent. They can afford to pay higher rents, which landlords know.

And so they have squeezed out the people who both 40 years ago and today would never have much chance of being able to be homeowners. So if you do get some more supply at that higher end of rent, then that will free up some of the existing stock for lower.

But what I'm also would want to get across here is that the government can provide incentives to some of these specialised larger investors to invest in social housing stock by providing ongoing subsidies for it.

Remember the scheme NRES that was introduced by the Rudd government the last of 10 years that provided incentives to so-called mum and dad investors to invest in housing that would be rented at below market rents.

um you know for for people who qualified for that now that scheme ran out because the coalition government didn't want to extend it they didn't like it and the coalition is for i think ideological reasons opposed to superannuation funds moving into the rental the build to rent market and senator bragg the housing uh the coalition's housing spokesman

He also, despite the coalition usually being fairly welcome of foreign investment, is running a campaign against foreign build-to-rent companies.

But the point is that part of what the government could do to meet its obligations to provide more social housing would be to provide subsidies to companies that have expertise in large scale.

rental housing developments to allocate a proportion of those developments for people who are on low incomes or who have particular special needs so that they can be accommodated in those places as well.

And so what I'm suggesting here is something that governments aren't doing at the moment, but which they should consider doing in order to address this particular problem that the market on its own is never going to solve. But we have community housing providers in that space, right? Yes, we do. We do.

And I used to be on the board of one of those.

But those community housing providers are dependent on ongoing subsidies from the federal government or state governments either to build the houses more cheaply than they could if they were entirely privately funded or alternatively to make up the difference between market rents and what the tenants in them can afford to pay.

How is that different, though? Shouldn't we be supporting that sector rather than... Well, I think we should be. We need to do both. I think we need... The scale of the problem is that we need to do more of both.

Basically, investors were providing this housing, and I know they were saying 80% buy...

existing property, but the other 20% of investors buying new property were basically providing cheap apartments in our capital cities, Melbourne, Brisbane, and that was causing a lot of stock to get built that was then keeping rents down.

And so while it wasn't great for the investor because they didn't get great assets and there was oversupply, what it was doing was flooding the market with rental accommodation, particularly so you got foreign investors buying this stuff as well. It was allowing the developers to build it. Governments were making money.

Developers were making money. The investor was losing, but the rental market was getting great amount of accommodation, great for uni students, great for young people. And so it was actually providing a really good society need because the investor was basically subsidizing

the rental market because they didn't know it, because they didn't know their investment returns were getting massively hit. The problem is they all found out that they were buying cheap stuff, didn't go up and buy, had building issues. And they're not gonna fall for it again.

My worry is that they're gonna go and buy new stuff, but they're gonna be competing with first time buyers because the developers are gonna have to build a better product And then they're gonna be like, oh, we could have sold this for 800, but we've got pretty good competition in this one.

So we can sell it for 900. So the first time buyer has to pay more because they're now competing with an investor. The second thing is, which I'm very frustrated about, is why didn't they loop in self-managed super funds and limited recourse borrowing arrangements together with this reform?

Because all we've seen is from the day after budget, you basically... I remember it was like nine o'clock the next morning. I got SMSF... non-bank lending. And all the last month or so, you've seen more and more buyers agents pivot to, hey, why don't you leverage your super?

Why don't you leverage your super? And we come back in two years' time, we're just going to see a huge issue there. So what's your take on that? All right. Well, I mean, the first thing I'd say to re-emphasize that the government is retaining the tax incentives for investment in new builds.

they will still get negative gearing and the 50% CGT discount. That's the only way a property investor can get negative gearing and CGT concessions is to invest in new builds.

Now, I can't guarantee because it's not the only factor involved in the decision, but that may result in some money that would otherwise have continued to go into pushing up the price of housing we've already got going instead to adding to the supply of housing. That's a good thing.

On the second point you make, I used to keep a list of the dumbest tax policy decisions of the last 25 years. And I think about number four on that list was the decision to allow self-managed super funds to borrow in order to buy residential property.

It was on that list. It was a really dumb decision.

And I agree with you that I think the government should reverse it, you know, and maybe they haven't got to, you know, they've probably think they've broken enough promises with what they've done already, uh, not to put another one in there, but I would be an advocate for stopping self-managed super funds from borrowing money to invest in housing.

Uh, and, and, you know, I, I would encourage the government to do that. Um,

Whether they will or not, I guess, remains to be seen. But I mean, the reality, this is a fact of life, that nobody really likes paying taxes. I mean, there are some above, I think it's the, or in the floor of the Internal Revenue Service's head office in Washington,

Exed in stone, there are the words from Judge Oliver Wendell Holmes that taxes are something we pay for a civilized society. And occasionally people will quote that in Australia, maybe not as often as they do in the United States.

But the fact is the number of people who genuinely believe that would probably fit in a phone box if you could find a phone box these days.

Most people want to follow Kerry Packer's advice that the government isn't doing such a good job of spending money that you would voluntarily pay them any more than you actually have to. That's to go half-back something we said before. A lot of small business people appear to believe that. So, you know...

