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Pete Hodgson - Wellington Chamber of Commerce

Pete Hodgson
Thursday, 15 June 2000, 7.30am, James Cook Centra Hotel, Wellington. Speech Notes

Address to Wellington Regional Chamber of Commerce

It's Budget day, of course, so I'm breakfast and Michael Cullen is lunch. This is not your main news feed for the day, but I can give you a taste of what's coming up.

A note of caution first. Budgets need to be kept in perspective. They affect the business environment, but they don't shape it. I think that's a point that gets lost sometimes. There's a tendency in this country to focus obsessively on what the Government is doing.

This Government accepts that it has a role in supporting and stimulating business growth, but we don't pretend to have a hand on every contour of the economic landscape. There are major factors like global demand, interest rates, and currency fluctuations that we must adapt to, just as business does.

Those of you following politics closely will realise there's quite a lot of Budget information out already. One of this Government's goals is to rebuild public trust in the political process, so we tend to be more open than past administrations. Budget secrecy has often been enforced for no better reason than to maximise publicity on Budget day. We have been somewhat less retentive.

So it's no secret that Treasury's Budget economic forecasts show slightly stronger growth, especially in the shorter term, than the Budget Policy Statement forecasts did in March. The outlook also includes falling unemployment, a reducing current account deficit and rising labour productivity.

That resembles the outlook we saw in the Reserve Bank's Monetary Policy Statement last month. The RB forecast growth of 15 percent over the next four years, business investment increasing 25 percent over the next three years, exports growing 19 percent and unemployment falling below 5.5 percent.

The Bank also expects labour productivity to rise, the balance of payments deficit to fall and inflation to remain subdued.

The indications are that we are not on a roller-coaster growth cycle like that of the 1990s. The growth New Zealand is seeing now is broader based, with stronger contributions from investment and exporting. It is less dependent on debt-funded private consumption and less inflationary, because its wider geographical and sectoral spread is putting less pressure on scarce resources.

The economy grew rapidly in the second half of 1999 – something like ten percent, annualised – but a combination of one-off stimuli in the December quarter suggest strongly that that's not a symptom of a boom-and-bust pattern. Those stimuli included the America’s Cup, Y2K provisioning, millennium celebrations and election advertising, all coinciding in a way that doesn't come around often.

Fiscally, the Budget will introduce some differences from the spending profile outlined in the BPS. Partly, as Michael Cullen has explained, that's because there were some nasty surprises in the departmental baselines on which pre-election fiscal projections were based.

We found out that the previous Government had included unrealistic and unsustainable spending reductions in some of the so-called baseline figures. The Treasurer had to find an extra $200 million a year to fill those holes in baseline funding, which looks set to displace or postpone some of the new stuff we would otherwise be doing. There's also a bit more front-end loading of spending, with tighter constraints in out years.

Discipline and restraint has been required because we have set ourselves a spending cap for our first term in office and we're sticking to it. The limit is an extra $5.9 billion over the three years, with two constraints. One is that we won't build into basic programmes any allocations that depend on sustaining current rates of economic growth. The other is that we don't compromise the ability of the Government to make allocations for predictable increases in spending occurring in ten, twenty or thirty years time.

That $5.9 billion has two main elements. There is unallocated spending budgeted by the last Government that we will allocate. And there is revenue from cancelling the scheduled tax cuts and raising income tax at the top end of the scale. The unallocated provisions total $2.7 billion over three years, and the tax changes generate an extra $3.0 billion over the same period. So we're relying very little on natural revenue growth, leaving only $200 million for that to cover over three years.

At that rate expenditure growth is tracking below nominal GDP growth, so we have falling operating expenses as a percent of GDP. We are looking at a substantial surplus in each of the three years.

Where will the money go?

You might remember that Helen Clark signed a commitment card before the election, and the first priority has been to honour the pledges on that card. Four of them are big-ticket items:
 reversing the 1999 cuts to New Zealand Superannuation rates,
 introducing a fairer student loan scheme,
 restoring income related rents for low income tenants of state houses,
 reducing waiting times for surgery.

