Cullen - Speech to Bayleys Cocktail Function
Wednesday 1 June 2005
Speech to Bayleys Cocktail Function
Level 14, Bayleys Building, Cnr Brandon St & Lambton Quay
All budgets prompt an immediate melee of claim and counter claim in which some of the key messages tend to get lost. Certainly, the rather bizarre suggestion that the media circulated in the week preceding the budget, that it contained sizeable tax cuts, was a great distraction.
What I hope is starting to emerge as the dust settles and people read through the document is that Budget 2005 is a balanced set of strategies for dealing with the challenges which lie ahead of the New Zealand economy. It is indeed much more ‘pro-business’ than many realise.
I have three reasons for saying that:
First, it follows a fiscal strategy that will progressively lessen the degree of risk that attaches to New Zealand’s economic future, which creates a stable platform for investment;
Second, it responds to the current soft landing forecast for the economy in the only sensible way: by a package of tax cuts and business support initiatives that target the need to increase productivity in an economy whose major problem is a capacity constraint; and
And third, it contains in the KiwiSaver scheme a plan for getting more ordinary New Zealanders hooked in to saving and hence engaged in the economy beyond the familiar bounds of the labour market and the residential property market.
The first strategy is a secure fiscal strategy. It is certain not sexy; but without it no other strategy can be maintained, sexy or otherwise. 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.
What we have put in place over the last five years is a programme of prudent management of public expenditure and revenue. This is one of the most important ways that governments can provide a supportive environment for economic growth.
Gross sovereign-issued debt has fallen from 35 per cent of GDP in June 1999 to an estimated 22.6 per cent 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’s government will, for the first time ever, move into a net positive financial asset position.
That is a very significant milestone towards addressing the most important of the threats to long term fiscal stability: that is, the coming demographic transition. 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.
Gross debt is forecast to move to about 20 per cent of GDP by the end of the forecast period, and to remain around that figure over the ten year projection period beyond that. Any proposal to increase that debt track, be it a significant cut in tax rates or a significant increase in baseline expenditure, will inevitably increase the likelihood of sudden and disruptive tax increases in the years ahead. That will have an impact on how the international financial markets and credit rating agencies view New Zealand and this will immediately be built into interest rates.
That does not mean we should lock in the detail of current fiscal settings in perpetuity; only that we need a very clear rationale for changing it. Cutting taxes in response to a large surplus one year, when forecasts show that surplus diminishing in the ensuring years, and indeed becoming a deficit in cash terms, is mere folly in anyone’s book. The same applies to unsustainable expenditure increases.
Nevertheless, Budget 2005 does include both tax cuts and spending increases. The key point I would make, however, is that in both cases these are modest in terms of staying within the fiscal parameters, and carefully targeted so that they are a good quality spend.
One of the main contributors to the current downturn is a severe capacity constraint. Our labour market is stretched too tight. Our level of capital investment in technology and infrastructure is holding us back.
Our economic engine, in other words, needs to be made bigger and given another gear. The worst thing to do in these circumstances is merely to stimulate the economy with more spending or significant and untargeted tax cuts. That would be like adding more oxygen to the fuel mix. We get a surge of power that dies out almost as soon as it appears.
The budget’s answer is to focus on raising productivity through two channels.
The first is the business tax package. This is 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.
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 talking of a net reduction in revenues of over $1.1 billion from these measures.
Alongside of there tax measures, Budget 2005 continues to support the Growth and Innovation Framework with fresh investment. This involves:
$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.
The centrepiece of the budget is the KiwiSaver scheme. As it builds to maturity, this scheme will bring a raft of social and economic benefits.
KiwiSaver is a government-sponsored work-based savings scheme, enabling people to put 4 or 8 per cent of their gross salary automatically into a managed savings fund. 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. Our working assumption is that 25 percent of the eligible workforce will have enrolled in KiwiSaver by 2012. All things being equal, the scheme should lead to a general increase in the liquidity of New Zealand’s capital markets. It represents a significant opportunity for financial intermediaries at both the retail and the wholesale level.
What lies behind KiwiSaver is both a desire to raise our level of domestic savings and to shift the savings culture so that New Zealanders take a more informed and more disciplined approach to creating and managing their wealth.
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 savings and a high external debt to GDP ratio put pressure on our current account balance. This makes New Zealand vulnerable to shifts in the availability and price of international capital, and adds a premium to our interest rates.
Increasing our pool of domestic savings should lessen our exposure to the risks of global capital markets. It could also strengthen the flow of finance to New Zealand businesses, given that investors tend to prefer to invest in their home market.
Its impact will exceed the total balances that accrue in KiwiSaver accounts. Making workplace savings a common feature of New Zealand life should have something of a multiplier effect, encouraging ordinary working New Zealanders to become more financially literate and seeing their stake in the country extending beyond the labour market and the residential property market.
I make no apology for the fact that Budget 2005 is a document that favours investment in the future over current consumption. We have created over the last five years an opportunity for our children to own their own future, and for that future to be characterised by a high-skill, high-value economy, quality health and education, and the environmental and cultural values that make New Zealand distinctive.
It is not an opportunity that we are about to squander. Thank you.