It's inevitable that people who are being asked to pay more tax are going to come up with all sorts of reasons as to why they shouldn't that go beyond, I don't want to pay more tax.

That's why they talk about unintended consequences and people moving off to Dubai or New Zealand or Trumpistan or something like that in order to pay less tax.

It needs to be seen for what it is.

And if the government is not going to collect more tax from investors who disproportionately are older and richer than people who are not investors, then they're going to do what they've been doing for the last 30 years, which is collecting a surreptitiously ever higher proportion of tax from wage and salary earners through bracket credit.

So can we just pivot off the budget for the last 5, 10 and just economic sort of view on... Australia, what's going on overseas? I mean, let's not go too deep on whether it's a ceasefire or not, but just structurally Australia's challenge, you know, it's, you know, we've got, yeah.

Where do you see the Australian economy going, the broader context and, And where are we at in this higher rates, longer environment? That also matters to this discussion, right? It's implementing at a time where consumer confidence is really low. Mortgage stress is probably highest. It's probably been for a while. Unemployment is rising.

Inflation is still under control. So there's a lot going on that this is coming in at a time when people are already quite nervous. Yeah.

And you would also throw into that, and I think it's related, the growing disenchantment of a large proportion of Australian voters with the established political parties and why they're flirting with One Nation and other extremists. And Australia is not Robinson Crusoe in that regard. That's happening almost everywhere in the world.

And maybe the interpretation I've been inching towards in the last few months is when you look at the outcome of the Hungarian election, where the people of Hungary overwhelmingly threw out.

one of the first right-wing populist governments that the world had seen. And it looks as though, judging by opinion polls, that American voters are having buyers regret about Donald Trump.

But by contrast, opinion polls are saying that similar parties have a very good chance of forming government in the UK, In France, in Germany, and if you take the opinion polls here in Australia at face value, potentially here in Australia as well.

If not forming government, then at least becoming the official opposition after the next election. Maybe the lesson is that people actually have to have some experience of living under a government like Orban's or Trump's before they realize just how awful it would be for them.

Oh, dear. I was hoping you weren't going to say that. It does feel that way, doesn't it? In the meantime, I think, I mean, obviously there are a lot of factors playing into the significant shifts in the political environment that we're seeing in other countries abroad and here in Australia.

But one of them that is economic is that over the last five years, household disposable income per head in real terms, that is adjusted for inflation, what people have to spend

has grown at a slower rate than over any other five-year period since the first half of the 60s. And I say the first half of the 60s because we don't have data going back further than that.

At a guess, I would say that over the last five years, real household disposable income per head has grown at a slower rate since the Great Depression of the 1930s. And in that context, it's no wonder.

that people feel that the system as represented by the major political parties and big companies and financials isn't working for them. And they're reaching out for anything that looks different without actually asking whether it would be better or not. They just want to try something different.

And why has growth in real incomes per head been so low? Well, part of it, the biggest part of it is because productivity growth over the last five years has been negative.

And at the risk of sounding like an economist, which I am, productivity is the only sustainable source of improvements in living standards. It's not about working harder.

It's about working smarter with better tools, with new ideas, all the sort of things we were talking about before when we were talking about entrepreneurship and innovation. And we, not uniquely in the world, but we haven't been doing it. We haven't been changing jobs as often.

We haven't been allowing badly performing businesses to go out of business so that the workers they employ and the capital they use can be used by someone who does a better job of managing them. Instead, we've been propping up.

failing businesses and putting taxpayers' money into them and that sort of thing, which is the wrong thing to do if you want to boost productivity.

Instead, we've been relying, for the most part, on China continuing to pay very high prices for very large quantities of the rocks under our ground and the gas under our coastlines. That's not going to go on forever. It's starting to fade already, and we haven't found –

any new engine of growth to replace our reliance on digging stuff up and sending it off to China. So you said productivity, but I think you also said there were two things.

Is COVID and the stimulus that was brought into the economy as a result of COVID, has that got something to do with that five-year period of slowest growth? Well, yes, although we had a rapid rebound from COVID as well, too.

So the comparison I'm making is between 2024-5 and 2018-19. That is before COVID hit. Yeah. Yes, COVID played a role in that, but the...

The trend we've seen over the last five years is basically a continuation of trends that in Australia started around about the time of the global financial crisis and in other countries started around the turn of the century. You know, if you think about it, we've had no substantial economic reform.

This century, you know, we had a lot of it in the 80s and 90s. Under governments of both political persuasions, you know, Hawke and Keating, and in their first two terms, Howard and Costello, did a lot of economic reform.

And some state governments like Nick Griners in New South Wales, you know, also did quite a lot of economic reform. Kennet and Braxton Brumby in Victoria did a lot of reform. We haven't had any of that.

Instead, we've had ultra low interest rates, which make people lazy and which allow inefficient businesses that would otherwise have gone out of business to be replaced by better ones to stay in business and continue to perform poorly. We've had less mobility in the labor market, fewer people. have been changing.

