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Cullen - Address to Chapman Tripp Business Seminar

Wednesday 15 June 2005

Address to Chapman Tripp Business Seminar

Level 11, The Holiday Inn, High & Cashel Sts, Christchurch

We are entering the season when opposition parties and lobby groups set about spreading moral and economic panic. One could argue that this is what democracy is all about; that it is the job of opposition parties to challenge the government’s programme, and that it is the job of lobby groups to argue their corner on behalf of their members.

But we gain nothing from these debates if they are based upon myths and half truths. This evening I want to talk about several of those myths, because they are not only misleading but also harmful to preserving the environment that has delivered economic growth at unprecedented levels over the last five years.

It is gratifying at least that no-one seems to be denying the underlying strength of the New Zealand economy. 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.

Between March 2000 and March 2005 the economy added on some 260,000 more jobs, of which 218,000 were full-time and 42,000 part-time. Labour force participation is now at 67.6 per cent, while unemployment is 3.9 per cent.

Incomes have grown alongside of employment, with real per capita incomes up 11 percent since the March 2000 quarter.

However, having put New Zealand back to work, we are now discovering the limitations of our capacity to grow. That is being seen in acute shortages of skilled and semi-skilled labour, with attendant cost pressures. This factor, alongside 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, is contributing to the current slowing of the economy to an annual growth rate of around 2 ½ percent over the next two years.

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 the US are discovering 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.

Even more so in an economy such as ours which is stretched tight as a drum, large scale fiscal loosening in the form of major tax cuts or undisciplined expenditure increases should not play any part in economic policy. That is something that the OECD reaffirmed earlier this month, stating in their Economic Outlook on the New Zealand economy that “any additional fiscal stimulus beyond that already planned could put the projected soft landing at risk and would need to be offset by higher interest rates in order to bring the economy back onto a sustainable growth path.”

Instead, what the budget focused on was a set of long-term strategies aimed at encouraging investment in capital, skills and technology. These have been well rehearsed by now:

A 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;

Ongoing public investment in infrastructure, research and targeted business support (particularly support for export industries);

$300 million over the next four years to develop quality tertiary education that is highly relevant to the skills needed in the economy, including higher funding rates for technical and scientific subject areas including science, trades, technical subjects, agriculture and horticulture;

An additional $45 million to expand Modern Apprenticeships and Industry Training to boost workforce productivity;

Changes to business tax in areas such as depreciation, R&D, and taxation of business migrants, aimed at ensuring a more productive use of capital and improving New Zealand's access to worldwide capital, skills and labour.

The point to note is that these initiatives are both modest in scale and also tightly targeted at improving economic performance. In an economy like ours it would be very easy to spark a vicious cycle of higher inflation and higher interest rates by creating an imbalance between taxation and spending or by reversing the trend of lowering public debt.

This is where the snake oil merchants come in, with their promises that we can make deep cuts in tax while maintaining or even increasing government expenditure on public services like hospitals, schools and police.

The truth is the only way to do this would be to borrow large amounts of money, which increases our debt, lowers our credit rating and increases interest rates. At the end of the day we cannot defy gravity.

This government has set New Zealand on track towards financial security for the long term. That means lowering debt and building up the Superannuation Fund so we can manage the impact of population ageing. If we squander that opportunity by borrowing to fund tax cuts or new expenditure then we will live to regret it.

What keeps the snake oil merchants in business are two myths about tax and government that are commonly believed but manifestly untrue:

The myth of big government; and

The myth of high tax.

The simple fact is there has been no spending blowout in New Zealand under the Labour-led government. Indeed we have reduced government spending in relative terms whilst maintaining and enhancing public services.

The size of the total public sector in New Zealand, compared to the size of the economy as a whole is significantly smaller than for the rest of the OECD.

In 1999, central government spending (that is, excluding state-owned enterprises and local government) was 33.3 per cent of GDP. It is now 30.1 per cent. That means there has been a three percentage point decline, or a ten per cent fall in the relative size of central government.

And if we add in state-owned enterprises and local government the same pattern emerges. The figures show that total government outlays were 41.0 per cent of GDP in 1999, which was slightly over the OECD average. In the last five years we have managed that down to 38.2 per cent in 2004, while the rest of the OECD has stayed more or less the same.

In addition, Crown debt has been falling relative to GDP, from 35.4 per cent of GDP in 1999 to an estimated 22.6 per cent in 2005.

In other words, over the last five years, the public sector in New Zealand has shrunk in relation to the economies that we compare ourselves to.

Of course, government spending has been increasing in nominal terms, but the population and the economy have both been growing, with the result that the relative size of the public sector has been falling relative to the tax base.

Even if the opposition parties concede on these figures, they argue that it is still possible to cut government spending. Despite that, they are already committed to extra spending on areas such as roading, prisons, law and order, policing, defence, and aged care.

One suspects they have been running the kind of a telephone survey that reveals that most people worry that government spending is increasing and think they pay too much tax, but nevertheless want more of the public services they value. This bit of cognitive dissonance is one of the staples of political polling. It does not make for good economic or fiscal policy.