Two more pledges – cracking down on burglary and youth crime, and promoting employment through better support for exporters and small business – require a combination of increased spending and some improvements to Government processes.

Closing the gaps between Maori and other New Zealanders is another high priority that will come through strongly in the Budget.

On economic development, we have faced up to the fact that New Zealand has lagged other countries in reaping gains from the hi- tech boom. We've been hampered by our small capital base, a poor understanding of technology by financiers and a brain drain.

In the Budget you'll see a series of initiatives to promote research and development, especially in the private sector, and to encourage inwards direct investment. We will boost the budget of Technology NZ and put public funding of R&D back on track to the target of 0.8% of GDP by 2010. We want to lead by example, to encourage increased private sector investment in R&D. That investment is undeniably low by international standards.

Labour's pre-election policy was to use tax deductions to stimulate R&D in
the private sector. We proposed to allow full deductibility of R&D in the year of expenditure.

But with the advice available to us in Government, and some feedback from innovators in the business community, we've decided a grants scheme is likely to be a somewhat more effective policy. Let me explain that, because there's been some criticism of that decision in the last week or so that I think shows a poor level of understanding of the tax situation for R&D, both here and overseas.

It has been pointed out by some of the critics that Australia allows a 125 percent deduction of R&D spending and Britain 150 percent. We've been asked, rhetorically, why New Zealand can't offer just 100 percent.

Well, we do. R&D costs on a company's revenue account are immediately 100 percent deductible. Scientific research costs on capital account are also immediately 100 percent deductible. The difference comes with some other capital expenditure on D, which is currently depreciated over the life of the asset rather than decuctible immediately. It is still, ultimately, 100 percent deductible, so the difference is one of timing.

A quick example. In most countries a building used for development is not 100 percent deductible. Nor is any plant in that building. But a production prototype is deductible in, say, Australia or Britain. In New Zealand the difference is that the prototype is depreciated.


Now we were thinking of allowing immediate deductibility of those R&D investments that are depreciated. But it became clear that a grants scheme has some significant advantages over that.

For a start, it allows us to help innovation-based businesses at the stage they most need help – at start-up. Tax breaks won't necessarily allow that. They're no good to you if you're still in a loss-making investment phase and you're not yet paying tax. Start-ups need cash now, not cash later.

Another plus is that the Government knows, with grants, that it's actually getting some new R&D for the taxpayers' money it's investing. With tax breaks, the overseas experience is that while you might well get some new R&D happening, you also get a lot of reclassification of existing business activity in pursuit of tax relief rather than innovation.

There has been some righteous indignation in some quarters of the business community when this has been pointed out. Sorry, but that's just precious. It's happened elsewhere. It would happen here. New Zealand companies are no more or less virtuous than any others when it comes to minimising their taxes.

Related to that issue is the question of compliance costs. To combat creative reclassification of activities as R&D, tax regimes that allow more than 100 percent deductibility typically grow complex layers of tests and qualifications. To protect the integrity of the tax base, the hurdles on the path to a deduction can't be too easy to leap. So you end up with evidence – mostly anecdotal, inevitably – of companies failing to pursue the higher deduction, even if they might be eligible, because of the compliance costs involved in securing it.

I should also note that the Australian and British schemes are not without strings attached. The UK does not offer 150% deductibility of R&D across the board, as commentators have tended to suggest. In fact only a segment of companies are eligible, and then only for new and additional R&D.

I can't give you the details of the grants scheme this morning, but I can tell you that some New Zealand companies receiving grants will find they can effectively gain a benefit that equates to a 150% tax writeoff.

One last point. This is new-ish territory, this grants programme. It resembles the Technology for Business Growth scheme, but it breaks new ground. We think it will work well. But we will keep it under constant review. We have some R&D of our own to do. We will learn by doing, like the rest of society. And we will make changes as the need arises.

