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Cullen Speech: Fiscal accountability

Thu, 29 Jul 2004

Debate contribution: Social responsibility and fiscal accountability

Social responsibility and fiscal accountability - you can have your cake and eat it.

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Speech Notes Hon Michael Cullen 28 July 2004 Epsom Debates: Social responsibility and fiscal accountability: You can have your cake and eat it tooMcGhie Lecture Theatre, College of Education, 74 Epsom Ave, Auckland

As you would expect of a Labour Finance Minister, I will argue that social responsibility and fiscal accountability are entirely compatible. Whether this implies that we can have our cake and eat it too depends upon how we are prepared to slice the cake, how many layers it has, whether we are happy to wait for it be properly cooked, and so on.

Social responsibility and fiscal accountability are two of the important building blocks of economic and social development. Each is a necessary, but not a sufficient, condition for growth, and here I mean growth in its wider sense, encompassing GDP growth and also growth in social capital, quality of life and community cohesion.

Within the political discourse of the last couple of decades we have become used to seeing them as adversaries. The Lange-Douglas era was, it is often said, marked by tension between the imperative to put an ailing fiscal ship back on to an even keel, and the imperative to steer that ship towards the promise of social reforms for which New Zealanders had been clamouring for more than a decade.

The National-led governments of the early 1990s raised fiscal accountability to the status of a kind of fetish, to be served even if it meant cutting the incomes of the most vulnerable New Zealanders.

Of course, both of these governments were reacting to the chaos of the late Muldoon period, when it seemed that both fiscal accountability and social responsibility had been thrown out of the window.

I believe the reality is that fiscal accountability and social responsibility depend upon each other. They are a kind of unhappy union of ying and yang. Each is tied to the thing that threatens its short term objectives; but each must acknowledge (albeit grudgingly) that in the long-term they can only thrive together.

This interdependence in the long-term is clear if we consider what happens when we lose touch with fiscal accountability. This may involve budget blow-outs that are not controlled, or tax cuts that are not sustainable without starving public services. The result is a loss of confidence in government, economic uncertainty, flowing on to reduced investment, fewer jobs, higher debt levels and so on.

Governments that go down this track find it hard to maintain a democratic mandate.

Conversely, when governments lose touch with social responsibility the impact is sometimes slower to arrive. This is because communities are often reasonably resilient and able to weather a temporary under-investment in social capital.

This can give the advocates of extreme fiscal rectitude a sense of having got away with tax and expenditure cuts, at least for a while.

The impact begins to show over time, however. The balance of fiscal and social policy in one decade tends to drive social indicators in the next.

Hence, if we reduce our investment in human and social capital we can expect in time to see people lose their sense of belonging and participating in society. We can expect to see higher rates of crime, of self-abuse and of the despairing life-style of dependency.

This feeds back into economic performance as the skills of the workforce are depleted, and the global labour market draws our most valuable workers away to countries where good social infrastructure and quality of life are more valued.

One has to ask: if the interdependence of fiscal accountability and social responsibility is so obvious, why are they still widely regarded as opposing forces?

I think the answer is twofold: timing and targeting. These are both things that governments find it very difficult to get right.

It is difficult to balance the need to achieve policy milestones now with the movements of economic cycles and the fact that these contract or expand fiscal options.

And it is difficult to make a shift from universal provision of government services to any regime that targets assistance, both because it alters the relativities within society and also because it creates tricky boundary issues, such as those around effective marginal tax rates for those moving from lower to higher income brackets.

However, if I might beat my own drum, I would like to argue that Budget 2004 goes a long way towards resolving these two tensions.

In terms of timing, it was five years in the making. We agreed when we came into office in 1999 that our mandate was to achieve fiscal stability first. We made solid financial management of the government's share of the economy a priority. We created a platform of stability, upon which now, tentatively, we can invest more strongly in the social side of the equation.

Total core Crown operating expenditure, at $42.2 billion, is now around 30 per cent of GDP - down from 35.2 per cent when we took office in 1999 - and even with the new spending announced in the budget this will increase only to 31.6 per cent in 2007/08.

One of our key fiscal objectives has been to keep gross sovereign-issued debt below 30 per cent of GDP on average over the economic cycle. Since taking office we have reduced that indicator from 33.7 per cent of GDP to 24.7 per cent, based on the current June forecast.

We have amended the debt target to further reduce gross sovereign-issued debt over the longer term, aiming for 20 per cent of GDP by 2015.

Alongside reduction of debt, we are continuing to strengthen the long-term fiscal position through making contributions from our operating surplus into the New Zealand Superannuation Fund. Transfers into the Fund will be $2.1 billion in 2004/05, and at June next year the Fund is forecast to total $6.3 billion. Meanwhile the Fund Guardians are moving from a cash portfolio to a fully invested portfolio by the end of this financial year, and, during the first period of investment, have exceeded their target rate of return.

