Michael Blythe on Property Taxes and How the Housing Market Responds

In this episode, we're talking with economist Michael Blythe and we're going to explore property taxes and whether changing them will have a material effect on the housing market. Why is it that economists seem to love land tax? Will the removal of stamp duty really unblock the supply of new listings, particularly from downsizes?

And why are the positive aspects of negative gearing and capital gains tax discount ignored by so many commentators?

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.

And I'm Chris Bates, mortgage broker, recently ranked number five in Australia out of over 18,000 brokers in the annual MPA Top 100 Mortgage Broker Awards. Before we get started, I need to let you know that nothing we say here can be taken as personal advice.

We always recommend you engage the services of an appropriate and experienced professional.

Our guest today is Michael Blythe. Michael is a respected chief economist and senior executive with extensive experience in economic policy and financial markets. He's worked for both the Commonwealth Bank of Australia and the Reserve Bank of Australia. And currently he is the chief economist and co-founder at Pinpoint Macro Analytics.

as well as economist in residence at downsizer.com and economist at large at iPartners. Now, recently he released a paper with the daring title, In Praise of Negative Gearing, and it certainly grabbed our interest. Now, thank you so much for joining us today, Michael. We're really looking forward to your insights.

Thank you. Michael, we were chatting offline a couple of weeks ago and I thought, how the hell have we not had you on the podcast? We have over 300 episodes. And so thank you so much for coming on.

We didn't get you on for that negative gearing article, but you kindly shared that with us yesterday. And let's start there. I mean, whenever people talk about housing affordability and the issues with our property market, tax always pops its head up. We need to change the tax system.

Why do you think that's the case that we always go there is that to solve our problems.

Well, I think it really comes down to about how important taxation is in driving investment decisions. Any economist will tell you the worst thing you can have really is tax-driven investment strategies as being the way you try and make money.

But clearly over the years, negative gearing has been seen by many people as one of the ways you accumulate wealth, the way you prepare for your retirement and so on. We've got this all to do with housing. Well, everybody knows about housing.

And the idea of a tax deduction, I think, is also very attractive for many people as well. So you do see a lot of money heading in the direction of housing for those reasons.

And from then, it's a pretty short step, I think, to saying, well, all these investors who are being subsidized by the government are adding to demand in the housing market, which is pushing up prices, which is making housing unaffordable for first home buyers. And then

All of a sudden, you've got the kind of classic tax debate in Australia, which is the winners versus the losers. And typically, it's the losers that make the most noise.

The winners kind of tend to sit quietly on the sidelines, I think, because they don't want to get into a debate about something that's obviously working for them.

Not just with negative gearing, but I think with tax in general. In Australia, you find this very kind of one-sided debate. You don't get the full story.

It's one of the reasons I wanted to have a closer look at the negative gearing side of things and just kind of putting the counter arguments, if you like, whereas maybe it's not such a bad thing after all.

Yeah, we want to talk about sort of the state government's tinkering with land tax and, you know, potential removing stamp duty, et cetera, a little later as well because that obviously feeds into the same idea about giving others that do not or are not currently participating in the property market the opportunity to participate or to buy property.

But can you give us a brief history lesson in both negative gearing and the CGT discount? Yeah. When did they come into effect and why?

Sure. Well, I think you've got to go back a little bit further than that. I think there's basically, we're all trained at birth that you need to get a house. You need to get one as soon as possible. Governments are sensitive to what people want.

So there's been a long history of government assistance programs to get people into the housing market, particularly for first homebuyers. they nearly all involve giving first home buyers some money in some fashion or the other.

And all that does, I think, is increase the amount of money people are prepared to spend. So I think the smarties who get in first do actually get some benefit out of these schemes. But very quickly, this benefit gets capitalised into the house price.

And so it's not a benefit at all for the typical first home buyer. So, of course, what do we do then? We start tinkering around the edges of the tax system as part of the whole process there to try and encourage people into housing.

And I think the initial impetus for negative gearing really came from that source. The idea was we'll encourage investors into the housing market. They'll boost supply. That will impact our price or restrain price growth and the like. And that's going to be helpful for first-time buyers and buyers in general.

Now, it didn't take too long. I think certainly back in the 1980s when this was a big topic as well, that the negative gearing idea started to be seen as a bit of a rock for higher income earners. And so we started to fiddle around with it.

So the first thing we saw was, of course, was the winding back of negative gearing by Paul Keating when he was treasurer. There's a lot of debate about this. A lot of people claim that it had no impact on the market at all. Other people claim it did.

Now, it's impossible to say with certainty, but if we do look at the hard data, we did see an increase in rents coming through at that time at a faster rate than before. And we did...

see various other indicators which suggest to me that it did have a more sort of upward pressure on the housing markets and certainly very quickly the reverse course and negative gearing was back on and it's been there ever since.

Now all this was happening at the same time where one of the big positives from the Labor government at the time was the economic reforms they were pushing through and one of those things they brought in was the taxation of capital gains

And like all governments or bureaucrats, I suppose, the system they designed was very complicated. It was all about having to index house prices and you were paying taxes on the real capital gains and the like.

And for most people, it's just so complicated that you had to hire an account to sort it all out. So, John Howard, when he was running the show, came up with the idea of we'll simplify the whole thing.