Now I want to leave Budget-related matters and go briefly into a couple of issues I think some of you still have questions about, namely ACC and the Employment Relations Bill.

ACC first. I know business complains it wasn't listened to on that issue. But the simple fact is we had a crystal-clear pre-election commitment to undo the partial privatisation of accident compensation.

We didn't, and still don't, believe that the premium savings offered to some employers by private insurers were sustainable. Those insurers' costs are inevitably higher than the ACC's, not least because they have substantial marketing expenses that ACC doesn't have. Economies of scale mean private insurers' administration costs per claim have also been consistently higher than ACC's.

Sooner or later, something was going to give in the private accident insurance business. Either premiums were going to shoot up, or entitlements were going to be squeezed. Neither option was acceptable.

Labour made its position clear on ACC before National's changes were introduced. We gave the insurance industry fair warning. Then we won an election. We won a mandate for our policy and we've carried it out.

It might sound like I'm saying if you don't like it, tough. There's a bit of that, because this is a democracy and we all have to live from time to time with democratically sanctioned changes we don't like. But I'd also urge employers to look realistically at whether they're suffering a financial or just an ideological loss.

Last week I noticed one employer has. John Heng, of Artel Industries in Palmerston North, gave us heaps of stick over our ACC policy because he was sure his premiums would go up. According to the Evening Post he found out recently that they'll actually be slightly lower.

He won't be the only employer who finds that. The Government and ACC are delivering a lower average employer premium than private insurers have delivered.

Latest data from the Department of Labour's Accident Insurance Regulator shows employers are paying an average premium of $1.21 per $100 of liable earnings to private insurers. The Government has set the new average premium rate at $1.16, which will come into effect on July 1.

The second ACC bill, to be introduced later this year, will also reflect that commitment to cheaper cover.

So our changes aren't simply a reversal to the old ACC, which certainly had its flaws. I think the improvement in ACC's service and administration in the past couple of years is pretty widely acknowledged. It can get better, of course, and we're determined that it will.

Some criticism of the Employment Relations Bill tends to resemble that of the ACC changes in forgetting that there has been a general election. But we accept also that employers have some genuine concerns about the legislation.

The Employment Relations Bill will re-shape industrial relations around the principles of dialogue and fair dealing. We're sticking to those basic ideas and we'll make sure the detail of the bill reflects them. But the Government is listening to concerns about whether particular provisions in the Bill have unintended and unwelcome side effects. We do want to minimise uncertainty over the sorts of risks that employers and employees may face.

The fine print is being worked over as the bill goes through the Select Committee process, and the time the Committee has to deliberate on submissions has been extended. The final result will not be loaded in favour of unions, or load inappropriate risk or compliance costs onto business.

And let's not lose sight of the bigger picture here. The Employment Contracts Act was fundamentally about breaking the unions and depressing wages. It was about reducing input costs. We have to get beyond that mentality, beyond a focus on cost reduction and into value enhancement.

There are profits in cost-cutting, but it can also cut corners and have a very short-term benefit. We need an eye on costs, but not to the exclusion of other other values, including business values. There is no future for New Zealand, economic or social, in a race to the bottom of the pay scale.

We want a high-skill, high-wage economy. Industrial relations legislation by itself won't take us there, but a more balanced, constructive industrial relations environment will help. The Employment Contracts Act did not deliver that. The Employment Relations Bill and other Government initiatives like the Modern Apprenticeships scheme are about more positive and forward-looking workplace relationships. They're about building a skilled and valued workforce, and there are gains in that for both workers and employers.
So there you have it. A Government that is fiscally cautious. A Budget that will not go up in lights or contain huge surprises. An approach to ACC and industrial relations that has raised some ideological hackles, but also some real concerns that we are confident we can address.

More than anything, a Budget that acknowledges a role for a modern Government to work with business to transform an economy. A role that involves partnership, facilitation, brokerage and carefully designed and managed funding.

Thankyou.

ENDS

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