The Fund will contribute to the reduction of net debt, which including the Fund's assets is forecast to be down to 8.7 per cent of GDP by 30 June this year. What is more by the end of the forecast period this will fall to zero, as financial assets equal gross debt. This will be the first time in decades that the government has been in the black in net terms.

This has been achieved in spite of a mixed economic outlook. The economy is forecast to grow by 2.8 per cent in the year to March 2005, and 2.5 per cent in the year ended March 2006. This represents a slow down from the 3.5 per cent growth we posted for 2003.

So on this stable platform we are now ready to commit to new operating spending of around $2.4 billion in 2004/05, rising to $3.8 billion in 2007/08.

The bulk of the new expenditure goes to the Working For Families package, which provides greater income security for 300,000 New Zealand families and stronger incentives for those families to derive their income from the labour market.

The package involves a set of linked changes to the tax and benefit system aimed at achieving three objectives:

- To support people with dependent children to move into work and to remain connected to the labour market;

- To make work pay by creating a much more significant wedge over benefit entitlements for people in paid employment; and

- To ensure income adequacy for families with dependent children, and address issues of child poverty in particular.

The timing factor again is important. It is a staged programme of new expenditure, reflecting what can be achieved within conservative forecasts.

The package will cost $221 million in 2004/05, rising eventually to $1.1 billion in 2007/08 and outyears. Once it is fully implemented over 60 percent of families with dependent children will be financially better off, with an average gain of $66 per week overall, and a gain in the $25,000 to $45,000 a year bracket of around $100 a week.

The package is also deliberately targeted. It places workforce participation at the heart of a strategy for the long-term well-being of families. The majority of the expenditure will be on families who are in work. The package is not just about raising living standards arbirtrarily. Instead, it is about altering the factors that make it hard for low-income New Zealand families to remain attached to the world of work.

That is why, for example, improved access to good quality childcare is an important part of the package. Childcare Assistance thresholds will be increased by about 50 per cent in October this year, immediately making a large additional tranch of families eligible. The Childcare Assistance rates will also increase, by 10 per cent this year, and a further 10 per cent next year.

In addition an extra $365 million over four years will be spent on early childhood education, including, from July 2007 an entitlement to 20 hours free education per week for all three and four year-olds. This commitment represents an increase of 79 per cent over government spending in 1999.

If we look at other areas of social spending, we see the same balancing act at play. In health spending, for example, we have recently announced the timetable for delivering cheaper primary health to New Zealanders who belong to Primary Health Organisations. We will inject an extra $415.7 million over three years to provide more affordable primary health care for everyone belonging to PHOs, as well as a standard prescription charge of not more than $3 per item, higher subsidies for influenza injections for older people, and other benefits.

The cheaper doctors' visits and cheaper prescriptions will be rolled out for 18 to 24 year-olds in July next year, and for 45 to 64-year-olds in July 2006. The scheme will be only extended to the rest of New Zealanders, the 25 to 44-year-olds, in July 2007.

What is driving this timetable is once more the need to maintain expenditure with prudent parameters, and the acceptance of the principle of targeting.

Improving access to the 18-24 age group, for example, will improve our ability to implement preventive health programmes in areas like mental illness, alcohol and drug abuse, and sexual health. Bringing the 45-64 age group into the regime of cheaper health care will be important because they suffer more from chronic illnesses, are more frequent users of the health system, and have higher avoidable rates of hospital admissions.

I do not believe the 25-44 year old age group begrudge the delay in including them under the cheaper regime.

It has been suggested that much of the Working For Families package could have been delivered via a cut in personal income tax. Not only is that untrue; it also illustrates what happens if we baulk at the principle of targeting.

The simple fact which the advocates of tax cuts fail to acknowledge is that tax cuts are an incredibly blunt instrument when one is trying to assist low to middle income families with children. The costs are tremendously high and the gains for those most in need are meagre.

For example, under the Working For Families package a family with four young children and a single income of $55,000 a year will be better off by nearly $150 a week once it is fully implemented in 2007. To deliver that amount of additional after tax income by a rate reduction would be near to impossible. A 20 percent flat tax rate, which has been suggested, would give that family just $39 for a fiscal cost of some $5.5 billion.

I take great comfort from the belief that, after decades of political parties making unsustainable promises in opposition and breaking them once in government, the New Zealand electorate has become very astute at identifying the purveyors of fiscal snake oil. If there are voters out there who are convinced by promises of large scale tax cuts in combination with significant additional spending on prisons and police (and this coming, one should not forget, from the lips of a former Reserve Bank Governor), I think they are very few.

What we have proved in the last five years is that fiscal and social goals can be achieved simultaneously, and moreover that New Zealanders prefer governments who will hold these objectives together, refusing to give way on either, but being honest about the need to manage a long-term expenditure track and the need to prioritise.

I do not think as a nation we will entrust our future to those without a credible fiscal strategy, or to those without the foresight to recognise the importance of social objectives and quality of life.

Thank you.

ENDS


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