We'll tax your capital gains at your marginal rate, but we'll give you a 50% discount on that. And I think if you look at that, that clearly did. boost investor interest in the housing market.

It's a similar system which was the aim but it did in fact boost interest in negative gearing in the housing market in particular.

So I think that also once again government tinkering had a positive upward pressure on house prices and didn't necessarily help the people that some of these schemes were designed to do. That's the kind of scheme that we've had in place ever since.

We've seen many suggestions over the years to change that, and the lesson most politicians have learned from those attempts is that it's not a good idea if you want to win an election.

as we um saw a couple of elections ago and so it seems to be off the off the table uh for the moment uh but uh there was a i think an interesting uh case here with the the changes to the stage three tax cuts uh i know they were widely viewed as being a negative or would be a negative sort of government at the time but it seems to be pretty well received and uh

I think it's probably going to embolden the government to be a little bit more ambitious in some of the tax reforms that they may want to experiment with, maybe not before the next election, but certainly this topic is not going to go away any time soon.

Yeah. Back in 1985, that's when they basically had a two-year period where there was no negative gearing. But also, didn't they change it? Wasn't it that no property was subject to capital gains tax prior to that and then just investment properties after that date? Is that correct?

That's right. So it's always been the case, the house you live in, there's no capital gains terms on that. And any assets prior to when the capital gains tax came in was tax-free.

So again, one of the incentives then was to try and convert income from wages or elsewhere into essentially a capital gain that wasn't taxed at all, essentially.

Yeah.

Now, we tend to think about negative gearing in housing, but you can use negative gearing for everything. So the stock market, certainly, but you never seem to quite see the same debate about when there's a negative gearing in the stock market.

It's all about housing, which again, I think just reflects how kind of tuned into the housing market that we all are.

Well, I guess it's quite visible too, isn't it? Somebody's got properties, they're there. If you're renting a property, you know somebody owns that property, whereas no one really knows who's got shares. It's much less obvious.

But one of the things I noticed in your report, though, that when you go back to that two-year period between 85 and 87, when there was no negative gearing available, as in no tax deductions available by negative gearing for property investors, it seemed to be a good thing for first-time buyers.

Didn't the price growth slow down? Rents went up, so definitely not a good thing for renters. But didn't price growth slow? Is there a correlation there or could that just be coincidental?

Yes, well, that's a trouble when it comes to this argument. You're never quite sure. Was it just the taxing driving this? Was there something else happening at the time that had an influence there? But you certainly saw a slowdown in lending to investors, which is what you'd expect.

So negative gearing wasn't there, wasn't attractive anymore. Includes, we'll say, an impact on the supply side with vacancy rates going down and rents picking up, which didn't help anybody. Interestingly, that piece I wrote that we're talking about, I had a lot of reaction to that and everybody has a different story.

about what happened in their area. So the things I've been talking about at the national level, but you can certainly pick those apart and find areas where prices went down, prices went up. It's just kind of that national picture where you get that message.

I think that's why there's no kind of real agreement whether it's helped or not. But the fact is the government backtracked pretty quickly on that one.

So it tells you they saw more negatives than positives in the end, whether that was just a political strategy or whether it was a reflection of the feedback they were getting at the time.

Of course, we'll never really know, but it is a pretty contentious part of the debate and plenty of people disagree with me on that.

Yes. Michael, do you think that the negative gearing of rates is a bit of a sideshow when capital gains tax discount is probably the big thing that really gives people a big tax advantage? Because I think maybe you pay about 20% to 25% capital gains tax.

A lot of countries around the world, just reading your reports, a lot higher than that. We might pay when you're a top tax investor.

income earner you're on you know 40 to 50 percent right so there's a there's a huge incentive to if you can keep income low and build you know uh assets that pay lower rates of tax capital gains tax do you think that's the thing that we probably should be changing more than potentially tinkering with negative peering

oh absolutely you know if in the end what you try to do is have some impact on on prices and negative gearing is not the way to go i mean people forget negative gearing means you're actually making a loss you're not making money out of it you're making up making a loss that's the whole point the payday comes when you sell the place and hopefully make a capital gain that's greater than your accumulated losses and that's where that

50% discount on the tax becomes very attractive. So if you really want to use the taxes to try and influence prices, then the capital gains tax is the thing that you should be looking at, but you don't hear particularly much about that.

Again, you then come back to the problem of where do you stop? Why should We treat housing differently from all other investments. And level playing field, you know, we all love level playing fields, especially when it comes to taxes.

So I suspect all you do in that case is that people would kind of switch from housing into the stock market maybe. So by changing these taxes, then you're probably forcing people into riskier investments. because the tax system favors those investments unless you change it across the board.

And then you have the problem, well, where it's a perfectly legitimate business expense if you borrowed money to build up a business and so on. So why, from an investment perspective, is housing any different? So it's all in or all out. Yeah.

And that's one of the big sticking points, I think, why it's just difficult to do this kind of stuff, because you don't want the unintended consequences, if you like, coming through.

And do you think that's where the unintended consequence, you do this tax change, right? Labor Party, for example, they say, right, we're going to halve the discount. It's only a 25% discount, not a 50% discount, right?

