Negative Gearing and Welfare: A Quantitative Study of the Australian Housing Market Yunho Cho Shuyun May Li Lawrence Uren Melbourne Melbourne Melbourne RBNZ Workshop December 12th, 2017
“We haven’t got any plans to review the policy (negative gearing) we took to the election. Can I just say to you that the issue of housing affordability is overwhelmingly a question of supply.” Malcolm Turnbull, PM of Australia “... deep down in the core of the Turnbull government, they know that if they want to resuscitate the Australian dream of owning your own home, they need to act on negative gearing.” Bill Shorten, Opposition Leader
Negative gearing in Australian housing market • Negative gearing: Landlords deduct housing investment losses from gross income at their marginal rates Figures: Negative Gearing 1
Negative gearing in Australian housing market • Negative gearing: Landlords deduct housing investment losses from gross income at their marginal rates Figures: Negative Gearing • Arguments for – facilitate construction of new houses – stimulate supply of rental housing – help renters with affordable shelter services • Arguments against – most housing investment is to purchase established properties – possibly worsen inequality – additional upward pressure on house prices 1
This paper • Question: What are the welfare implications of negative gearing for heterogeneous Australian households? 2
This paper • Question: What are the welfare implications of negative gearing for heterogeneous Australian households? • Model: General equilibrium OLG model with incomplete markets and heterogeneous agents – uninsurable idiosyncratic income shock – endogenous house prices and rents – income tax code and negative gearing for housing investment 2
This paper • Question: What are the welfare implications of negative gearing for heterogeneous Australian households? • Model: General equilibrium OLG model with incomplete markets and heterogeneous agents – uninsurable idiosyncratic income shock – endogenous house prices and rents – income tax code and negative gearing for housing investment • Calibrate: Match life-cycle profiles from micro-data and moments of Australian housing market • Simulate: Compare stationary equilibria with and without negative gearing 2
Main findings Repealing negative gearing • Improves housing affordability and increases homeownership rate – lower house prices and higher rents ⇒ lower price-to-rent ratio • Reduces housing investment – aggregate rental supply and landlord rate fall – most of young landlords with high earning driven out of the market 3
Main findings Repealing negative gearing • Improves housing affordability and increases homeownership rate – lower house prices and higher rents ⇒ lower price-to-rent ratio • Reduces housing investment – aggregate rental supply and landlord rate fall – most of young landlords with high earning driven out of the market • Overall welfare gain of 1.5% and 76% of households better off – redistribution plays a key role for welfare gain – with redistribution, renters are winners and landlords are losers 3
Model
Demographics • Unit-mass of finitely-lived households • Live and work for a = 1 , 2 , ..., 14 periods – the model period is 5 years – households enter the economy at age 21 and exit at age 90 • Age-dependent survival rate, κ a with κ 14 = 0 4
Preferences • Expected life-time utility of household � 14 � � β a − 1 κ a u a ( c a , ˜ h a ) , β ∈ (0 , 1) E 0 a =1 ˜ c : non-durable consumption; h : housing services • Utility function 1 − α � 1 − σ � c α ( λ ˜ h ) u a ( c, ˜ h ) = , α, σ ∈ [0 , ∞ ) 1 − σ λ > 1 for homeowners; λ = 1 for renters 5
Preferences • Expected life-time utility of household � 14 � � β a − 1 κ a u a ( c a , ˜ h a ) , β ∈ (0 , 1) E 0 a =1 ˜ c : non-durable consumption; h : housing services • Utility function 1 − α � 1 − σ � c α ( λ ˜ h ) u a ( c, ˜ h ) = , α, σ ∈ [0 , ∞ ) 1 − σ λ > 1 for homeowners; λ = 1 for renters • Accidental bequest: assets of deceased households equally distributed to surviving households 5
Housing • Housing services ˜ h can be obtained by purchasing or renting • Households can buy at price p or rent at p r per unit • Households become – landlords if h > ˜ h > 0 – owner-occupiers if h = ˜ h > 0 – renters if ˜ h > h = 0 • Renters can live in houses that are smaller than the minimum housing size available to homeowners • No renter-landlords 6
