Hon Dr Michael Cullen
Deputy Prime Minister, Attorney-General, Minister of Finance, Minister for Tertiary Education, Leader of the House

13 March 2007 Speech Notes

Embargoed until: 9.15am
The economic outlook 2007 and beyond

Speech notes for Deutsche Bank International Investor Mission, Wellington

I want to start out with an update on the state of our economy and the outlook.

From the end of 1999, when the Labour-led government came to office, we have been growing at an average annual rate of three per cent.

That's faster than the average of developed countries.

We are growing faster than Europe, Japan, the US and the UK and as fast as Australia.

While gains have been enjoyed across the economy, our business sector has particularly prospered.

According to company tax returns, profit growth averaged over twenty per cent a year in 2003, 2004 and 2005 (the most recent years we have data for).

The New Zealand economy is a quarter larger today than it was in 1999.

We went through the cyclical slow-down last year and we're seeing strong evidence now of a rebound.

GDP grew at somewhere close to 1.0 per cent in the last quarter of last year.

Demand is being pushed along by a number of factors:

- Confidence is high. Retail sales have been strong, dairy prices have increased and business confidence is the highest it has been in several years.

- Unemployment is at its lowest levels since the early eighties and very low levels by comparison with other developed countries.

- Wages have been growing and the number of hours worked has also been up so there is more cash in the hands of income earners.

One very strong factor has been buoyancy in the housing market.

A Barfoot's survey last week showed seventeen per cent of house sales last year were for more than a million dollars.

Treasury expects domestic demand to keep growing strongly at least through the early part of this year.

That's created some problems. Domestic demand pressures prompted the Reserve Bank to increase the Official Cash Rate last Thursday.

As the bank pointed out, there remains a real risk to our economy from the way our domestic and external sectors are out of step.

The domestic economy has been persistently much stronger than the export sector, and we're seeing the evidence in a current account deficit of nearly ten percent of GDP.

That's partly because our households just aren't saving enough and partly because we are not doing well enough at selling the high value, knowledge and skill-based exports we need to in order to reap the benefits of the global economy.

We need to save more and we need to sell more.

So I want to talk about the main measures the government is taking to address these issues.

Clearly one of our challenges is to find more effective tools to manage inflationary pressure.

When interest rates go up our export sector suffers much of the burden. The resulting higher exchange rate makes exports less competitive and businesses pay more for capital. But it is not the export sector that is providing inflationary pressure.

The Reserve Bank governor mentioned last Thursday that the Bank is looking at a range of other tools to help reduce inflationary pressure, rather than simply leaving the challenge to interest rates alone.

The Official Cash Rate will always be the main weapon but he gave examples that would target the very rapid expansion in mortgage credit. That growth in 'borrowing on the house' has amplified the increase in house prices and produced a wealth effect that has pushed along domestic demand.

The examples of potential tools he mentioned included tightening tax rules on housing investment and changes to bank capital requirements to help moderate the amplifying effect of credit on the housing cycle.

I want to stress there are no formal proposals on any of this yet and any policy option will need broad support.

But it will help address the ongoing challenge of better managing the domestic economy without hammering exporters.

The government through fiscal policy has an important role to play in supporting monetary policy as well.

To put it bluntly, there is no point in trying to give tax cuts or to increase spending if the gains are simply taken away in higher mortgage costs or an inflationary spiral.

I need to point this out every time the government's cash surplus is updated because there are those who believe the government can simply spend its cash reserves - although this is a subject on which the Opposition leader and the Opposition finance spokesperson do not appear to be able to agree. The leader usually calls for me to reduce the government's operating surplus and then the finance spokesperson blames the government for spending too much.

Holding mutually contradictory positions is the privilege of Opposition. Governments have no such luxury.

The government is active on a range of fronts to take pressure off monetary policy, increase savings and develop our export sector.

Cash surpluses have been used to pay down debt steadily.

Gross debt is around twenty per cent of GDP and we no longer carry any net debt at all, taking into account the New Zealand Superannuation Fund.

New Zealand has better public finances than nearly all other OECD countries.

The NZ Superannuation Fund will ease pressure on the government's finances in the future. By setting aside some of the future cost of superannuation, New Zealand will be better placed to meet the cost pressures that are ahead as more of us retire.

We're also boosting our savings rate with the introduction on 1 July of KiwiSaver – a unique voluntary, workplace-based savings scheme for all employees.

The introduction could hardly be timelier following the Reserve Bank's warnings about household dissaving and the need to manage domestic demand pressure.

It is an historic piece of economic and social legislation.

Workers will be able to set aside four or eight percent of their incomes in KiwiSaver.