But do you think if there's a continued problem with housing affordability that, you know, there's not going to be, hey, we should start taxing the growth on your home. Maybe we should bring in inheritance tax. Do you think?

That's the fear of people when they're making big tax reform is if they're making that change, what's the one around the corner and is that one going to come and bite me? So the status quo is sometimes a safer option for people.

Yeah, it's kind of that salami approach. You have a little bit here and people worry about what's coming next and it reflects one of the problems we've had in Australia for a long time, I think, and that comes down to we don't kind of think about tax reform overall.

We'll change a little bit over here, we'll change a little bit Over there, the history of these things is we always overcompensate the losers to get the big tax kind of changes through, and you're just left with a mess. And the other problem, I think, comes back to the spending side of government.

Governments decide how much they want to spend, then they work out how they're going to fund it. And so it's looking on the bookshelf, it's a good idea, we'll raise some tax money doing this.

And so you get this kind of piece in the world's form that doesn't really work and in fact in some ways can be a negative. And we were talking, well, didn't we start talking about mentioning land tax earlier on and we've seen some fiddling on that land tax.

Well, it's all run by the state governments. We saw the Queensland government come up with the idea to help on their financial side about any investors in Queensland. The land tax would apply not only on the property they own in Queensland, but across Australia. And what do you know?

Queensland investors stopped investing en masse, and that particular one never made it through to the government. At the light of day, they backtracked all that pretty quickly. Of course, they have pushed it through in Victoria, where there's been a big increase in land tax and the same story.

That's hit the investment side of the Victorian housing market pretty strongly, as I understand it. So again, it's one of these things where the playfields are on the level. It's because Victoria is different from the rest of Australia and investors will respond to that.

And then you get the problem with the supply side of the equation coming through again.

We've seen, certainly in the PIPA survey last year, we saw really a reaction of investors in terms of their sentiment towards investing in those two states, but also their selling actions and intentions as a result of those muted change and actual change.

But also the ACT has moved from stamp duty. They're phasing in a broad-based land tax. So it's not just targeted investors. That's in this idea of stamp duty being an ineffective tax versus land tax, which is a more effective tax.

Is there any sort of evidence or reflections that you can sort of shed on this particular thing?

Because I guess a lot of states are looking at that and how that's rolling out and what the impact on prices has been and whether or not it's in fact increased supply in the way that a lot of people say reducing stamp duty or removing stamp duty will do.

Can we take any lessons from what the ACT has been doing?

Again, as an economist, you go back to the theory and so on. It tells you that stamp duty is not a good tax. It's one of the worst taxes. It's one of those taxes that throws sand into the gear wheels because it discourages people from transacting, typically.

Quite often when you see all these surveys about why people are reluctant to move, it comes down to moving costs. And the biggest moving cost, of course, is that duty, say, to shift or land tax. I mean, that makes a lot of sense from a longer-term perspective there.

But then, of course, you've got this kind of transition problem, I think, because you've now made it cheaper.

to buy a property because you're not paying that standard duty and you're paying that kind of small land tax maybe forever but at least initially when you're trying to make that first purchase we've increased the spending power of first home buyers and that's going to shift the demand story again and

I haven't seen the latest figures, but I think the ACT market is still pretty hot, perhaps partly as a reflection of those tax changes. I think ACT, given the kind of the workforce there, you've got a lot of people who've come from university and started working in Canberra.

So in a sense, you have a more highly qualified workforce there that's more likely to see some of the benefits from that. then it's probably going to be the story more broadly.

But it's that transition phase that you're creating issues, particularly at a time when we know across Australia demand for housing is really, really strong. And again, any economist can tell you, prices, it's all about demand and supply.

And when population's growing, the rate it is at the moment, the demand side is strong. At the same time, new construction is falling away. So that kind of demand-supply gap is only getting bigger at the moment. How do you fix that?

Well, you know, in the ideal world, you'd increase supply, and the government's put out some pretty ambitious targets there about how many houses they want to build over the next five years. 1.2 million, I think, is the number. We've never built that many houses over any five-year period ever.

uh in uh in in australia at a time and a lot of building companies have in fact been going broke it's just hard to see that happening yeah uh so if you're really worried about the price story at the moment you have to um uh fiddle around with the demand side well there are lots of talk about cutting immigration and i mean the numbers will go uh go down there but uh

you know, ask any business whether they want to see the local supply tap turned off and there's not going to be many people jumping up and down in favour of that. Of course, the other option is to put interest rates up.

That's a pretty good way to limit demand for housing, but hands up, who wants another rate rise coming through? Not many people really, so we're kind of trapped, I think, at the moment that any option to try and fiddle around with demand and supply is...

It's either not going to be enough or it's going to have, again, adverse consequences elsewhere in the economy.

I think one of the things complicating the demand-supply equation in terms of property sales is the rental problem at the moment, the rental crisis. So you've got, you know, where do you go? If you don't buy property, what's your alternative? You know, it's pretty dire at the moment.

Also, one of the things around stamp duty, one of the big arguments is, oh, well, a lot of the reason people don't downsize is because of the cost to buy another property, the stamp duty, the transaction costs.

And I'm curious to know whether in the ACT we've seen evidence or not that taking that inhibition away, taking that barrier away has freed up any supply in terms of that more mature housing stock.

