ACT Auckland Regional Conference

Reflecting on the `Reform of the U.K. Public Sector' paper prepared by Ruth Richardson, Steve Robson and myself, I realised how little had changed.

Sixteen and a half years ago I was putting together the 1987 Budget in the face of a high fiscal deficit and debt levels that had reached 90% of GDP.

Debt servicing cost the equivalent of one dollar in four of government revenue.

The knowledge that any further growth in debt levels or even a failure to reduce it as a percentage of GDP was not sustainable and was likely to:

• head to a credit rating downgrade

• the budget deficit becoming progressively harder to control as annual debt servicing costs rose

• that in turn would put even more pressure on interest rates and inflation

• and run the risk of a sharp fall in the value of the New Zealand dollar.

In short, we were faced with the danger of a vicious cycle unless we started to control and then reduce public debt - preferably in a policy climate which also encourages ongoing GDP growth.

In these circumstances I put before key Ministers (Lange, Palmer, Caygill and Prebble) four options.

In the end we went with a mix of all four which resulted in a fiscal surplus and a small reduction in overall debt levels. This part is history - what is not widely known is the radical option I put forward. Why I argued strongly for it, and why it was rejected by other Ministers. Lange in particular taking an absolute dislike to it, telling Mike Bassett I had gone mad.

The radical proposition was put forward as a proposal to be carried out over a two or three year period.

Positive Objectives of the Proposal:

1. Reduce public debt to zero (50% stage one)

2. Cut income tax to 15 cents in dollar (15c up to $25,000, 30c above $30,000 stage one)

3. Increase targeted assistance for low income groups

4. Run budget surpluses.

Achieved by:

1. Sale of all state owned commercial enterprises including most real estate

2. Increase GST rate to 15 cents in the dollar

3. Remove remaining tax breaks leading to companies and others paying more tax

4. Increases in tax revenue due to growth

5. Reductions in net government expenditure - in part from user charges for higher income people for some social services

The strategy was essentially to ask people to accept some major trade offs.

Large upfront benefits -

• tax cuts - 15 cents in the dollar,

• increased low income support,

• a rapid solution to the budget deficit and high public debt.

In exchange for -

• a higher GST rate, 15 cents in the dollar,

• giving up public ownership of most state commercial assets,

• and charging higher income people for some social services.

Higher GST verses Income Tax Cuts:

I argued that the fairness of this type of trade-off had already been accepted in 1986 and that the large tax reductions for those in the $10,000 - $20,000 income groups would also help gain political acceptance.

Public Ownership verses Income Tax:

I argued that we had to ask ourselves (and the public) whether e.g., Government ownership of the BNZ is worth the $200 million per annum in debt servicing cost we could save if we sold it, equal to $150 a year for everyone earning over $10,000 a year.

The total package of asset sales was worth the equivalent of around $40 a week for someone on the average wage.

That is the trade off I asked Ministers to consider.

I argued that when you remembered that objectives like -

• protection from the abuse of monopoly power,

• better social services etc,

could be achieved without government ownership the trade-off was even more attractive.

Targeting of Assistance verses Universal Benefits/Free Services:

I argued that the problems associated with universal free services were -

a. efficiency considerations;

b. a failure to achieve equity objectives.

a. Efficiency Considerations:

The problems were numerous and included -

• the difficulty of assessing performance in the absence of contestability and in the absence of incentives for managing assets well.

• the difficulty of holding managers accountable because it is hard to assess performance.

• the difficulty of providing adequate incentives for performance in a form that will attract and hold the best managers in the absence of performance assessment, it is hard to justify paying managers competitive salaries.

• the tendency (in the absence of assessment, accountability and incentives) for the interests of producers, particularly the interests of professional groups, to come to dominate decisions on resource use at the expense of consumer groups.

• the effects of the higher taxation required when the government finances production rather than apply `user pays'.

b. Equity Objectives

The equity problems associated with universal free services in 1987 are still with us today and include -

• Producer Capture: Careers are made in various `welfare industries' and policy considerations are often dominated by organised employee organisations.

• High Income Capture: Though assistance is ostensibly freely available, in several areas the use of subsidised social services is dominated by people from wealthy backgrounds.

• Middle Income Churning: For many social services middle income earners are both the most important funding source (via income tax) and major users. This process imposes avoidable costs and thereby welfare is reduced unnecessarily.

• Erosion of Individual Incentives: Whenever services are offered free or cheaply they inevitably displace alternative sources of supply.

• Reduction of Choice: Whenever social services are provided via state dominated organisations they service tends to be homogeneous, however, individual needs vary and those are simply not catered for.

I argued that in order to achieve the government's equity objectives it was vital that we asked and answered a series of questions: -

• What are the reasons for government support?

• In what circumstances does the Government need to provide such services itself, or merely pay for them?

• Should providers face competition, including government providers?

• If government support is provided who should the money go to - client or provider?

• What is the best way to achieve any minimum standards required by government?

I pointed out that universal provision of a given minimum standard does not imply necessarily provision by the state, nor does it imply state ownership of the assets. Rather the aim would be to adopt the most efficient and equitable means of ensuring access to the desired standard of service.

Targeted financial assistance for lower income and otherwise disadvantaged clients of services would, I pointed out, be vital.

I summed up the case for social policy reform in this way.

At present the dominance of state ownership and universal provision in social policy is undermining equity goals and stultifying efficiency promoting initiatives.

A shift to financial support for low income users in a user pays environment with more competitive suppliers would permit more successful equity targeting, promote more efficient production, and increase the consumer orientation of services.

I stated the case for the radical strategy in this way:

1. It offers benefits up-front in exchange for the costs of GST increase, expenditure cuts and for tackling the sacred cow of government ownership. That makes it easier to win acceptance than for tax increases, spending cuts or asset sales on their own.

