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Cullen Speech Business Herald Post-Budget Seminars

Speech To Business Herald Post-Budget Seminars

Hon Dr Michael Cullen, Minister of Finance

5.30 pm, Tuesday 5 June 2001

Wellington and Auckland

The detail of the Budget is now long gone, and while I am happy to answer questions about it; I would like to use my time tonight to assess the reaction to it.

The interesting thing about the Budget was that it was delivered in the same week as the Australian Budget, and there was a major difference in emphasis and style between the two. Circumstances in Australia may well have been different, especially with their short-term economic outlook, so comparisons between the spending profiles in the two Budgets are difficult to make.

From where I sit, the general reaction to my Budget has been positive. People want a solid economy and improving personal prospects, and do not seem to want to be bribed, especially with their own money.

There has been a predictable expression of disappointment from some spending sectors that wanted more. In particular, health and tertiary education have been critical of the amounts allocated to them.

With health, it is important to remember that it did get significant attention in the Budget. Let me give you some ballpark figures. Health got 44 percent of the money available for new spending in this year’s Budget. In dollar terms, health expenses are up by 5.7 percent. The government has committed itself to just under $1,000 million in new operating funding and $450 million of capital funding in the health sector over the next four years. That is big money in any language.

More importantly, though, there is a better focus on where the money is going. The new allocations protect the funding base of the existing system, extend spending on elective surgery, emphasise that prevention is better than cure, and see the health system as one that always strives to improve quality of life. After all, we all want a health system, not a sickness system.

With Tertiary education, I have not heard negative comments except from inside the sector. The tone seems to be that we have to get more focus into the sector before we put more money into it and our patience and determination has been applauded.

I have been a bit surprised at the muted responses to what I see as the very positive and forward looking aspects of the Budget: our initiatives to develop human capital, spend on industry training, promote research and development and cover weaknesses in our venture capital market.

Our economic and regional development programme is now taking shape, and building up to the full funding levels envisaged in last year's budget. The focus is on innovation, through incubator support for fledging companies, support for the commercialisation of intellectual property and help for small firms to develop early stage business concepts and projects. This is in addition to projects that assist industry, community and regional development initiatives.

We are backing New Zealand's innovators with a $100 million seed and start up capital investment fund in partnership with the private sector to assist in the development of innovative high-tech business. There is also an increase of $11.6 million in direct research funding.

And to make sure we have the people with the right skills for a changing economy we are spending an additional $56 million over the next four years to create more than 17,000 extra industry training places.

These policies are designed to build on our strengths and unlock potential at all levels.

There are, of course, those who want fiscal discipline and tax cuts, and I say yet again, that you can’t have both.

Except, perhaps, for the National Party, which has produced a wish list that would make the Australians look like tightwads, and also wants tax cuts and falling government debt. How they intend to squeeze those three quarts into a pint bottle simply confounds me.

I want to respond next to the criticism that the government has a rising debt profile, when expressed in dollar terms, and more specifically to the suggestion that the debt and the prefunding of New Zealand Superannuation are linked, via borrowing to put money into the fund.

I have to say that a lot of that criticism is not so much a criticism of the Budget, but a criticism of the government’s long term fiscal objectives and short term fiscal intentions, masquerading as a criticism of the Budget.

I say this with some irritation because politicians who rail against the debt track never raised this as a concern when successive Budget Policy Statements and Fiscal Strategy Reports were presented to the Finance and Expenditure Committee or to Parliament itself.

I do note, with some amusement, that the same politicians have simultaneously criticised me for spending too much and too little.

Let me put this debt business in perspective because it has become the victim of distortion through over-simplification.

The government collects revenue and incurs expenses in the course of financing its operations. Operations must meet various targets: revenue to GDP, spending to GDP and operating balance. I have always said that the operating balance must, in general, be sufficient to cover transfers into the superannuation fund. If it is not, the government must explain what it intends to do with any shortfall, and how it intends to make up for any underpayments if they occur.

In this Budget, we forecast operating surpluses of $1.4 billion in fiscal 2002, and $2.4 billion, $3.1 billion and $3.7 billion in the years after that. They are fully adequate to cover transfers into the super fund of $600 million in 2002, and $1.2 billion, $1.8 billion and $2.5 billion in the years following.

Indeed, over the four years of the forecast horizon, the forecast operating surpluses are 72 percent above the amounts needed to meet fund transfers.

Alongside its operations, the government funds its capital programme. This also needs to meet defined targets. They are gross debt to GDP, net debt to GDP and net worth targets. The debt financing will jump around. For example, refinancing hospital and housing corporation debt through central government will lower the cost of debt servicing. It will show up as an increase in Crown gross debt but not Crown net debt. Delays in (say) building new schools or prisons will show up as a fall in net debt in the current year, but this will be offset by a rise next year. Lumpy spending on re-equipping the defence forces will cause a “blip” in nominal debt when it takes place in four or five years time.