Do we have anything on that or is it sort of yet to be determined? I think it's probably a little bit too early to say any kind of thing definitive to show on that front yet.

And, you know, of course, the problem is, I suppose, the ACT is the smallest housing market, pretty much the smallest housing market across the country. So, yeah.

Now, whether this is enough to really change the supply story in a way that has any kind of real noticeable consequences, we're yet to see. But you do raise an interesting point here, though.

I think one of the things that most people don't really realise is the housing market is not like any other market. Now, you walk into Woolworths, you can buy everything you can see.

But if you look at the Australian figures, turnover housing sales, about 6% to 8% of the stock is transacted every year. New construction adds maybe 1.5%, 2% of the stock. So at the most, something like 10% of the housing stock is in play at any point in time.

You don't need much of a shift in demand and supply to have a big impact there. And we see that reflected in prices, bankruptcy rates, rents, and so on. The other 90% is off the market because people don't want to sell.

They're quite happy where they are or they feel they're trapped because of these transaction costs and the like. But in some ways, it's not so much fiddling around with the 10% that's in place. What can you do for the other 90% that maybe gets a bit more of that?

Yeah. And to put that in context, there's like 11 million properties in Australia. And I think last year, the last time I looked at CoreLogic's figures, there was something like roughly 500,000 transactions over the previous 12 months. So that's 500,000 transactions. out of 11 million properties. So that's what you're talking about there.

And, you know, that's how we value the rest of the market, isn't it, based on those transactions. Of course, if you suddenly – and those numbers are down because I remember not that long ago when the sort of average annual transaction was around about $600,000.

So, you know, we have talked about supply being down, but obviously there's supply, there's transactions, there's new listings, there's all these different sort of figures that we keep an eye on in terms of what's happening in the property market. But do you see any material shift in changing that transaction figure? No.

I mean, I suppose at a time when interest rates are high, you know, a lot of people have been squeezed out of the market. Now, all the debate now is rates are coming down, and that's probably right.

Maybe not for a while yet, but all we're going to do when we reach that part of the monetary policy cycle in Australia is, you know, increasing again the demand side of the equation. Yeah.

It doesn't necessarily play out in a way that helps first-time buyers again. Well, probably not. We'll take the pressure off existing households, and that'll be a good thing. But whether it feeds back in a positive way into the story, I don't know.

So you're probably more likely to get increased sales when household finances are under pressure. And that choice then comes down to, am I actually better off selling and getting out and maybe coming back into the market later on or not?

But again, is that the way you want to increase transaction activity in the market by squeezing households to the point where they have no option? Possibly not. So again, it just comes back to there are so many pluses and minuses of work.

You try and fix one problem and another one comes up or you create a bigger problem somewhere else.

Michael, I guess if we fast forward a few years, right, and let's say the property market takes off again, right? Let's just do a hypothetical, right? The interest rates start to get cut. Borrowing capacity goes up. We've still got a migration, building shortage.

You know, there's more and more people wanting to enter because like you said, when you're born, you need to own a home. That's sort of the belief that we've got. From a social point of view, like, What's your take on the pros and cons of, you know, an expensive property market?

Like, you know, what are the things that I guess are good for us in terms of our wealth?

But what is, you know, why is it such a big issue when we've got, you know, real issues with affordability and what's your take on the whole, the property being too much of a, too big to fail problem?

Well, I mean, I think it is how sales account for most debt in Australia, encouraged by government policies in many cases. And financial stability is a very important part of keeping the economy together.

So you want to take every step you can to avoid that instability, because we've seen just how damaging that can be in other countries.

and equally how long it can take to resolve those problems when they run away from us. I mean, I guess what you're really talking about in a way is do we need a change in mindset in Australia?

Being a lifetime renter, is that necessarily a bad thing in plenty of countries where people do exactly that?

But as I said right at the start, you know, we've all been trained from birth. You've got to get into the housing market and governments have tried to help us do that along the way. So, I mean, I think that will be very difficult to think to do.

Equally, I'm reminded of, that was probably about 10 years ago now, period there where housing was seen as very unaffordable. Yeah. Not surprising there, I suppose.

And so what we started to see was a lot of discussion about, well, you're actually better off, the money you'd be paying in your mortgage, you're actually better off putting that into the stock market or superannuation or something like that and accumulating wealth that way.

And provided you've got enough of that wealth at the end of the story, well, then you can afford to keep renting. And the calculations people did then actually showed that the...

You actually made more money investing in the stock market than what was costing you to try and pay off this mortgage over the next 30, 35 years. So that quickly disappeared as an idea when the next housing boom came along, but it is reality.

Which also reminds me, you know, another interesting part of the story here is a lot of those countries where there are more renters than owner-occupiers, or the gap, if you like, is kind of filled by not kind of individual investors, but actually companies, big owners of the housing rental stock in Europe, for example, I think 10% plus.

is owned in some countries. You don't see that in Australia, very limited. And so the kind of individual investing here has kind of filled the gap that the corpus has filled in other countries.

So another option here is maybe we want to get the bigger players to see housing as another asset class that they can invest in, not just the

you know, the house down the road, but the kind of the big developments and this kind of buy a rent idea, I guess, that is another kind of popular component that people are talking about at the moment is a reflection of that.

