Checking In on the Aussie Budget’s Early Effects

Capital gains taxes are back in the spotlight, with the Brits reportedly considering raising them and US Congresspeople again mulling indexing cost basis to inflation. But they are perhaps most front-and-center in Australia, where home prices are tumbling amid recent capital gains tax changes—yet where, despite many fears otherwise as the changes loomed, stocks aren’t. There are some key global lessons here.

Australia’s changes, which were unveiled in May and passed in June, were twofold. The first, capital gains tax reform, applied to stocks as well as real estate. Under the ancien régime, Aussies paid their top marginal tax rate on all capital gains, but assets held more than a year enjoyed a 50% discount. Stock investors liked this because they could hold on to positions with huge embedded gains until a year where they didn’t have much income, then book the gains at a major tax discount. Starting next July, this changes: Capital gains tax rates will have a 30% floor, which exceeds the top marginal income tax rate for folks making less than A$45,000 per year, and instead of the 50% discount, cost basis will be indexed to inflation.

The second change applies only to real estate, but there was talk that it would hurt stock demand—talk we never quite thought had a connection to reality. It changed Australia’s “negative gearing” for real estate, amending how landlords and landladies could use rental property losses to offset taxable income. Before, losses could offset all income, including earned income. From next year, losses from new-build properties can offset only residential property income and capital gains. Nothing is changing for stock market negative gearing, which applies only to leveraged investments (it generally isn’t advisable to invest with borrowed money, friends), and existing rental properties are grandfathered into the old system. Nevertheless, there was abundant chatter that these changes would hit Aussie stocks.

So far, that hasn’t panned out. Aussie stocks did wobble as Treasurer Jim Chalmers released the new tax plans in May, falling that month while global stocks rose. But since then, they have zigzagged higher, much like global markets, and remain ahead of the MSCI World Index on the year. Morningstar reports Australian stock ETFs continued seeing strong inflows in Q2, undeterred by the looming changes.^[i] Demand for Aussie stocks looks just fine to us, with sector trends (in this case, Australia’s heavy bias toward natural resources) likely a greater return driver than tax changes.

Contrast this with Aussie home prices, which are floundering. New official data out this week showed the national median home price falling -0.7% q/q in Q2, with declines concentrated in New South Wales, Victoria and the capital region—basically, the most populous areas.^[ii] Separate reporting suggests this may understate the case, with Sydney and Melbourne home prices falling as much as 6.7% and 6.3% year to date, with some analysts projecting further declines to come.^[iii]

Now, disentangling potential causes is always easier said than done, and Australia’s rate hikes may be playing a role here. Mortgages there are mostly floating rate, so hikes swiftly raise monthly payments, knocking values. But Chalmers has conceded the point, saying tax changes likely played a role in home values’ decline, which cuts against the Treasury’s predictions that they would merely slow home prices’ growth, earning the number crunchers there a lot of flak for their modeling.^[iv] 

We think it is fair to say the tax changes make residential real estate rental properties less enticing as an investment. It doesn’t surprise us that this is having an effect on prices. It is reportedly a contributing factor in one highly publicized (and likely overleveraged) developer’s insolvency, as well as contributing to pushing up the number of builders going under.^[v]

But it also doesn’t surprise us that Australian stocks are doing their own thing regardless. Stocks and real estate have always moved independently of each other, each with their own supply and demand drivers. Negative gearing changes are hitting property demand right now and may, according to some projections, eventually stall construction. But stocks are tied more to the broader economy and corporate earnings, with a heavy influence from global developments. Local capital gains rules may affect demand at the margins, if investors seek to lock in long-term gains at the 50% discount before the new rules kick in, but that applies only to Australian folks. International investors are subject to their own capital gains rules.

So keep all this in mind as capital gains rate debates play out elsewhere, whether it is folks arguing a UK hike would be bearish or US inflation indexation magically bullish. We reckon both would largely end up being non-factors for returns, however unhappy or happy they may make individual taxpayers.