The key is to keep debt in line with declared objectives, which the Budget does.

Now I want to pose the counterfactual. What if there was some extra constraint applied to the government’s finances to say that as long as there is a superannuation fund, debt must not increase in dollar terms?

There are three scenarios.

One is that there is no fund. Under this scenario, because we are not borrowing to pay into the fund, nominal debt can increase. So if a future government borrows to restore an air strike capacity and give every school child a laptop computer, that would be fine. It would be legitimate to “borrow” to fund assets that depreciate in value but not assets that appreciate in value. That would be bizarre.

Scenario two is that it is not legitimate to increase nominal debt at all. Under this scenario we take an arbitrary moment in history – 30 June 2001 – and an arbitrary level of prices and incomes, and put a money debt straightjacket on the community for the rest of time.

As inflation continues, even at low levels, and as the economy grows, the debt to GDP ratio would gradually decline. That is a legitimate debt target to have. It is just that it is not our debt target. What Mr English seems to be saying is that we are wrong for not having a debt target that was more ambitious than even the one he had when he left office!

The argument is not about borrowing to put into the fund. It is about borrowing at all!

Scenario three is that it is not legitimate to put money into the super fund unless surpluses (and as a technicality it would require cash surpluses at that) are big enough to fund both the transfers and the full net cost of the government’s capital programme. That would be highly contractionary – requiring higher taxes or major cuts to spending programmes to boost already large surpluses.

This, though, is where the logic leads. If the opposition wants, as it says it wants, $510 million to reverse the top income tax rate, $375 million to cut company taxes, $2.4 billion to double teacher salaries, $80 million for universities, $260 million for hospitals, and on and on the wish list goes,

then it must make an equivalent reduction in capital spending or else it will be “borrowing” to fund these things.

That, or it is trying to apply one set of rules for things it likes and another for things it opposes.

The Opposition may well think it has a politically populist angle, but it is showing up a hugely simplistic and dangerously distorted grasp of the fundamentals of fiscal management. It is trying to score political points, but is damaging its own credentials and credibility in the process.

Finally, I will make a few comments about the call to cut corporate taxes to 30 percent.

I won’t say a lot on this because I would like the debate on any recommendations that the Tax Review may come up with to be uncluttered. However, the clamour has been so persistent that I couldn’t claim to be responding to Budget commentary with credibility if I didn’t make some comment.

There are three responses needed.

Firstly, it is not valid to compare a 30 percent nominal company tax rate in Australia with 33 percent in New Zealand. We need to compare the burden of corporate tax in both jurisdictions. Australian corporates have other non-discretionary levies to pay, and work has not been done to explicit plus implicit taxes on both sides of the Tasman.

Secondly, it is important to identify what a lower corporate tax rate does. For New Zealand resident shareholders company tax is merely a withholding tax. They are eventually taxed at their marginal tax rate, so if a shareholder has, say, a thirty nine cent marginal tax rate the only difference between a company tax rate of 30 and 33 percent is that an extra nine rather than an extra six cents has to be paid at the end of the day.

The actual benefit of a lower company tax goes to foreign resident shareholders, for whom it is, in the main, the final tax. Leaving aside the political question of whether our fiscal priority is to give tax breaks to foreigners, the core question is whether this actually attracts any new foreign investment. Since this is a small increase in what is left over from profitable investment, is the business community really saying to me that the profit potential of investment options for foreigners here versus elsewhere is so finely balanced that this will swing deals? I doubt it, but at least we need evidence not emotion to inform that decision.

My recent experience is that after tax profits in New Zealand have been driven by factors like the level of the dollar, the weather, consumer confidence, overseas prices and the state of the world economy and a three percent tax on profits would have been swamped by these first order influences on revenues and costs.

Finally, a lower tax rate might allow higher levels of retained earnings to be reinvested. This assumes shareholders are willing to forgo dividends. Even if they are, the level of reinvestment is governed more by the prospects for future profits than by the untaxed amounts left over from past profits. In this regard, it is just as important to ensure that economic conditions, the skill system, the innovative environment and economic development initiatives create opportunities make profits. There is no benefit in even having a company tax rate of zero if there are no profits to be made.

Overall, I am happy with responses to the Budget. It presents a robust economic outlook backed by a strong fiscal position. There is some explaining to be done on some of the content, and some debate to be held on some of the options for the future. If before the Budget I had had the advantage of advice received since, I really wouldn’t have changed it. On that standard, I may not have satisfied you, but I have satisfied myself!


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