Cullen Address to Wellington Chamber of Commerce
Michael Cullen Address to Wellington Chamber of Commerce/AON Risk Services Business Luncheon
Intercontinental Hotel, Grey & Featherston Sts, Wellington
I am confident that history will judge Budget 2005 as an important further step towards putting New Zealand back in the top half of the OECD. That is the goal that the Labour-led government adopted early in our first term of office, and although it is what is known in business as a ‘stretch-target’ we have made considerable progress towards it.
We are performing very well on relative measures of social well-being, personal security and educational standards. And we are starting to regain the ground we lost during the last quarter of last century in terms of economic performance and incomes.
Indeed, while the immediate outlook is for growth to slow, we need to recognise the significant momentum the economy has gained in the last five years. The economy has grown almost 20 per cent over that period, outstripping the prevailing growth rates within the OECD, and exceeding that of our major trading partners such as Australia, Japan and the US. That has been translated into rates of employment and income growth not seen in this country since the boom years of the 1960s.
What this means is that we have succeeded in halting the slide relative to the OECD average, and have pulled back some territory. We are still positioned towards the back of the pack, however. The challenge is to sustain a higher rate of growth, driven primarily by improvements in productivity, over a period of decades.
We have succeeded in putting New Zealand back to work, but we are now hitting a potentially severe capacity constraint. That is being seen in acute shortages of skilled and semi-skilled labour, with attendant cost pressures.
Like most forecasters, the Treasury expects the economy to slow over the next two years to an annual growth rate of around 2 ½ percent. This is due to the lagged impact of recent interest rate increases, the lagged effect of the appreciation of the exchange rate, slowing net migration and a period of weaker trading partner growth.
The strength of our dollar reflects in part the strong relative performance of our economy, but is driven primarily by the weakness in the US dollar. And that in turn is something of an object lesson in fiscal policy, since while there are many positive signs of recovery in the world’s largest economy, the US continues to suffer from large current account deficits in combination with a fiscal deficit that is only barely under control. The lesson of course is that cutting tax without cutting expenditure is merely a recipe for burdening an economy with more debt, increasing its vulnerability to external shocks, and undermining investor and consumer confidence.
That is why, for my government, large scale fiscal loosening in the form of major tax cuts or undisciplined expenditure increases does not play any part in our strategy to get the economy back onto a higher growth path. Instead, we are continuing to refine a set of long-term strategies aimed at encouraging investment in capital, skills and technology.
When we want to boost productivity we need to create more and more skilled New Zealanders, better equipped, with smarter technology, more efficient communications and better business strategies.
There are several ways a government can contribute to this.
Through a stable long-term fiscal and regulatory environment which is conducive to investment and to the maturity of the capital markets;
Through direct public investment in infrastructure, education, research and targeted business support (particularly support for export industries);
And through encouraging a workforce and a population who are engaged with the process of growing New Zealand’s economy, who are financially literate and can clearly perceive a secure future for themselves and their families in this country.
Governments in the 1990s lost sight of these objectives in various ways. We have worked hard to bring them back into focus, and Budget 2005 makes more progress on all fronts.
For many business people the goal of fiscal security or stability may seem a remote concern. However, it is not, as anyone will attest who attempted to run a business during the late 1970s and 1980s. Fiscal instability, due either to uncontrolled expenditure or insecure government revenues or both, creates an environment of uncertainty, where it is known that governments may have to alter tax policies or increase debt to fund essential services.
By contrast a credible programme of prudent management of public expenditure and revenue provides an underpinning of stability and security which encourages business investment and consumer confidence. It is an important consideration for credit rating agencies and financial markets when they assess sovereign risk and determine interest rates.
It means, as we have done, ensuring a sustainable ratio between government expenditure and GDP. It has also meant, for the past five years, running surpluses so as to reduce public debt.
Gross sovereign-issued debt has fallen from 35 percent of GDP in June 1999 to an estimated 22.6 percent at the end of June this year. Alongside this, the accumulated assets in the New Zealand Superannuation Fund will stand at around $6.5 billion.
Indeed, the result of our stewardship is that in 2006-07 the New Zealand government will, for the first time ever, move into a net positive financial asset position.
That is a very significant milestone; but it is still a step along the way to where we need to be. The goal of fiscal policy is threefold: to meet the necessary expenditures on quality public services; to fund public investment in essential infrastructure; and to address future threats to fiscal stability - all of this within a taxation regime that is competitive internationally.
The most important of the threats to long term stability remains the coming demographic transition, and what the budget figures show is that, as a nation, we are far better placed to deal with this than we were five years ago.
