Ordinary Australians expect to be able to buy their own home. Young and lower-income Australians are fed up with policies that work against them being able to do so. The proportion of homes they can afford to buy is shrinking year by year - right now, month by month. For a bold government, there is an opportunity to cut through and make big reforms by appealing to people's sense of fairness and the need to get policy back on track. In one swoop, it should remove the two big tax distortions of the market. End the exemption of the family home from capital gains tax. End the tax break for negative gearing - or limit it to new homes built by the investor. And, at the very least, require temporary residents to report their property purchases, so we can know whether we have a problem or not. Over time, those changes will bring down housing prices relative to income. Tax breaks for housing have inflated house prices. Phase them out, and prices will fall back into a range that ordinary people can afford. Last week, the Tax Office reported that at least 1.2 million Australians - one in every 10 taxpayers - are now negatively geared landlords. On average, in 2007-08, they claimed losses of more than $200 a week on their properties. This gave them a tax break of about $5 billion that year - 4 per cent of all income tax revenue. In effect, other taxpayers had to pay that $5 billion to subsidise their losses.

As public policy, this is ridiculous. But since negative gearing was restored in 1987, this tax break and the decision to halve the tax rate on capital gains have seen investors' share of finance to buy existing homes jump from 8 per cent to 40 per cent. Those squeezed out were first home buyers. My article last week led to an interesting debate on The Age website, and later on the Business Spectator website. Not surprisingly, many landlords argue passionately that negative gearing is good for us - but mainly because they misunderstand how the housing market works. Let's take those arguments, and see how they stack up to reality. Claim 1: If tax breaks for negative gearing were limited to offsetting rental income, landlords would pull out of the market. This would create a shortage of rental housing, and drive up rents. The victims would be the renters. Response: This is a basic misunderstanding of something that is quite simple. If a house is not sold to a landlord, it will be sold to someone buying their own home. There will be one less home for rent, and one less household looking for rental accommodation. Supply will fall by one, demand will fall by one. There will be no change in the balance of supply and demand, hence no shortage, and hence no rent rises on this score. It would be different if investors stopped building new housing. But 91 per cent of lending to investors is for purchase of existing homes. One option for reform is to restrict the tax break to construction of new homes. Claim 2: We saw what happened when the negative gearing tax break was abolished in 1985. Investors stopped building new homes and and rents soared. That will happen again.

Response: Sorry, but that is an urban myth. Yes, construction fell, but by investors and owner-occupiers alike, and why? Because interest rates soared to 17.5 per cent for investors and 15.5 per cent for owner-occupiers. Even so, construction by investors was a higher share of GDP in those years than in 2009. As for rents, Bureau of Statistics figures show capital city rents rose 22 per cent in the two years when the tax break was abolished, and 23 per cent in the following two years after it was restored. End of urban myth! Claim 3: Investors in all kind of assets are allowed to write off losses against income from other sources. To restrict rental investors to writing off losses against rental income only would introduce a new distortion that would simply push investment elsewhere. Response: This argument normally has force. But when 70 per cent of housing investors are claiming losses, we have a distortion here and now. It is sending investment into activities that clearly do no good to the economy, and harm those who want to be able to buy their own homes. The problem is not landlords: they will always have an important social role. The problem is the tax laws, and the politicians on both sides who lack the courage to right the wrong done to younger and lower-income Australians.

We also need to build more homes, especially in inner and middle suburbs where people want to live. But that is another story, for another day. Tim Colebatch is economics editor.