Indeed, the tally of National’s additional spending promises amounts to some billions of dollars per annum. That means they will need to cut spending in other areas by that amount, plus another $4 billion plus per annum to pay for the tax cuts they have led people to expect. Yet they still claim that basic services will not suffer.

The most polite response one could give to that idea is: baloney.

The facts are that almost 80 per cent of government spending goes on social security (including NZ Superannuation), health, education, defence and law and order. Core government spending, what one might call spending on the bureaucracy, is only 4.3 per cent of total spending.

By any standards that is not an excessive amount to spend on ‘head office’. Besides, it is frankly absurd to think that we can keep nurses on the wards and police on the beat without having a team of professional administrators providing the essential backup. There are no frontline staff without others organising their pay and conditions, providing training, purchasing and managing their equipment, providing legal advice and so on.

So, contrary to myth, our public sector is small in relative terms, and that is due largely to good stewardship by this government. The fact is that New Zealanders value their public services and understand that the vast bulk of their taxes provide the tangible services that sustain communities.

The second myth I would like to explode regards tax. There are two main parts to this myth:

First, the contention that New Zealanders pay high rates of tax relative to other countries, with Australia the comparison most often cited; and

Second, the contention that tax cuts would deliver a significant boost to the disposable incomes of ordinary New Zealand families.

Again the facts suggest otherwise. Even after the tax cuts announced in the recent Australian federal budget, Australians pay more tax than New Zealanders. The top New Zealand rate is 39 cents in the dollar and applies to incomes above $60,000 per annum. By comparison, Australians pay 42 per cent on incomes between A$58,100; and 47 per cent on incomes over A$ 70,000.

The Australian Budget announced that these thresholds would rise in two steps, from 1 July 2005 and 1 July 2006, but the 42 and 47 per cent tax rates remain.

In addition, they pay a 1.5 per cent Medicare levy, which is in essence a dedicated health tax.

Someone on the average New Zealand wage of just over $40,000 would pay tax of 20.6 per cent in New Zealand and 20.9 per cent in Australia, including the Medicare levy. This is after the 2006 Australian tax cuts.

For someone on NZ$62,000 the comparison is unchanged: average tax of 25 per cent in New Zealand, and 25.1 per cent in Australia, including Medicare levy.

In short, if anyone tells you that Australians pay less tax, your best response is, once more: baloney.

The same picture emerges if we compare ourselves with almost any other developed nation.

As for the question of who would benefit from tax cuts, that is again answered by looking at the recent Australian changes.

The Australian tax cuts have an estimated cost in lost revenue of A$21.7 billion over four years, or an average A$5.4 billion a year. For that expense, Australian taxpayers earning up to $58,000 a year receive a measly $6 a week. Meanwhile, those earning $125,000 or more receive an extra $87 a week.

In New Zealand the numbers look the same. A tax cut that delivers anything significant to ordinary business people and ordinary workers would be extremely expensive. Every cent knocked off the bottom rate of tax of 15 cents would cost $215 million; every cent knocked off the middle rate of 21 cents costs $325 million; and every cent knocked off the 33 cent rate costs $95 million. Finally, knocking a cent off the 39 cent rate would cost $115 million.

It is not surprising that in all of the proposals for tax cuts put forward by opposition parties, the primary focus is on reducing the higher rates. The fact is that the kitty runs out well before any changes can be contemplated to the lower rates. That is what happened with the tax cuts of the 1990s. They had little or no effect on lower income groups, and had their greatest effect on incomes several times the average wage.

The lessons from both sides of the Tasman are that tax cuts are very expensive, and produce very small gains for the bulk of taxpayers. Inevitably the lion’s share of any tax cut would go to those with the highest taxable income, since they benefit from all of the rate and bracket changes.

Tax cuts are like a buffet meal where the guests can all see and smell the food, but are summoned to partake of it one table at a time, starting with the wealthiest table and moving down the scale. By the time the table of small business owners or of families on the average wage gets their turn, everything has been eaten bar a few crumbs and scraps of gristle around the bone.

That is not the end of the story, for, to continue the analogy, at the end of the meal everyone is presented with the same bill to pay, regardless of whether they come out feeling full after a hearty meal or still hungry because they were last to the table. That bill has three components:

Rising interest rates for those with mortgages or business loans;

Higher public debt which places an additional impost on our children who will have to repay it; and

Cuts in services such as health care, education, police or any of the other things we value as New Zealanders, like border control, civil defence, or public broadcasting.

It is a bill that New Zealanders do not need to pay.

I appreciate that tax cuts have become something of a cause celebre within parts of the business community. All I can do is urge you to consider that larger context. In the present environment, large scale tax cuts would provide a short term stimulus to the domestic economy and then leave us in a weaker position.

We have worked hard rebuilding our economy and strengthening our public finances so that we carry less debt and impose less risk on the economy. If we squander that because of a combination of cherished myths and unscrupulous promises then we will all be losers.

Thank you.

ENDS

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