There are only two options for addressing this challenge: accumulate assets to pre-fund some of the liability, or shift that liability onto individuals by foreshadowing future tax increases or pension cuts.
Our choice has always been to accumulate assets. It is the only acceptable way to smooth the passage through those difficult years. As the New Zealand Superannuation Fund continues to grow, its necessity as a piece of public policy is gaining wider acceptance, as is its positive impact on liquidity in the New Zealand capital markets.
It is in this context that we need to consider the ongoing need for strong fiscal surpluses. In operating balance terms, we are forecasting an OBERAC surplus of $7.4 billion this year, $6.7 billion next year and an average of $4.8 billion in the following three years.
As large as these figures sound, they are just sufficient to fund contributions to the New Zealand Superannuation Fund and meet other capital needs.
What that means is that if we do not achieve surpluses of this level, either due to tax cuts or unforeseen expenditure increases, then the result will be inevitably a trend increase in the gross debt to GDP ratio.
In other words, our fiscal options are limited if we are serious about meeting head on the need for future stability. My government has proven that it is very serious about that.
In the years to come a great deal of my effort as Finance Minister will go into getting better control over the key areas of spending where growth has been particularly volatile, notably health and education.
Over the next three budgets the allowance for new spending has been set at $1.9 billion a year, thereafter growing by inflation. That is a target that will require careful prioritisation and some moderation of expectations.
That does not mean we will be niggardly when it comes to spending money on things that strengthen our economic fundamentals and maintain quality public services.
That is why Budget 2005 gives infrastructure spending a further boost through additional transport spending. The total funds available to the Land Transport Fund over the coming four years will be $8.4 billion. This includes all of the proceeds from the increase in excise duty that came into force on 1 April, taking the resources available to the Fund from $1.54 billion in 2004-05 to $1.75 billion in 2005-06. In addition, a further $100 million a year will be provided to the Fund in the three years to June 2009 to enable planning to proceed for a higher rate of roading construction.
This is just one element in an ongoing upgrade of our infrastructure. After a marked slowdown during the 1990s in the rate of public investment in roads, electricity, water and so on, we have increased by over 70 per cent the net purchase of physical assets by government.
The budget also continues our programme of investment in education, science and innovation.
It includes a tertiary education package providing close to $300 million over the next four years to develop quality tertiary education that is highly relevant to the skills needed in the economy. It includes higher funding rates for technical and scientific subject areas including science, trades, technical subjects, agriculture and horticulture.
There will also be an additional $45 million to expand Modern Apprenticeships and Industry Training.
Key elements of the Growth and Innovation Framework also receive more investment, including:
$31 million to increase the gains from international economic partnerships;
$49 million to implement the digital strategy announced earlier this week;
$72 million to increase support for business research and development; and
$118 million to increase capability in scientific research.
These are investments in programmes that are already working for New Zealand businesses, boosting our productivity and expanding our capacity and the return on our skills.
Alongside new spending targeted at increased productivity, the budget announced a package of cuts in business tax aimed at ensuring a more productive use of capital and improving New Zealand's access to worldwide capital, skills and labour.
The key elements of the package are:
Changing tax depreciation rates to reflect better how assets decline in value. Depreciation rates for short-lived plant and equipment will increase and rates on buildings will reduce;
Raising the low-value asset threshold from $200 to $500, thereby reducing compliance costs from having to maintain fixed asset registers;
A temporary tax exemption of five years on foreign income for people who are recruited to New Zealand to work, be they foreigners or New Zealanders who have been living abroad for ten years or more;
Better access to tax deductions for R&D expenditure for companies who bring in new equity investors, so as to match the growth cycle of technology companies; and
Finally, a range of tax simplification measures including alignment of payment dates for provisional tax and GST and changes to FBT.
The cost of these and other tax measures in the budget will be an estimated $1.86 billion over the forecast period. This will be partially offset by revenue from the new carbon charge of around $720 million over the same period. However, we are still looking at a net reduction in revenues of over $1.1 billion from these measures.
I want to turn finally to what is often a forgotten element in the productivity equation: encouraging a workforce and a population who are engaged with the process of growing New Zealand’s economy.
One of the enduring features of the New Zealand economy has been significant current account deficits. What this indicates is a low level of household savings (among the lowest rates in the OECD), and a correspondingly high level of dependency on foreign capital. That is a concern because overseas investors naturally factor in an additional risk premium to their expectations of a return, tend to be less interested in the venture capital end of the New Zealand market and, of course, repatriate a portion of our national income and, all things being equal, are less likely than New Zealand investors to reinvest it in this country.