2. A tax cut to 15 cents would set us a phenomenal stimulus to growth. Attract business and investment to New Zealand in preference to Australia. The boost to employment and GDP growth would dramatically ease the pain of adjustment associated with reducing inflation and reducing industry assistance.

3. Conversely, given that the US and UK have cut their income and company tax rates, we will lose investment to them if we increase tax rates (Lange solution). We will be a successful economy only if we offer a climate for investment that is as, and more attractive than, other economies.

4. The strategy will short-cut the process of getting the government accounts into balance.

5. It comes out best in terms of the full employment objective.

6. Privatisation was becoming less of a bogey with e.g., Australia and Poland undertaking some.

7. The strategy is bold and comprehensive and allows the government to take the high ground.

Lange argued in writing strongly against the proposal saying:

• Our supporters would be appalled

• We would not be united

• We would be seen as uncaring

• The 1987 Budget should do little more than signal our intention to reform the social services

• On the ossie of the growing public debt he said it persisted because we refused to ask taxpayers to pay for past mistakes

• `If we spend it, taxpayers have to pay for it"

• On asset sales he said we had made commitments which we could not repudiate in 1987

• On reform of social services he stated my approach was simply wrong - that people who support Labour were enriched by it and that tax cuts meant little to them.

Lange's preferred Budget strategy involved:

• Not cutting government income but rather talking about better value for money.

• On social services he stated, "People will pay for public health and education services. They may not be happy with the service they get now but they value them and would pay for better services. That is the UK evidence. People support public hospitals, pensions and schools. That is what concerns them most. (Sound familiar).

• On the revenue side, he stated there was nothing inevitable about tax reductions. They have served their purpose. Any more will be seen as the worst kind of electoral indulgence.

• He concluded by saying that this years' deficit (it ended in a surplus) should be lower as a percentage of GSP. It can be lower in money terms if that can be done by a mix of efficiency gains and additional revenue.

Clearly 16 years later the arguments between the left, many conservatives and reformers has changed little.

In my reply to Lange I stated we were arguing about means not ends and that my proposal would get us there, his would not.

I argued that his approach -

• Was silent about any strategy for increasing employment or real wages,

• That we have had a 25% real increase in spending in the social policy areas over the last 3 years - for what?

• That in the same way that SMP's were captured by the meat and transport industries, low interest loans were captured in higher house prices and could we be sure more government expenditure on health, education or other social services will not be captured by the wrong people.

• That a higher government expenditure / tax scenario he was painting was also a higher unemployment one as well. I asked the question "do you really think we are doing more for our traditional supporters by offering more welfare rather than more jobs and higher wages?

• I went on to advocate the idea of "negative funding" and the need for an approach that really does put people ahead of institutions, that helps people to help themselves.

• I summarised by saying that what David wanted in the budget was not achievable. We cannot lower the deficit unless we cut spending or increase revenue. That trying to get more tax only from the upper income taxpayers was not an option as there was little income there to begin with and the incentives would once again be perverse away from effort towards avoidance, evasion and emigration.

In my reply to Lange's letter I made a number of points I still believe to be relevant to New Zealand's situation:-

• Tax increases hurt the disadvantaged through their negative effects on employment and real wage levels.

• Tax increases are needlessly costly in social terms. They hit low income people. They hit hardest at people who are at a disadvantage in the labour market.

• If we can attract skilled people and investment here, through a low tax environment, we can generate job growth in a way no other scenario offers.

• The guaranteed minimum income concept for those in work - provided a level of protection for people at the bottom end.

• Top-end people can start to pay more for social services in exchange for the tax cuts they receive.

• It would allow us to retarget social policy expenditure to do more in areas of real need.

• If we have e.g., 10 disadvantaged tertiary students out of 100, we have to give an enormous bonus to the other 90 if they all get the same level of assistance that the 10 really need.

• That this was like what happened with secondary teachers pay claim last year. A 35% pay increase across the board wasn't enough to fix the problem of shortages in specific areas, but cost us an arm and a leg and still did not fix the problem.

I concluded by:

• Restating that we had to put people ahead of institutions in our social services e.g. we are putting a lot of health resources into ACC patients with minor complaints while waiting lists persist.

• That we had to overcome the problem of providers capturing much of the benefits of social policy expenditure. This would clearly invite a change in incentives - and the organisational structures accountability system that determine them. That this was absolutely critical to any real change of attitude, of culture in an institution.

• I stated that I believed my strategy could deliver on both scores. That is offered the means of changing incentives and attitudes, so that providers faced the incentive to work in ways that best achieved our goal of putting people - the consumer in the system - first.

• Good government meant being hard-nosed about meeting our objectives. It is not about running things. Air NZ brought its international fares down not because we ran it but because of competition.

• In the social policy area - we needed to do more for consumers by changing the environment in which the service providers operated than by just adding to our investment in the existing institutional set up.

Finally I said:

"I don't want to leave any impression that I am dogmatically committed to one particular way in social policy reform. I am not. But I would like a discussion about it that does not rule out any option before we start.

We have to start with our goals.

We have to be realistic about the inherited problems we face and the resource constraint that imposes on us.

We have to be clear headed and thorough in analysing the policy options for achieving our goals.

And we have to be hard-headed about the decision we finally take.

There will be political judgement involved in that decision, and in how and when it is presented and implemented.

We should not however make that political judgement before we have the considered discussion."

The same arguments continue today.

The same problems exist today.

One has to ask the questions:

• What would New Zealand be like today had I got my way?

• What would Ruth Richardson have done in 1991 (more in education, health and welfare for sure)?

• What has changed in the intervening 17 years?

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