House prices would fall about 2 per cent if Labor went ahead with its previous election policy to change property tax breaks, modelling from the Grattan Institute shows.

The modelling carried out initially in 2016, and updated for ABC News, suggests the change could boost the federal budget bottom line by about $7 billion a year.

It is unclear what exact policy changes to property tax breaks Treasurer Jim Chalmers has asked Treasury to look into, although he has admitted he personally asked for Treasury to undertake modelling. 

Labor took to the 2016 and 2019 federal elections proposals to limit negative gearing to new homes only, while exempting all existing negatively geared properties.

It also proposed halving the 50 per cent capital gains tax (CGT) discount for those who held an asset for more than 12 months, again exempting existing investments.

Experts say changes to property tax breaks would be unlikely to lead to a major fall in property prices, but investors could be forced to sell and that could force rents higher. 

The debate comes as the latest data showed home prices edged higher in September, up 0.4 per cent nationally according to CoreLogic, but the pace of price growth had lost momentum during the past few months.

What is negative gearing and why investors could sell up if tax breaks change

Negative gearing allows investors to deduct losses from their income —  such as interest payments, property charges and maintenance —  when they exceed rental income.

Australian Taxation Office (ATO) data shows 2.3 million Australians declared rental income in 2021-22, with about 71 per cent of landlords owning only one investment property.

About 950,000 landlords made a loss that year, when interest rates were still at historic lows.

Landlords are expected to book even bigger losses going forward, given interest rates only started increasing in May 2022.

Since by its nature, negative gearing requires that investors make a loss, on its own it is not the main reason people invest in property.

Investors typically chase capital gains, putting any potential change to the tax discount front of mind for many.

Ray White auctioneer Greg Brydon has raised concerns about any tweaks that would cut existing tax breaks for investors.

He argued tax changes could have a bigger impact on some investors than rising interest rates.

"When we're looking at properties in Melbourne, there's 30 per cent of the marketplace that have a mortgage, so the increase in interest rates is probably not affecting them so much," he said.

"But if you're looking at the tax breaks that are attributed to that, there's a lot of people that would be heavily affected if they were taken away or even diminished."

Property investor Sue Bunworth, a landlord in Melbourne, said changing tax rules to landlords' detriment would impact her vote and would mean she would have to consider selling the investment property.

"It's going to be very uncertain for us (if changes are made), because that's what we're banking on (the capital gains on the sold property) for retirement."

Scrapping negative gearing could see house prices fall but push up rents 'marginally'

Over the years, numerous groups including the Organisation for Economic Co-operation and Development (OECD), have suggested that capping tax breaks for housing could help reduce house prices and ensure that property is not concentrated in the hands of older and wealthier Australians. 

Grattan Institute's Brendan Coates said while their updated modelling suggested the impact on house prices would be minimal, possible changes would still help more renters to become home owners. 

This, he argued, would raise the rate of home ownership, because first homebuyers would be bidding against fewer investors at auctions.

Mr Coates said separate modelling by NSW Treasury economists predicted similar reforms could raise the rate of home ownership by 3 percentage points – from 67 to 70 per cent – in the long term.

Separately, researchers have also looked at the impact of negative gearing on rents and found that getting rid of the tax break would force some investors to sell and marginally push up rents.

A University of Melbourne study by academics Yunho Cho, Shuyun May Li and Lawrence Uren found eliminating negative gearing would reduce total housing supply by 1.8 per cent and increase rents by 2.5 per cent.

"The exact percentage increase varies depending on assumptions and how the additional revenue from the removal of negative gearing is used," Dr Uren said.

Negative gearing may encourage investment in housing that would otherwise not take place, he noted, and "as result, it does increase the supply of housing".

Dr Uren said while their research did not focus on capital gains tax discount, there was a case for change.

Since 1999, the capital gains tax discount was made a little more generous, with investors able to halve their capital gains.

But prior to that, it was adjusted with inflation.

"Returning to a system of indexation makes sense and would not be difficult to implement, given changes in information technology."

He said the federal government was relatively limited in the range of tools that it had available to deal with the housing crisis but believed the "underlying affordability problem is due to a lack of supply of housing".

Housing supply an 'enormous' issue

Peter Tulip, chief economist at the Centre for Independent Studies, shared this view, noting that while there were equity considerations for looking at these housing tax breaks, the benefits tended to be skewed towards those on higher incomes.

He said getting rid of them would have "very little effect on housing affordability".

He contended that to solve the housing crisis, governments needed to increase the supply of new homes.

"Estimates put it at 30 per cent to 50 per cent effects on house prices. So in contrast to tax concessions, zoning is huge."

He said while builders and developers want to provide more housing in inner cities where people want to live, they faced restrictive planning rules from local and state governments.

"We have restrictions on height, we have restrictions on where land can be used, what it can be used for — all sorts of restrictions on supply make it difficult to provide the housing that people are very happy to pay for," Dr Tulip said.

The government's 1.2 million housing target was a start, he said, but called on federal policymakers to "get serious and do some policies that have much bigger impact on housing supply, and hence affordability".

CoreLogic head of research Eliza Owen said changes to property tax breaks would take some heat out of the investor market, but agreed increasing supply was also important.

"We also see that a lot of investors utilise negative gearing strategies, so it may lead to some sell-off in investment properties, which would also bring prices down."

And while it could impact the amount of landlords renting out homes, she said this could be offset by first home buyers getting into the market more easily.

"It's fair to look at these reforms as a way to make the housing system more fair and equitable, as well as other policies which could bring housing values down — and a lot of it looks like that's going to come from an increased amount of housing supply," she said. 

Benefits of negative gearing, CGT discount skewed in favour of those on higher incomes

Ben Philips, associate professor at ANU, said negative gearing was often cast as being the cause of high house prices.

"But I don't think it's the major player in why house prices in Australia and, frankly, many other countries are so high and have increased so much in recent years," he said.

He noted that there might be some scope to look at the favourable treatment of capital gains for investors.

The Henry Tax Review recommended reducing the 50 per cent CGT discount to 40 per cent.

Mr Philips said that may be worth revisiting, "but again, I don't think it's likely to have a huge impact".

He said removing the CGT exemption on the family home would have a far greater impact but that "politically, it's very difficult".

And like Dr Tulip, he agreed that planning reforms would be "much more beneficial and fruitful in terms of boosting supply" and making housing more affordable.

Mr Philips said that if changes were introduced to skew negative gearing towards new builds, "that it would be somewhat beneficial towards building more houses".

He also argued that "from an equity perspective, it's certainly true that the gains of negative gearing and capital gains will go to investors, and most investors are usually middle to high-income households".

Treasury has modelled the impacts of who gains most from housing tax breaks.

Treasury's data is a bit older than the ATO's. Its tax expenditure statement released in January shows that 2.4 million landlords claimed $48.1 billion of rental deductions in 2020–21. This resulted in a total tax reduction of $17.1 billion.

Of the total number of people with rental deductions, almost half (1.1 million) had a rental loss (were negatively geared), which added up to total rental losses of $7.8 billion. These rental losses provided a tax benefit of about $2.7 billion.

Treasury noted that about 80 per cent of the tax reduction went to people with above-median income, and 37 per cent of the reduction went to people in the top income decile.

The CGT discount – which also applies to assets other than property, such as shares — is estimated to have saved Australians $25.2 billion in 2022-23, up from $9.3 billion in 2020-21.

Treasury said 82 per cent of the CGT discount benefit was received by people in the top 10 per cent of taxpayers.