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Cullen: Address to Beattie Rickman Luncheon

Hon Dr Michael Cullen
Deputy Prime Minister, Minister of Finance, Minister of Revenue, Attorney General, Leader of the House

10 August 2005 Speech Notes

Address to Beattie Rickman Luncheon
Beattie Rickman Offices, Cnr Bryce & Anglesea Sts, Hamilton

This afternoon I would like to talk about what a Labour-led government would seek to achieve in the New Zealand economy in the next five years.

We certainly have much to celebrate from the last five. The economy has grown almost 20 per cent over the last five years, outstripping the prevailing growth rates within the OECD.

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. We now have the second lowest unemployment rate of OECD nations with comparable data.

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

What this means is that we have succeeded in halting the slide relative to the OECD average income per capita, and have pulled back some territory. Meanwhile, we are also advancing through the OECD ranks in terms of measures of social wellbeing, personal security and educational standards.

Life expectancy has increased, while smoking, road casualties and suicide deaths have declined. Children starting school are more likely to have had early childhood education, and child poverty rates fell from 27 per cent in 2001 to 21 per cent in 2004. Most employed New Zealanders say they are satisfied with their work-life balance.

In other words, we are having our cake and eating it too, in terms of a growing economy and the lifestyle that we value. This is keeping skilled New Zealanders at home, and attracting other skilled migrants, as evidenced by the recent increase in applications from skilled people from the UK, who are choosing New Zealand over the many other options available.

Our challenge for the next five years is to hold this all together; to sustain a high rate of growth, driven primarily by improvements in productivity, and to maintain those things that make New Zealand an attractive place to live, things like health care, law and order, education and a good pension system.

That challenge is made somewhat more tricky by the fact that our economy is coming under pressure from the lagged impact of recent interest rate increases and the appreciation of the exchange rate, slowing net migration and a period of weaker trading partner growth.

Most forecasters expect the economy to slow over the next two years to an annual growth rate of around 2 ½ per cent, and beyond that to pick up to a growth rate of around 3 ½ per cent. In other words, a soft landing followed by a relatively speedy recovery.

So what lies ahead, and what are the priorities that a Labour-led government would pursue in its next term of office and beyond?

Our number one economic priority is to increase productivity. 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.

There are prospects for increasing the size of our workforce, but we need to be realistic about these.

Our immigration policies have focused on better matching of migrants to emerging skill needs. These are starting to have an effect right across the skill spectrum; however, there will always be a limit to our ability to absorb new migrants, as the spread of the Auckland metropolis demonstrates. Importing skills is only part of the answer.

Another part of the answer is in the government’s Working for Families package, which includes childcare measures aimed at providing better choices for parents of small children who want to return to full or part-time work. Once again, however, we cannot expect this to solve all our labour shortages.

The real results are to be gained by productivity gains, which increase how much value each member of the workforce contributes on average. That means two things:

- Increasing skills; and

- Increasing capital investment, both in terms of infrastructure and in terms of businesses’ own investment in technology.

Building skills has been a major focus for government investment in the past five years, and more investment is planned. Budget 2005 included $300 million over the next four years to develop quality tertiary education, and an additional $45 million to expand Modern Apprenticeships and Industry Training.

Last week the Prime Minister announced further investment in trades training through the Modern Apprenticeship programme. We will create another 5,000 places, taking the total number to 14,000 by 2008. This is part of our broader goal to have 250,000 people participating in structured industry training.

More broadly we have turned around a tertiary education sector that had been growing in a largely unfocused way under a market model where institutions were rewarded for enrolments rather than results. Our response is to ensure that tertiary providers are much better hooked into the workforce needs of local and regional industry, and design their programmes around what skills are needed in their local economies.

That is why we are introducing higher funding rates for technical and scientific subject areas including science, trades, technical subjects, agriculture and horticulture.

We also announced recently that student loans will be free of interest to students while studying and after graduation, so long as they remain resident in New Zealand. The loans system was brought in during the early 1990s, and it has succeeded to making tertiary study more accessible. What is increasingly obvious, however, is that there are unwelcome effects of large amounts of student debt.

The principle that there should be some sharing of the cost of study between the individual and the taxpayer is still a sound one. After all, graduates draw significant benefit from their qualifications; and the community draws significant benefit from having high rates of tertiary education. It is a question of balance, and what many people have been telling us is that the burden was tipped too far towards imposing costs on individual students and their families.

The changes should also roll out the welcome mat for New Zealanders currently working offshore who have incurred penalty interest on their loans. The evidence suggests that there is a significant number of these people, for whom a return from OE comes along with a visit from the debt collector. What we have done is reduce a barrier that was keeping Kiwis offshore when it was beneficial for both parties that they return.

A more skilled workforce needs a higher level of capital investment if it is to meet its full potential. It matters little how smart our people are if they do not have the latest technology and spend good portions of their time stuck in traffic. We are moving on both fronts.

