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Cullen: Address to Property Council Breakfast

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

11 August 2005 Speech Notes

Address to Property Council of NZ Breakfast

Sky Convention Centre, Rooms 1 & 2, Auckland

This morning 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 about 20 per cent over the last five years, 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 over 67 per cent, while unemployment is 3.9 per cent, which is the second lowest unemployment rate of OECD nations with comparable data.

Incomes have grown alongside of 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?

First, some things we would not do. We would not undermine the platform of fiscal stability and strength we have built up in the past five years.

This government and its predecessors have worked hard to ensure that New Zealand is no longer ‘the shaky isles’, at least in terms of being vulnerable to macroeconomic shocks.

We are a haven of stability, and this is no time to undermine that by heading backwards into the era of higher debt and volatile shifts in expenditure. Any uncertainty regarding how the government will afford essential public services like health and education and police translates into instability and risk for the business community.

It is very hard to do business in an environment where government may at any time need to increase debt, thereby adding pressure on interest rates, or alternatively increase taxes or cut expenditure in short order.

We have worked hard to maintain fiscal discipline, and in the process risked getting offside with our traditional constituency by keeping a rein on social spending. The economy is the better for it, and, given that the expenditure risks in the next decade are all on the upside, any fiscal loosening is likely to be punished quickly, both by the Reserve Bank and by international observers.

So much for what we will not do. As for what we will do, 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.

A more skilled workforce needs a higher level of capital investment if it is to meet its full potential. 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.

As most of you will be aware, Budget 2005 made important moves towards this goal through addressing the issues raised last year by Craig Stobo in his report on the taxation of investment.

As you are aware, direct investments in New Zealand companies are presently taxed at the company level, with imputation to alleviate double taxation. For most direct investors, these investments will be on capital account, with the result that capital gains on sale are not taxable income.

Investments through a financial intermediary, such as a unit trust or superannuation fund, are typically taxed according to the nature of the intermediary as a business and are on revenue account as a result. This means any resulting capital gains are considered taxable income. As a result, direct investments are generally in a superior tax position relative to indirect investments.

The 2005 Budget included announcements to solve the distortion against using financial intermediaries. In particular Collective Investment Vehicles, such as widely held unit trusts, will be able to make tax free capital gains on domestic shares in the same way as individual investors do now.

The taxation of offshore investment is a much more difficult matter, but it is one that is critical to get right. The government recently released a discussion document with proposals to address this issue.

There is likely to be some fierce debate, not least because there are numerous advisors who have built up considerable intellectual capital in structuring investments that take account of the current rules. There are some who would prefer if we let sleeping dogs lie; however, it is very important to avoid New Zealand's scarce domestic capital being encouraged to chase offshore tax advantages.

These changes need to be seen in the context of a number of policies aimed at strengthening our domestic capital markets. The KiwiSaver scheme, of course, is a major new initiative which will over time boost our domestic savings rate and should therefore stimulate local markets. Added to that are the initiatives we have pursued on venture capital and the commissioning of the Webb Taskforce to look at how we might strengthen the role of financial advisors in New Zealand. The taskforce’s report is now available on the MED website.

Our objective ultimately is to raise the level of financial literacy in the population, and orient more New Zealanders towards managing their wealth for the long term. Property investment will remain an important part of that equation.

It is not surprising that when Kiwis decide it is time to invest for the future, further property investments represent an attractive option, since it is something that is tangible and familiar, and it does not require dependence upon advice from professional investment advisors.

My government has always respected this as a choice that many New Zealanders make, having weighed up all their options. However, from a broader point of view we have made no secret of the fact that we would like to see an increase of domestic savings with diversification into a wider range of investment vehicles. We think it is important over time that we become a nation of share owners as well as, but not instead of, a nation of home-owners.

To see why diversification is a good strategy, one needs look no further than the current outlook for the residential property market.

A slightly weaker labour market and continued slowing in net migration inflows are expected to lead to a fall in residential investment in the next two years. The impact of higher mortgage interest rates (albeit delayed because of the high proportion of home loans which are at fixed rates) will also contribute to the fall.

In addition, residential rents have not kept pace with construction costs and house prices, with the result that returns from investment in housing are reducing. Our major cities have seen a rapid growth in the number of apartments; but that, combined with a downturn in the numbers of foreign students, has increased the risk of an over-supply in that part of the market.

Indeed, residential investment growth is estimated to have fallen to zero in the March 2005 year and is forecast to be negative in the 2006 and 2007 March years before stabilising after that.

Despite all of this, property remains an important element in a well-chosen investment portfolio. From time to time there are calls to introduce various forms of property tax in order to achieve the much-vaunted ‘level playing field’ amongst different asset classes.

As you are aware, the main concerns raised with respect to property are that mortgage-free home ownership provides owner-occupiers with the benefit of an imputed rent and that capital gains go untaxed. The government’s view is that New Zealand’s income tax base is one of the cleanest in the OECD.

The Tax Review 2001 considered whether capital gains should be taxed on a more comprehensive basis by introducing a separate capital gains tax. They concluded that the disadvantages of a comprehensive tax on capital gains – increasing the complexity and the costs of the tax system – outweighed any theoretical benefits from including the gains in the tax base. The government agrees with this analysis.

So our position on the taxation of property is that the status quo is quite adequate, and that, all things considered, change does not promise significant overall benefits. A level playing field is, after all, only a theoretical concept. Real playing fields have their soft patches, slight tilts and areas of subsidence. Within certain limits, the players learn to work around them without affecting the quality of the game.

In other words, any new form of property tax is off our agenda. In our judgement there is more than enough scope to ensure that the tax system provides New Zealand investors with a largely neutral investment environment. And, as I have outlined, the outlook for the New Zealand economy provides plenty of scope for optimism, provided that we maintain our current programme of investing in infrastructure and skills, and maintain a prudent fiscal policy.

Thank you.


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