Unfortunately, all these kind of supply-side issues are just going to take a long time to actually have any real effect. That's not to say we shouldn't do them, but we shouldn't expect to see things improve tomorrow when we go down that path.

Well, because there's structural and a mindset in terms of the psyche of the country as well. As you said before, we were born thinking we should buy a property, so it takes a lot to sort of get out of that headspace.

But also, it's a problem that we've created by our increasing property values that the from a corporation's point of view, to make enough money, to make enough sense. A, you've got to have better tax environment. The land tax is a killer in these cases.

But also, you've got to have a situation where your investment is giving you a good yield, and that then puts a lot of pressure on the rents that they've got to charge in order to make that investment stack up from a company's point of view.

So it's almost like we've created a problem in this country where that makes that really untenable as a corporate solution.

And look, back to the sort of negative gearing thing, is there any substance to the argument that's put out at the moment by some proponents of change that negative gearing is bad for both homebuyers and renters?

Well, I suppose the argument there is if the property that you want is being sold to an investor, then yes, clearly it's a negative for the owner-occupier and that investor does need a rate of return on their investment.

And the mentality there, particularly when it comes to interest rates, is, well, as rates are going up, my mortgage is going up on my investment property, so I'm going to charge you more rent.

But that is a common belief that that's how rents work. But the reality is that owners can only charge what the market will bear. Currently, the market will be increased rents. And so it's not because of interest rates that those rents are going up.

it's because there's a lack of supply of rental properties, right? And people will conflate those two things. But the fact is that, you know, through the COVID years, yes, interest rates went down. Again, we could conflate it. COVID years, interest rates went down and so did rents.

And now interest rates are rising and rents are rising. Different reasons, but it looks like it could be the same. So that's one thing. But also, like, if we had more corporations in the rental space, they, by virtue of their –

you know, their power and their market dominance could create more of, I guess, more control over rents, whereas individual investors, it's a very – it's hard to corral that market. You know what I mean?

Like there's not like everyone – there's not a union of property investors that can all meet and decide they're going to set prices. You know what I mean? It's very much market-driven.

Yep, and I think that's right. And, you know, there's a lot of circularity here in a way. You know, years ago when I used to work for the Reserve Bank, you would get endless phone calls from people asking, what is the latest inflation rate?

And it took me a while to work out, but essentially these were property investors who wanted to know what the inflation rate was because they were going to increase their rents by whatever the inflation rate was.

So you look at the data, and for years and years and years, rents grew somewhere between 2% and 3% a year because that's what the inflation rate was. Yeah.

You know, part of the story now, of course, is inflation's high. So, you know, rent's just another price. And so it's, you know, either a reflection of genuine demand and supply pressures and or, well, here's a great way to... or smokescreen to put up rents.

As I say, in the end, you squeeze renters out of the market as well, and that process comes to an end. So it does look like it's a genuine demand story at the moment because

Rents keep rising and they're not showing any particular sign of slowing at the moment. So, of course, what do we do? We start talking about rent controls and the like.

So, our initial kind of reaction is to dive into the tax box again or the policy box again to create another distortion in the market to try and fix another problem somewhere else in the market.

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You worked at the RBA and I just had to have to go there because it's always topical. Everyone really wants to know what's happening right now. We like to produce content that's a bit more educational and evergreen.

But I mean, what's your take on, you know, where we're at, you know, as an economy, you know, as a, you know, getting our inflation under control in our position in the global market and what's going to happen with interest rates, et cetera. What's your take?

view on you know have we tamed the beast have we put the genie back in the bottle and are we going to be able to you know orchestrate this nice soft landing or do you think there's a there's another story that people are missing and you know it's not going to go as as easy sailing as sometimes people think yeah i mean we've

Apply the traditional medicine, a whole series of rate rises there, and they have an impact on the economy. So we look at the GDP growth figures. Every quarter last year, there's a slower rate of growth than the quarter before it. So the economy has slowed down a lot. There's no surprises there.

And inflation has dropped well below the peaks. But as always, it's what's below the surface there that is the issue, I think. And that is nearly all the deflation or slowing inflation we've seen has been on the good side of the equation.

Services prices, like rents, are still growing pretty quickly. And, you know, they're much harder to contain, you know, insurance costs going up, you know, because of the cost of all those bushfires and floods and things, you know, there's nothing that you can do with interest rates.

I found that rents, well, you know, we could put up interest rates again, but is that going to fix the... The housing crisis, no, it's not going to help at all. So you've got this problem, I think, on the services side of the story that's proving much harder to squeeze.

And I think the way that plays out in the end is this idea that rate cuts are imminent is misplaced because they're not going to cut rates until that services story starts to be heading in the right direction. I say it's not just Australia.

Across the world, it's the services inflation story that's proving particularly difficult to contain. And Australia got a new governor at the Reserve Bank and the basics of monetary policy, the aims aren't really any different.

But what she's made very clear at her top up to the story really is that she doesn't want inflation just to be below 3%. She wants it at 2.5%.

And so, you know, it's that kind of extra yard that we're going to have to go to kind of hit the numbers that she's looking for before she'll be happy to lower interest rates. And that's going to take time.

Again, it's one of the lessons of history is it's that kind of last 1% of the inflation rate is the hardest. to achieve.

