Usually pre-budget leaks are all about giving people snippets of what will be contained in the treasurer’s budget speech; this year, perhaps in keeping with the odd timing of the budget, the biggest leak has been about what will not be included – namely changes to capital gains tax or negative gearing.

The government’s overarching housing policy narrative is about aspiration – that we all want to get ahead and if we are not negative gearing now, we all aspire to do it one day. Essentially it is the replacement of the great Australian dream.

Home ownership? Pfft. Buying one home isn’t cool; you know what’s cool? Buying multiple properties to negative gear.

But aspiration is hard thing to measure – especially when it comes to home ownership.

It is also worth remembering that 30% of Australian households are renters, for whom thinking about buying a second property is a very long way down the list of priorities.

But now we have the treasurer and a prime minister standing with a couple talking about how they are negative gearing properties as an investment for their one-year-old daughter.

We have the prime minister saying that it was “beside the point” that most of the benefits of capital gains tax go to the top 10% of income earners because “of course people on the highest incomes will make the highest gains because they tend to have more property”.

And we have government backbencher Alex Hawke on Sky News arguing, “Everybody relies on property speculation, investment to generate their basic wealth – it’s a fundamental of Australia’s wealth creation”.

Yep – a government MP talking up property speculation. Cripes, someone send Hawke a copy of The Big Short.

The ramp up in negative gearing talk has come not just from the government’s announcement on the weekend, but also the timely release of the Grattan Institute’s latest report on the topic, “Hot property: negative gearing and capital gains tax”.

The report addresses not just negative gearing but also the forgotten child of the housing affordability debate – capital gains tax.

In reality it is changes to capital gains tax in 1999 that really set the fire under the housing market by turning negative gearing from a niche activity to one which the treasurer would suggest is a favourite of nurses and teaches and police officers – the archetypal “mum and dad investors”.

Prior to 1999 capital gains were taxed at a real rate – the nominal return less the inflation rate over the period you owned the investment. The Howard government then changed it to taxing the nominal rate, but only for half the amount.

At the time there was actually debate over whether or not this would lead to people paying more tax.

Mark Latham – then on the opposition backbench – argued the change was “an open invitation for the tax minimisers, the tax avoiders and the capital speculators to do their worst in the Australian economy”.

And whatever you might think about Latham’s more recent contributions to public debate, he sure as heck was on the money on this issue.

Prior to the CGT changes, the number of rental properties that produced a loss were roughly equal with those that made a profit. But as soon as the changes came in, rental losses became much more attractive:

The Grattan Institute’s report released this week also shows the monetary impact of the changes – rental losses very quickly started outweighing the profits:

The reason is the combination of the CGT discount and negative gearing made for a very attractive tax minimisation scheme.

The tax system thus in effect encourages you to engage in “debt-financed and speculative investments” because negative gearing enables you to minimize your current income and the CGT discount enables you to minimize the tax on your profit – because you get to choose when you sell your property.

It’s a combination that has produced an odd state of affairs where the Reserve Bank notes that “in most countries the earning of rental income is seen as the most important reason for investing in rental properties ... This seems to stand in contrast to the situation in Australia.”

Ain’t that the truth – and it is one that really can’t be denied.

There was no reason in the early 2000s for why suddenly landlords would start losing money on their rents – it was a purely driven by the changes to the capital gains tax – and the level of impact clearly demonstrates that the discount is too great.

And yet we now have the government in effect arguing that not only is the distortion not a concern – it is something that should be encouraged.

We also have the prime minister arguing that the ALP’s proposed changes are attacks on economic freedom and that negative gearing “is not a tax break, it is a standard concession.”

Please.

No one has any issue with being able to deduct business expenses, but that is not what negative gearing is.

Negative gearing is about deducting the interest costs of an investment property against income that has nothing to do with that investment.

As the Grattan Institute notes, “Negative gearing effectively converts wage income into more concessionally taxed capital gains”

And it does so in a manner that distorts the housing market and sees most of the benefits go toward the wealthiest.

The Grattan Institute notes that 54% of the benefits from negative gearing goes towards the top 20% of taxpayers. But importantly, because negative gearing is used to reduce people’s taxable income the report also notes that when you look at peoples’ incomes before taking out the rental losses, the benefits are even more unequally distributed – with 47% going to the top 10% and 68% to the top 20%:

The benefits of capital gains tax are even more weighted towards the wealthiest.

The argy bargy over negative gearing often falls into who benefits. As the Guardian’s Gareth Hutchens noted, essentially it breaks down to the opposition referring to percentages and the government wanting to use nominal figures (because while a greater percentage of surgeons who negative gear there are more nurses in total who do):

But really the issue is of a tax policy that drastically changed people’s habits towards minimising tax and had the side effect of setting fire to the housing market and leading to a massive spike in the level of housing debt:

Over and above whether negative gearing or the capital gains tax benefit the wealthy (which they do) the issue is whether the tax policy has distorted Australia economy.

It clearly has and as a result at the very least, the discount to capital gains tax needs to be reduced.