Housing as risky asset • Sales of housing asset subject to idiosyncratic house price shock ω ∈ Ω • Ex-ante expected capital gain is zero ⇒ E ( ωp ) = p • ω not realized until house is sold – households know unconditional probability of the shock π ω 7
Housing as risky asset • Sales of housing asset subject to idiosyncratic house price shock ω ∈ Ω • Ex-ante expected capital gain is zero ⇒ E ( ωp ) = p • ω not realized until house is sold – households know unconditional probability of the shock π ω • Competitive construction firm buys from selling households and sell old and new houses to purchasing households at price p 7
Maintenance and transaction costs • Homeowners bear maintenance expense at constant rate δ • Landlords incur additional (fixed) expense ζ • Linear transaction costs � 0 if h − 1 = h TC ( h − 1 , h ) = φ b ph + φ s ( ωp ) h − 1 if h − 1 � = h 8
Borrowing and saving • Households can save by holding a risk-free asset s ′ > 0 that pays interest r • Households can borrow s ′ < 0 , subject to a collateral constraint s ′ ≥ − (1 − θ ) ph • Borrowing also requires – downpayment θ – interest payment at rate r + m 9
Taxation and transfers • Net rental income � ( p r − pδ )( h − ˜ � h − ˜ � � h NRI ≡ h ) − ζ + ( r + m ) s I { s< 0 } I { h> ˜ h h } 10
Taxation and transfers • Net rental income � ( p r − pδ )( h − ˜ � h − ˜ � � h NRI ≡ h ) − ζ + ( r + m ) s I { s< 0 } I { h> ˜ h h } • Total taxable income Y = y a + rs I { s> 0 } + NRI • If NRI < 0 , negative gearing applies 10
Taxation and transfers • Net rental income � ( p r − pδ )( h − ˜ � h − ˜ � � h NRI ≡ h ) − ζ + ( r + m ) s I { s< 0 } I { h> ˜ h h } • Total taxable income Y = y a + rs I { s> 0 } + NRI • If NRI < 0 , negative gearing applies • Counter-factual policy experiment by setting Y = y a + rs I { s> 0 } + NRI I { NRI> 0 } • Progressive income tax system • Receive lump-sum transfers F 10
Government and construction sector • Government collects tax T ( Y ) , sells assets of deceased households R , and distributes lump-sum transfers F 11
Government and construction sector • Government collects tax T ( Y ) , sells assets of deceased households R , and distributes lump-sum transfers F • Competitive construction firm – buys existing houses from selling households – develops unoccupied land L at constant price – sells old and new houses at market price p 11
Government and construction sector • Government collects tax T ( Y ) , sells assets of deceased households R , and distributes lump-sum transfers F • Competitive construction firm – buys existing houses from selling households – develops unoccupied land L at constant price – sells old and new houses at market price p • Solves static problem H new = max L pψ 1 L ψ 2 − L � � which gives the law of motion for the aggregate housing supply H = H − 1 (1 − δ ) + H new ψ 2 • Housing supply elasticity given by ε = 1 − ψ 2 ∈ [0 , ∞ ) 11
Parameterization overview • Earnings process estimated from the HILDA survey – gross income that includes pensions and other social benefits but excludes any investment income • Tax function calibrated to the current Australian income tax system • House price shock quantified from the SIH • Discretize state space for housing h ∈ { h (1) , ..., h ( K ) } h rent ∈ { h rent (1) , ..., h rent ( J ) , h (1) , ..., h ( K ) } • Preference parameters and landlord fixed cost calibrated internally 12
Model fit • Homeownership and landlord rates over life-cycle and income quintiles 13
Simulation
Steady state Baseline No NG ε = 2 Price 1.180 1.160 Rent 0.164 0.168 Price-rent ratio 7.209 6.907 Frac. of homeowners Frac. of owner-occupiers Frac. of landlords Frac. of renters Rental supply (relative to housing supply) Aggregate housing supply (normalized) Transfers Debt to income ratio 14
Steady state Baseline No NG ε = 2 Price 1.180 1.160 Rent 0.164 0.168 Price-rent ratio 7.209 6.907 Frac. of homeowners 0.667 0.722 Frac. of owner-occupiers 0.500 0.584 Frac. of landlords 0.167 0.138 Frac. of renters 0.333 0.278 Rental supply (relative to housing supply) Aggregate housing supply (normalized) Transfers Debt to income ratio 14
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