So you can very quickly go from 8% to 4% in inflation, but trying to get from 4% to 3% and then 3% to 2.5%, it's that last 100 yards that is the most difficult to achieve. And so the risk there is interest rates stay where they are for longer.

Is there any good signs in the services sector at all, though, where, you know, is it high migration LBS? I mean, is there or is this a problem across lots of different things? Yeah, maybe hideous on rent. Are insurance premiums starting to taper?

I mean, you know, I guess with inflation, it's always a rolling band, isn't it? So if you have a lot of inflation fast, it's probably not a bad thing. What's your what's your capacity to pay their right to insurance companies? You know, it's just keep increasing.

what's your is there good signs there or do you think that you know if anything that's not going to go away and that's potentially going to lead to higher prices and you get this sort of price um you know inflation spiraling effect that's kicks on and then people start asking for more wage increases because the cost of living sticks around and their mortgage is smashing them and then we have to keep putting our prices up do you think we're heading down that route or do you do you have can we see more positive signs

Yeah, I mean, it's interesting. Despite all the extra labour supply, wages growth has actually picked up. And what do you know, wages are actually growing faster than prices. Right at the moment, real wage growth has returned. Not a lot of it, but it is there.

And so, you know, again, the biggest driver of service prices is wages. If that picked up, then that certainly kind of argues against it coming back.

How have we actually got any kind of slowdown in services prices? Well, largely by paying for it. The government has paid to lower service prices. So we've had from state governments, for example, various subsidies put on your electricity bill and the like.

commonwealth governments increased the child care rebate and so on so yeah there are bits of services inflation that have actually slowed quite noticeably including rents because commonwealth rental assistance has gone up as as well but you know we've kind of bought it it's not a permanent slowdown in inflation so those kind of pressures are still still there had so now that

Reserve Bank worries about inflation expectations and the longer inflation stays high, then the more we kind of get that ingrained into people's expectations and they adjust their behaviour, i.e. wage demands and so on, to reflect that. So that's what the Reserve Bank worries about.

I'm right, inflation expectations are pretty well contained, but it's a risk that they are concerned about.

One of the things that we talk about quite a bit in this podcast is that, you know, the blunt tool of interest rates and it really, it only targets as subset of our, I mean, what we've got 11 trillion, hang on, I'm trying to remember, the value of property in this country and it's something like 22% of it is in debt.

Yeah.

So therefore, those owners are the ones disproportionately impacted by interest rate rises. And then you've got a whole segment, you know, self-funded retirees, for argument's sake, benefiting from interest rate rises.

So it's, there's only a section of our community that's really impacted by the blunt tool that the RBA has to deal with inflation. And of course, if it's services, inflation with services, it's totally out of the control of interest rates. then is it just a waiting game?

I mean, yes, you're saying you can buy, the government can pay to get inflation of services down, but other than that, what tools do they have at their disposal?

Well, the Reserve Bank has one tool, and that's interest rates. They're deploying it the way you would expect them to respond. But as you say, it does have a very skewed impact.

And again, way back when I worked for the Reserve Bank, it was kind of interesting, depending where interest rates were, you got a lot of letters from home buyers with a mortgage who were complaining about interest rates too high, but you also then got a whole stream of letters from

retirees who were complaining the interest rates were too low. So in that sense, interest rate settings were probably about right because nobody was happy in a way. So at the same time, the Reserve Bank has been tightening policy.

We've had what has really been very expatriate fiscal policy settings, courtesy of the

All those payments that are made during the COVID period, which a lot of people put in the bank, which are sitting there now available to keep funding consumer spending or help with the mortgage payments and so on. So again, policy changes, things were done for very good reasons at the time, but it

You know, it's come with these kind of longer-run consequences that we're playing out now. Housing is definitely part of the story. I mean, the housing component of the CPI is actually bigger than food, for example.

So housing is a bigger driver of overall inflation than pretty much every other component of the CPI, including food. Wow.

Again, a lot of that, how do you control that? Well, as I keep saying, put interest rates up again, but nobody's going to be happy with that, of course. So they are in a bind. It probably is time to think about other issues.

There's been plenty of suggestions out there in the past about, well, we've got this GST rate that's been 10% forever. Well, if you can actually make that a bit more flexible, put it up. when needed and backed out again when needed. So there are fiscal leaders you can pull there.

Now, you can try other reforms in the housing market, again, for example, that might increase transaction activity. And we've talked about stamp duty and land tax and so on. But the interesting question, we talk about this housing crisis and supply shortages and the like.

But if you look at the data out of the last census and do the calculations, you can actually show there are 13 million spare bedrooms in Australia right now. And so we don't so much have a housing shortage as a bedroom glut, but those bedrooms are just the wrong area.

So try to relocate those bedrooms or make those bedrooms available in some way is another thing to think about and downsizing. Here's an obvious example there.

As you free up those bigger homes for, you know, people who have nothing else, you free up those bigger blocks of land that are then suitable for, you know, redevelopment. And, you know, you're probably impacting on the supply side of the story in a positive way there.

It does kind of lead you back to stat duty again because one of the biggest reasons people don't want to leave is that cost of moving is particularly old. Yeah. People who don't want to pay that.