Low domestic savings, for a given level of investment, puts upward pressure on the current account balance and the external debt to GDP ratio. This makes New Zealand vulnerable to shifts in the availability and price of international capital, and adds a premium to our interest rates.
It is also a concern to the extent that ordinary working New Zealanders are disengaged from the process of investing in the future of the economy. At present their involvement is largely confined to the labour market and the residential property market.
The new savings strategy announced yesterday is aimed at encouraging individual investment in long term asset accumulation, as well as strengthening New Zealand’s capital markets.
As I said in the budget speech yesterday, if we want to own more of our future we will need to pay for it by increasing our level of domestic savings. As any analysis of New Zealanders’ net wealth will show, that is a task that many of us find very difficult.
The Securing Your Future package will make it easier for people to develop a long-term savings habit. At an estimated cost of $588 million over the next four years, components include:
KiwiSaver, a government-sponsored work-based savings scheme, including features to assist first home purchase;
a substantial expansion of the Mortgage Insurance Scheme and;
education programmes for financial literacy and first home buyers.
KiwiSaver will be a voluntary scheme, enabling people to put 4 or 8 per cent of their gross salary automatically into a managed savings fund. However, to make participation easy, new employees will be automatically enrolled in KiwiSaver and have three weeks to decide whether to remain members. Existing employees, the self-employed and beneficiaries will be able to opt in.
Savers will have personalised accounts they can take with them as they shift jobs.
There will be no tax incentives for saving per se; however, the government will contribute directly with a contribution of $1000 to each new account. It will also pay part of the fund management fees, increasing the return that people get on their investment. Policy design for KiwiSaver is well-advanced. We expect to introduce legislation to the House toward the end of this year and see it passed next year, enabling KiwiSaver to open on 1 April 2007.
Parallel to this, in April 2007 we will be changing the tax regime for investments to remove some perverse incentives:
Firstly, New Zealand based collective investment vehicles will no longer be required to be taxed as entities. Instead, they will have the option having their income regularly attributed to individual investors to be taxed at their marginal statutory rates. This tax cut will cost around $25 million.
Secondly, we will remove taxation on the gains made on the sale of domestic shares by collective investment vehicles, at a cost of some $100 million a year.
And thirdly, with respect to the more difficult area of offshore investment, we will release a discussion document in the next few weeks which will include proposals to abolish the so-called ‘grey list’ for portfolio share investment, and to tax collective investment vehicles on the basis of the change in their accrued value. The objective is to reduce the extent to which offshore investment in shares is taxed differently, depending on how and where the investment is made.
A secondary feature of KiwiSaver is to assist with first home purchase. As you know, home ownership has been declining in New Zealand. This is matter for legitimate concern, since the security of home ownership is linked with better health and educational achievement and a stronger sense of community. Ownership helps people participate in society, giving a sense of control and independence.
So while KiwiSaver's main purpose is to help people save for their retirement, first home buyers will be able to withdraw their funds for a deposit on a house. They will then be able to divert their fund payments into repaying their mortgage.
When people have been KiwiSaver members for at least three years and are ready to buy their first home, the government will help with their deposit. They will receive $1000 for each year's membership in KiwiSaver, up to a maximum of $5000.
Our estimates are that KiwiSaver will enable around 3000 households a year to realise the dream of owning their own home.
At a broader level, what we are aiming to do with these policies is to shift the savings culture so that New Zealanders take a more informed and more disciplined approach to creating and managing their wealth.
That is why we have included in the budget savings package a set of education programmes for financial literacy and first home buyers to be developed over the coming year.
In summary, Budget 2005 is a budget aimed at securing the future. It encourages ordinary New Zealanders to take a greater stake in our economic future, and in so doing should increase the liquidity in the New Zealand capital markets and reduce our dependency upon overseas sources of capital.
It encourages greater investment in increased productivity through targeted spending on education, science and business support and through targeted cuts in business tax.
And it maintains a strong fiscal line aimed at strengthening the country’s capacity to manage long term threats to fiscal stability.
I make no apology for the fact that it does not deliver across the board tax cuts. As popular as that option may have been, we are not in the game of short term stimulation. Budget 2005 is a document that plays the long game and favours investment in the future over current consumption.
What that should demonstrate to New Zealanders is that we are not about to queer the fiscal pitch just for electoral gain. The course we have set in the last five years is a good one, and we intend to stay that course.