I mean, for all the talk there is about the increasing precariousness of employment, the proportion of the workforce who've been with the same employer for 10 years is higher than it was 25 years ago.

The proportion of the workforce who've been with the same employer for less than a year is smaller than it was 25 years ago. The proportion of people who are casual employees went up an awful lot in the eighties and early nineties, but it hasn't really changed

much since. And the thing is that change in all its forms is one of the drivers of productivity and innovation. You know, people changing jobs, people leaving jobs and starting new businesses, that sort of thing. Or, you know,

Badly performing firms going out of business and the workers and capital they were using being employed by someone who does a better job of managing. That's what drives productivity and economic growth.

And part of the problem, and this might explain why it's not unique to Australia, is that Western societies and some Eastern societies like China and Korea are getting older. And as we get older, we get more risk averse. We get more focused on security in all of its forms.

We're actually less likely to take risks. And in that sense, the aging of our population is probably a contributor to the fact that we're becoming less innovative less open to new ideas.

And I think the decline in the quality of our education system, the dumbing down of our curriculum, the fact that kids come out of school and into the workforce with fewer literacy skills and numeracy skills than they did 25 years ago, these are all part of the problem that we and other countries like us have been grappling with for a long time.

You've got so much going on. I think you're absolutely right. That stat you said about worker mobility. I mean, that is to me is like a real, you know, you've got a job, you've got security. I'm not going to take a risk.

I'm not going to, when you go to a new job, you've got to perform right. You've got to, and you've got to find ways to justify your income and you've got to add value to organization and you can't just sit. So that's pretty scary.

The finally there is a, if you don't mind, there's a higher, if rates longer than the RBAs, um,

know we're in the fours you know inflation they're still pretty expecting inflation to get under control and etc but what's your thoughts on this sort of you know overall the next five years this higher inflation it's really going to be really sticky rental inflation like you know energy you know like the what's your take on where this inflation rate's going to go and are you more bearish or hawkish or you know what what do you think

Well, I suppose I'd say I'm probably moderately bearish on that issue because I think the low inflation which the world enjoyed from, say, the early to mid 1990s until the onset of COVID.

was produced by factors that have gone away, in particular by the rise of China as flooding the world with cheap goods. China isn't doing that as much now, and the rest of the world is resisting it. We're putting up barriers to imports of cheap goods in the name of, quote,

sovereignty and security and all of that sort of thing, or bringing back manufacturing. And so we're resisting the idea of importing things from overseas because other countries can make them better and more cheaply than we can. We're seeing taxes go up to pay for increased government spending.

That can result in higher inflation. We want to spend, or governments are saying we need to spend more money on defence. Well, there you're spending money on things you hope you will never use. That's bound to result in increased cost pressures. You know, that's kind of unavoidable.

And, you know, we are in many places running short of workers. You mentioned that before, Veronica, when you talk about the lack of tradies and things like that. Sure.

Now, you know, you said before our unemployment rate has gone up a bit to four and a half, but that's still pretty low by historical standards. Most employers are telling surveys that they still can't find the workers they need. And in those circumstances, you know, wages are likely more likely to go up.

They might get eaten up by higher inflation, but you're going to have cost pressures on labor. So you've got that. And central banks can't ignore that. They will put interest rates up.

But the other thing that's important happening is around the world, longer term interest rates are going up, bond yields are going up. And that's one, because of higher inflation. Two, because nobody seems to care about government debts and deficits anymore. Governments keep

paying for things not by asking people in most cases to pay more tax but just borrowing more and the bond markets are expected to supply it so they're demanding a higher price higher interest rates for supplying it and then there have been legitimate concerns particularly in the united states that the independence of central banks you know which is one of the uh

Principal first lines of defence against inflation is central banks being able to raise interest rates when they think it's necessary, rather than having politicians tell them that they can't, which is what used to be the case in Australia.

There's been this perception that the independence of central banks is under threat from politicians like Donald Trump or Viktor Orban, or if he were to come to office tomorrow. Nigel Farage in the UK and Marine Le Pen in France, none of these people believe in independent central banks.

So the markets around the world, the bond markets that ultimately set longer term interest rates, they're doing it slowly rather than dramatically. But this has been going on for 18 months without attracting a great deal of attention.

But I think, yeah, I mean, interest rates are going to be higher for longer. We will look back on that period, particularly, I suppose, during COVID. But, you know, between the financial market, between the global financial crisis. Yeah.

And COVID, when interest rates were the lowest they'd been in centuries, we will look back at that as the unusual period, not the norm. Right. No, that's amazing. I really appreciate your time, Silas. Very, very valuable chat. And yeah, thanks for coming on. That's a pleasure. Thank you for having me.

I've really enjoyed it.

That's been great. Thank you, Saul. Appreciate it. If you have a question that you'd like us to answer in an upcoming Q&A episode, you can send us a voicemail or written question via the website, theelephantintheroom.com.au, or you can email us directly at questions at theelephantintheroom.com.au.

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