I was going to go exactly there, Michael. So good job taking us down the downsizing route because I know you've done a lot of work in this space.

I mean, that way you ended on there was the perception problem or the barriers for people to move and how they see their family home and their attachment to it. What's your take on the whole Because there is this belief, right? There's all these spare bedrooms. The people are in these homes.

If only we could free them up. But they've got a tax-free asset. The kids want to keep them in the home. They don't want to leave the area. They love their home. All the family come there for Christmases, et cetera. They know that they feel comfortable and safe there with their neighbors.

And they can't go and find anything in the area because they just haven't built properties that suit them. Like, What's your take looking at all your research? Because it seems so obvious. Let's move them on. You've had your time. You don't need those bedrooms anymore.

It's time for you to shift out and give it to someone who needs it more. But there's a real challenge in motivating them to move. And things about putting more money into superannuation, yeah, I mean, it's helpful, but it doesn't seem to move the needle. What's your thoughts?

Yeah, I guess the issue there is if you look at people aged over 60, at least half of them have been in their current dwelling for more than 20 years, 30 years, 40 years in some cases. They've been there a long time. They know how the local area works.

They like the place they're in. They're near all the services and so on that they need. So why would I want to leave, particularly if I'm going to have to pay all these taxes and charges when I do? How do you shift that?

Well, I think part of it's going to happen naturally anyway because what you find is that a lot of people in that age bracket, that kind of 60 to 70 bracket where most potential downsizers sit, a lot of them are asset rich because that house they've had for 20, 30 years has been a great way to increase their wealth, but they're cash poor, their income is

drops dramatically when they retire, and it's very hard to spend the house without actually selling it. That house has also grown in age the same rate that the person living in it has, and so that older house now has a lot more maintenance required with it.

It's got a garden you've got to look after, and not surprising when you look at the demand for services, the biggest demand amongst older age groups is for gardening, home maintenance, and the like.

So how do you kind of fix up the income problem they have with the increasing kind of negatives of the house they have? And downsizing is one of the ways you can do that, obviously, provided the place you move to is worth less than the one you're in now.

Then you're freeing up assets that can be invested to boost your income. And then you come to this problem, of course, is people say, well, can't find anything.

in the area and I don't want that or it's too too expensive and you know some of the things that people tell you when they when they say why they roll up into downsides that shouldn't be surprised really but did surprise me when I heard them well one of the questions you get is where am I going to park my caravan

You know, these people who have got plenty of time to go on holidays and so on, and the dining room table is the other big issue. Because if I don't have the dining room table, then the family can't come around for Christmas dinner and the like.

So these are the sorts of issues that don't occur to people who aren't in that downsizing group, certainly don't appear to be occurring to developers and so on of building that. So we need to build the right dwellings in the right area, essentially. Yeah.

Michael, in your research, did you find that there's a sweet spot where they're a bit more hopeful, they're a bit more optimistic, they're not against change? Maybe it's circa around the retirement age, they're still in the workforce.

But once they get through that and they get into, say, their 70s, let's just say that's the line, they become more risk adverse. They don't want to go through a big life change, particularly if they lose a partner or something like that. Do you find that there's a downsizing sweet spot?

And then it becomes all too hard. I'm just going to stay where I am. And I think that's a huge opportunity missed there because, you know, they're probably the ones who can downsize the most, right? They've got less needs. Do you find that's a problem there? Absolutely.

That's 60 to 70 age bracket. That's the kind of sweet spot, if you like. Two-thirds potential downsizes, according to the surveys, are in that age group. And certainly once you get above 70, then the response then becomes more, it's too hard, too frail. What's the point of moving?

So, yes, that's the kind of group that do where all the action is. And they're a surprisingly large group. Again, according to the surveys, there's something like 1.9 million people in Australia right now who say they're thinking about downsizing sometime over the next two years.

Now, thinking and doing it is a different thing. In fact, it does give you an idea of the potential market there. You can only kind of unlock it somehow and do the calculations.

And you'd be looking at something like over $700 billion worth of property sales across Australia over the next couple of years as all those people go ahead.

And the average kind of equity release, when you look at what people could sell their house for now versus the kind of property they intend on buying, is across Australia about $340,000. So that's a pretty hefty equity release.

Of course, it varies dramatically across states and within capital cities and the like, but that's the Australia-wide average.

Put that into superannuation, for example, and you could boost your income tax free by another $21,000 a year for the average downsize, and that's pretty useful. injection of cash, you end up in a more age-appropriate dwelling and you boosted your income.

And that's the kind of message that needs to get out there as opposed to the very natural reaction people have. They want to age in place, as we like to say these days.

What's your thoughts on the failings of our aged care system and the Royal Commission into aged care highlights that and I guess the belief that a lot of older people don't want to go there. They do everything they can to stay in their home.

Maybe the government encourages that because it's sometimes cheaper for them. How's that problem causing, I guess, further issues in our housing market by not freeing up that stock or those properties where they don't have a place to go? They want to stay there to the very end.

I mean, you can understand why governments want to do it. It's a good way of containing costs. Much cheaper to keep your existing house than having to build some purpose-built construction for that. And now when we look at government spending broken down by age,

Now, what is really interesting is it's the older age range is where most government spending goes, by a long way, on a per capita basis. And that makes sense because age care is very expensive. Health costs are very expensive the older you get. And of course, age pensions and the like.

