Rangitikei LEC Dinner Function - Michael Cullen
Monday 20 June 2005
Rangitikei LEC Dinner Function
Rangitikei Club, Bowen St, Feilding
The four weeks since the budget have reminded me of George Santayana’s famous warning that, “Those who fail to learn from history are doomed to repeat it.”
I am not talking about history in terms of classical antiquity, but recent New Zealand history. We have only to look back over the past decade or so to see the folly of some of the proposals that are starting to emerge.
It seems many New Zealanders are at risk of forgetting what the country was like when the Labour-led government took office in 1999: rudderless economic management; mean-spirited social policies; a subservient foreign policy; successive rounds of tax cuts matched by expenditure cuts such as the cut to New Zealand Superannuation in 1999.
In five years we have turned this situation around 180 degrees. Positive economic management and a willingness to form government-business partnerships has contributed to economic growth of almost 20 per cent over the past five years, outstripping the prevailing growth rates within the OECD.
We have seen rates of employment and income growth to match this economic growth. Indeed 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.
We have restored the level of New Zealand Super, established the New Zealand Superannuation Fund to help smooth the effects of population ageing and, within two years, we will finally have financial assets that exceed our liabilities.
- We have achieved this alongside growth in the quantity and quality of the public services New Zealanders value: health care, education, law and order, environmental protection.
- However, we are now approaching some difficult terrain, including the lagged impact of recent interest rate increases and the appreciation of the exchange rate, slowing net migration and acute shortages of skilled and semi-skilled labour, with attendant cost pressures.
The combined effect of these factors will be that our annual growth rate will probably slow to around 2 ½ per cent over the next two years.
For that reason, 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:
- The KiwiSaver scheme 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.
These initiatives are 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.
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.”
For an example of what can happen with lax fiscal discipline, we need look no further than the tax cuts of the mid 1990s. As was predicted at the time, those tax cuts benefited a fairly small portion of the population, namely those on higher incomes. The justification at the time was that they would spark a wave of new investment that would strengthen New Zealand businesses. It is no surprise that that did not happen.
Instead, the tax cuts weakened the government’s finances just as the Asian financial crisis hit. It has been argued that the tax cuts made the impact of that crisis on the New Zealand economy more severe and more lasting that it need have been.
The lesson of history is clear. Weakening government finances makes the whole economy vulnerable to external shocks.
In light of this, the promises made by opposition parties that we can make deep cuts in tax while maintaining or even increasing government expenditure are a case of wilful amnesia appealing to wishful thinking.
What sustains this are two myths about tax and government:
- The myth of big government; and
- The myth of high tax.
These are commonly believed, but manifestly untrue.
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.
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.
In addition, Crown debt has been falling relative to GDP. Under the last National-led government, we were spending 3 per cent of GDP servicing debt. By 2004 we had reduced that by almost half, to 1.6 per cent – that’s a difference of $2.1 billion a year in actual money.
So what the facts show is that, over the last five years, the public sector in New Zealand has shrunk in relation to the economies that we compare ourselves to. National may talk about small but smart government; but Labour has the track record that shows we can do it.
Of course, government spending has been increasing in nominal terms. And, indeed, we have delivered to New Zealanders more of the services they want. Surgical procedures are up. Early childhood education is expanded. Police numbers are up and crime rates down.
However, since the population and the economy have both been growing, the relative size of the public sector has been falling relative to the tax base.
The opposition parties may concede on these figures; but 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. And they will need another $4 billion plus per annum to pay for all the tax cuts they have led people to expect. Yet they still claim that basic services will not suffer. If that were true, the massive increase in borrowing required would lead to a big lift in interest rates.
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.
Moreover, it is frankly absurd to think that we can keep nurses on the wards and police on the beat without others in the back room organising their pay and conditions, providing training, purchasing and managing their equipment, and so on.
So, contrary to myth, our public sector is not large in relative terms and reflects good stewardship by this government.
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.
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.
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.
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 want to pay; nor do they need to pay it.
It is essential that we explode the myths that are clouding the real debate about fiscal and economic policy, not only because they are misleading, but also because they are harmful to preserving the environment that has delivered economic growth and improved quality of life to ordinary New Zealanders over the last five years.
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, not just Labour.
Moving forward, we need to remind people what Labour is planning for the next three year term.
For many working families the gains on 1 April 2006 will be larger than on 1 April this year because on that date, the new In-Work Payment will begin, enhancing and simplifying the present Family Tax Credit.
With the further increases in Family Support, many two children families will get targeted tax relief of $50 a week, or even more in some cases as a result of a big lift in thresholds.
The following 1 July, hundreds of thousands of modest income families, particularly superannuitants, will gain from the big increases in the Rates Rebates Scheme. For many, the gains will be as much as $500.
And the April after that, 1 April 2007, KiwiSaver will begin. This is the biggest attempt to lift workbased savings since the Third Labour Government in 1974/75. By 2012, we expect a quarter of the workforce to have signed up. For young families this will be the chance to save towards the deposit for their first home and be rewarded for those savings.
This was the centrepiece of this year’s budget, not the tax cuts, which some journalists persuaded themselves were going to happen and blame me for not getting. And I blame myself for not disillusioning them earlier.
At the same time, we will be rolling out faster the primary health care strategy, increasing funding for cancer control, mental health, cataract operations and a great deal else.
We will be boosting police numbers, providing for the longer prison sentences the public demands, investing more in business growth, looking a further ways of helping tertiary students doing the courses which we need them to do, providing for 30 hours free early childhood education, progressively lifting the asset test on those assessed as in need of long term geriatric care, continuing to equip our defence forces for the roles we have defined for them as part of our commitment to world peace, helping rural people with the costs of getting to hospital - the list goes on.
We have a good story to tell about the last five years. We have a great story to tell about the next three. Let’s go tell it.