Its unique feature is automatic enrolment - new employees are automatically enrolled. With 700,000 people starting new jobs each year I hope this will be a real catalyst for many to embrace KiwiSaver.

Everyone who signs up will get a kickstart $1000 contribution from the government immediately.

The incentives are very strong for young people to join as they start out in the workforce. And, as we know, the younger a person starts saving the more benefits multiply later in life.

By making employer contributions tax exempt we are making it even more attractive for workers to save.

KiwiSaver will help deepen the pool of capital available for development, manage domestic demand pressure and increase our household savings rate.

I want to emphasise that KiwiSaver should help to take pressure off our export sector and off interest rates.

If we want the Reserve Bank to keep interest rates low for businesses and mortgages, we need households to spend less, save more.

We have had a conspicuous absence of a workplace savings scheme to encourage savings and KiwiSaver is a state-of-the-art tool to address the issue. Even the UK is considering a similar scheme, dubbed BritSaver.

The effort to increase our savings needs to be complemented by a lot of other work.

The government is determined to ensure New Zealand takes its place in global marketplaces.

Our focus is on transforming New Zealand into a high value, innovative and export-led economy. Inspiring innovation, lifting productivity and building a highly educated and skilled workforce are critical to seizing global opportunities for

We've made very substantial investments in the knowledge economy.

There's been heavy emphasis on skills - at all levels, ranging from Modern Apprenticeships to an overhaul of the tertiary sector to better align higher education with the economic outcomes we need.

While the government is investing in skills, we are also working through the Business Tax Review on other measures that will improve New Zealand's productivity and competitiveness.

Science, technology, research and development in both the private and public sector are being strongly supported.

The results of the Business Tax Review will be announced as part of this year's budget.

The focus of the review will be on improving New Zealand's productivity and competitiveness.

I've already widely commented it will involve the headline corporate rate; assistance, through the tax system, to the drivers of growth; and a much more favourable and well understood international tax regime to encourage Kiwi companies to expand overseas.

I know you have an interest in those international tax issues and it's worth outlining those briefly.

We're looking at making changes to international tax rules to make our companies more competitive.

The worry is that current rules encourage some companies to shift overseas where their offshore income is treated more favourably.

Let me give you an example:
A Kiwi company with a subsidiary in China receives special tax reductions in the first years after it makes its investment under China's foreign enterprise income tax.

Its income is fully exempt in the first and second profitable years, and it pays fifteen percent in the third, fourth and fifth years. (But the company would still be subject to tax on that income in New Zealand.

So while it paid no tax in its first year in China it would pay 33 cents in the dollar back here.

The rules give the Kiwi company an incentive to migrate overseas.

We want to ensure New Zealand companies operating offshore with subsidiaries can obtain the same advantages in another country as their competitors. The changes we are looking at will be a radical shift in the way we tax the income of companies like this.

We are looking at treating differently income earned 'actively' and passively.

Income earned through manufacturing or industrial activity might be exempt from New Zealand tax rather than taxed as it's earned.

Many in submissions to the Business Tax Review urged this change.
It's especially important to our larger, export-focused companies. Indeed my office received a call just last week from a New Zealand company that relocated to Hong Kong several years ago because of the current tax distortion. Its chairman said the proposed change was a major step forward.

For some businesses, a change to an active/passive regime is as important, if not more important, than lowering the corporate tax rate.

Nearly every other country distinguishes between active and passive income.

Many delay taxing international income until dividends are paid. In Australia, the income is exempted altogether.

There's more to the international tax review.

We are also considering reducing non-resident withholding tax rates in the tax treaties that we negotiate with other countries. This is the tax on earners who are not resident in New Zealand - from their interest, royalties or dividends.

Lower rates of NRWT would help encourage inward investment. It might also benefit New Zealand firms investing offshore because reciprocal arrangements could apply as tax treaties were renegotiated.

The aim of changes to our international tax review is to ensure companies based in New Zealand can compete fairly and effectively in the global marketplace.

We have a challenge partly because we are isolated and lack the natural networks that other developed countries have simply because of their scale or proximity to other developed countries.

But we are meeting our challenges with a smart and active mix of policies and partnerships with the private sector.

New Zealand represents a very positive environment for international investors.

Our economy is performing better than the average of OECD countries and we are again entering an upswing in the economic cycle.

Government finances are sound and applauded by international agencies. We are investing in infrastructure to create world-class transport, energy and telecommunication networks.

There is much to be positive about in our business environment and I am sure you will find the opportunities attractive as you look closely at the direction of the New Zealand economy.

Thank you.

ENDS

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