So you can see why they're kind of focusing on this. So yes, it's a great strategy for From that perspective, that doesn't help with the broader housing and demand and supply story. No, probably not, because you're making it easier for those people to stay in their existing drawings.

Do we want to throw them out the street? No, absolutely not. But these are the sorts of policy issues that need to be thought about.

And this, of course, feeds back into negative gearing, doesn't it? Because the idea of property investing is so that we can build assets that will ultimately fund our retirement. So we are less of a drain on the public purse when we get to that age.

And yet the big argument about negative gearing is the cost to the taxpayer now, particularly with rising interest rates. So it's all part and parcel of the same picture, isn't it?

Yes. Oh, yes. I mean, you go around a big circle here, really. But yeah, that's right. So the fact that government finances are under pressure and they're going to stay under pressure just tells you that the pressure for the individual to fund their own retirement is only going to continue.

We've seen popping into the debate the idea that people in aged care and so on need to pay more of the costs depending on their wealth and income, of course, which just kind of highlights that point.

So how do you raise or how do you build your wealth so you can fund your retirement? Well, superannuation.

Most people feel they're kind of forced to put money into superannuation, so they don't want to put any more in necessarily, particularly since the rules seem to change every year, so people are a bit suspicious about that. And what's the one investment we all know and love? It's housing.

And so you do get a lot of people who want to take advantage of the negative gearing as a result. And I'd actually argue that people focus on the short-term cost of the budget of negative gearing, and there are some...

Frankly, rubbish numbers, I think, about how much it's costing government revenue and the like.

What you've actually seen in Australia is the number of people who are making a profit out of their investment property is going up, and it now actually exceeds the number of people who are making a loss on their investment property.

This is data from the tax office, and it is a couple of years behind where we are right now, but it's negative gearing on that basis is actually making a contribution to the government revenue.

Yeah, if it's a couple of years behind, it doesn't take into account interest rate rises, but nor does it take into account the recent rent rises. Yeah.

But one of the things that's been one of my bugbears is that proponents of axing negative gearing often quote that 80% of the deductions go to top earners and use this as evidence that's unfairly benefiting those who are already wealthy. But that's not actually the truth of the situation, is it?

No, there's plenty of people at the other end of the income and wealth distribution who are taking advantage of it. For sure, wealthier households get more of the benefit, but surprise, surprise, the rich have more of everything, including housing.

Yes, they also pay more tax.

Yeah, essentially there. But, you know, there are plenty of, when you look again and look at the tax office data about who is claiming these negative gearing deductions, you know, there are plenty of teachers and nurses and the like who are doing exactly that.

So it's by no means just the rich that are getting some advantage, although in pure dollar terms they would be. But as I think you were going to say, it's the top end of the income range that pays most income tax in Australia.

So as it should be, of course, but we look at the figures and look at not just...

tax payments but adding on the benefits that come the other way from the government pensions and all the like it's only the top 20% of taxpayers in Australia who paid more in tax than they received back in government benefits

So we are relying on a reasonably small group, kind of net funders for the rest of us.

Can you just say that again, please?

So if we look at the tax people pay and the benefits they get back in terms of age pensions and schools and all the rest of it, The lower income groups, it's a negative. So they get back more in benefit than they pay in taxes.

And it's only the top 20% where that balance shifts. So they pay more in tax than they get back in government benefits.

That's not often published or publicised.

I mean, that's, you know, again, right, you said at the start, one of the reasons I did this negative gearing paper was because, you know, all the negatives get trotted out all the time, but none of the other kind of other factors to think about here do. So, yeah.

Well, I'm not going to say that, you know, rich people deserve at least some benefit in there somewhere. But, you know, again, this is the group that is funding the equation. So we've got an over-reliance on income tax in Australia.

And because of our progressive tax system, government benefits and the like, it's only the top end that are paying more than they're getting back.

And I just think, you know, I think that's sort of fair in a society, but it just needs to be recognised. And I think that that's why I thought, great, say it again, because I'd never heard it expressed that way. Yeah, interesting.

We've got one minute to go, so we're going to quickly ask you, do you have a property done before us, a lesson we could learn?

Well, I suppose the...

It really comes down to don't let emotions sway you, I think, in both directions.

And I think one of the classic story or issues that people have is they see prices are going down or they get told prices are about to collapse and the like and they want to get out of the market. And there are plenty of people who have done that over the years.

And then they found they can't get back in. So in the end, buy and hold has always been the best strategy. And that house you bought 30 years ago is looked after pretty well when you look at your assets and liabilities and the rent you're not paid. Yes.

Yeah, totally agree. Not to knee jerk. Michael, that's been a really fascinating and interesting chat. We really appreciate your time. Thank you so much for that.

Well, thank you for inviting me. Thank you, Michael. I'm surprised we haven't had you on. So I'd love to have you on again. And a big shout out to your chart pack, actually. So Pinpoint, we'll put a link in the show notes. And yeah, it's an amazing chart pack.

I worked out about it recently. And yeah, it's a great resource for anyone who wants to track these things. So thanks so much for coming on. I would love to have you on again. Thank you. Pleasure.

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