We have reversed the decline in infrastructure spending in the 1990s and are now getting traction on creating the transport, power and water systems that will serve a world class economy. We have increased by over 70 per cent the net purchase of physical assets by government.

Budget 2005 gave 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. In addition to that, we have earmarked a $500 million windfall tax gain to major roading projects.

Equally important is our need to turn around the rate of business investment, which is relatively low in areas such as technology and R & D. That is why we are encouraging equity investment in small to medium enterprises by changes to rules governing access to tax deductions for R&D expenditure. These will benefit companies who bring in new equity investors after their initial development stage, and will therefore make investment in growing businesses more attractive to investors.

This is part of a package of tax changes aimed at ensuring a more productive use of capital and improving New Zealand's access to worldwide capital, skills and labour.

One of the major changes is 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. This is designed to assist New Zealand businesses to recruit top talent and to assist in the process of settlement of skilled migrants.

Other key elements were 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.

A cynic might argue that we would have got more political bouquets from the business community in using that $1.1 billion to take a slice off the top income tax rate. Given that knocking a cent off the 39 cent rate would cost $115 million per annum, we could arguably have dropped that rate by 3 cents, at a cost of slightly less than $1.1 billion over the forecast period.

Our judgement was that, when faced with the capacity to cut a small margin off the tax take, it is always better to make changes that demonstrably boost investment, rather than those that merely boost domestic consumption. Why? Because we need more investment, and domestic consumption, while not a bad thing in itself, is problematic in an economy that is already pushing the limits of our labour force and our key infrastructures.

This is a point that appears lost on many people. With a domestic economy that has maintained an impressive momentum for over five years, we now have a severe skills shortage and capacity constraints in many key industries. The Reserve Bank is already concerned that inflation is in the upper end of the target range, and would be rightly concerned at any loosening of fiscal policy.

In other words, a tax cut that boosts investment buys us future growth; whereas in the current environment a tax cut that boosts domestic consumption buys us nothing but inflation or higher interest rates.

If we want a tax cut that does not spark inflation or higher interest rates, we have to make compensatory cuts in spending. “Easy”, our opponents say, “Everyone knows that government spending has blown out in recent years, such that billions could be cut from the budget without affecting anything that anyone really values.”

Wrong again. In fact during our term of office we have reduced government spending in relative terms whilst maintaining and enhancing public services.

Today 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.

On any government’s watch there will be glitches such as hip-hop tours and twilight golf. But the fact is that these are dust on the scales. (And, I should point out, dust that we have wiped away very smartly.) Over 80 per cent of government expenditure goes on pensions, health, education and law and order. The remainder goes on items that are just as crucial to our way of life, such as border control, environmental protection. Very large sums have been allocated to infrastructure.

In this light, National’s ambition to cut $1 billion of spending is at best heroic, and at worst pure folly. It is even more so in light of their promises to increase spending on defence and prisons, to name only two of their promises.

There is no painless way of cutting spending, and transparency demands that they are upfront about which public services are their lowest priorities.

What is more, if we look ahead over the next decade and beyond we see that there are very significant upward pressures on government expenditure. An aging population will demand more expensive health care, and so far the health care industry has maintained a unique status as one in which technological advancement increases prices rather than reducing them. This government has made important investments in primary health and public health which should over time improve our health status, but it will be a long and hard struggle to extract savings out of the health budget.

We must also bear in mind the impact of demographic change on pensions. That will be offset to a considerable degree by the NZ Superannuation Fund, once it reaches maturity; but the fund will by no means meet all of the expenditure pressures, and, of course, we need to continue depositing additional resources into the Fund if it is to do its job.

So, looking forward, the fiscal picture looks difficult enough without the added pressure of having to absorb tax cuts.

Reversing the declining trend in public debt is another option. But it is a deeply dishonest option, and one that is unlikely to fool anyone. Shifting the cost of current tax cuts onto a future generation would break faith with the efforts that we and recent National-led administrations have made to bring debt down towards prudent levels, while exposing the economy to external shocks and generally depressing international confidence in that economy.

If you look at the current forecast debt track, it shows debt reducing to around 20 per cent of GDP within the next few years. A decision to reverse that declining debt track, and hence jeopardise our credit rating, would need a very good justification.

In my view, and I believe the view of most New Zealanders, a large scale tax cut which necessitates harsh cutbacks in services and yet yields very little in terms of strengthening our economic fundamentals does not make the grade.

Some of those who are most animated about New Zealand’s tax system simply need to get out more. We are a middling nation when it comes to tax rates, and score very well in studies that look at the transparency and efficiency of tax systems.

When it comes to tax, the best advice is always to read the small print. We are all able to calculate how much more money will end up on our pocket from a cut in our marginal tax rate. We need also to make the more important calculation of what that will mean for business, the economy and the services we value.

Thank you.


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