Getting ahead and accumulating wealth is likely to become even more difficult than it is now for ordinary Australians. This is especially so for outright home owners who no longer have access to the risk-free savings option of paying off the mortgage.
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For owner-occupiers who still have a mortgage, low interest rates still provide a unique opportunity for those who resist the temptation to increase their borrowings to reduce their mortgages rapidly.
Because our tax system provides no assistance to owner-occupiers to service a mortgage, paying it off is a certain and safe way to build up wealth. The higher the income tax rate, the larger is the income required to service a mortgage. But the benefits of reducing the size of the mortgage are also higher.
For example, even for medium marginal tax rates around the 30 per cent level, reducing the principal on a 4.5 per cent interest rate mortgage provides an annual equivalent pre-tax yield of 6.5 per cent.
This is more than twice the return available on cash and term deposit investments and comparable with the yields of more risky fully franked dividend paying shares. The lower the size of the mortgage, the smaller also will be the adverse impact of any further increases in interest rates.
Low interest rates reduce the benefits of saving to those without mortgages. Building up a savings account or term deposit attracts only a low interest rate which is subject to income tax at the recipient’s marginal tax rate. More risky investments such as property and shares generate higher returns which are also subject to tax but there are no guarantees against the loss of the capital invested.
These investments in many cases are motivated by the desire to reduce tax burdens by making capital gains which are taxed at a lower rate only when the asset is sold. The current tax legislation encourages investors to take even more risks by borrowing heavily for investments and generating losses which can be offset against other taxable income.
This negative gearing opportunity allows taxpayers to reduce their fully taxable current income to benefit from more favourably taxed capital gains at a future date. Unfortunately for those wanting to accumulate a house deposit or be certain of a comfortable retirement, there are no guarantees that the after-tax future gains will compensate for the losses currently being occurred.
Uncertainties about future prices and negative gearing and capital gains tax arrangements are not helping investor confidence. Restricting access to negative gearing and increasing capital gains tax rates will confirm these concerns. With access to superannuation tax concessions already greatly reduced accumulating wealth in Australia would then be much more difficult.
Daryl Dixon is the executive chairman of Dixon Advisory
