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Post-Budget speech to Trans-Tasman Business Circle

John Key

Post-Budget speech to Trans-Tasman Business Circle

New Zealand Room, Sky City Convention Centre
Ladies and Gentlemen

A year ago when I spoke to this audience, New Zealand was in the midst of the global economic and financial crisis.

If that wasn't bad enough, the crisis came at a time when New Zealand was already well in recession, after several years of unbalanced and unsustainable growth.

The Budget we delivered last year was therefore focused squarely on getting the country through the downturn in as good a shape as possible.

We had to make some tough choices, but they were the right ones.

This year, the context for the Budget is quite different.

The worst of the global crisis has now passed.

And as the clouds part, it is clear that New Zealand has weathered the economic storm better than many other developed economies.

The economy has begun to grow again, although tentatively. The Household Labour Force Survey shows that unemployment is dropping, which is great news.

Unlike a number of countries, our banking system has not suffered major stress. Nor are we in the midst of a debt crisis.

Our longer-term strengths as a country remain just as they were before the recession hit.

Yet, so do our longer-term economic challenges.

New Zealand incomes are below those in the countries we like to compare ourselves with, including Australia.

The growth we did experience over the past decade was largely driven by consumption, borrowing and government spending.

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Since 2000, New Zealand's overall debt to the rest of the world has jumped from $90 billion to $170 billion. Government spending rose 50 per cent in the 5 years to 2009.

Productivity growth across the economy - which is what really matters - was actually negative.

The tradables sector, which includes sectors like agriculture, forestry, food manufacturing and tourism, and through which we actually earn a living in the world is no larger today than it was in 2002 and has created almost no new jobs.

That sets the scene for quite a different Budget this year.

This year's Budget is focused on looking forward - building on the recovery so that we come out of the downturn in a better position to create jobs, build productive firms and attract investment.

It's about creating opportunities for families to get ahead here in New Zealand.

The Budget has four objectives, all of which are inter-linked.

Overall, the Budget is about lifting the long-term performance of the New Zealand economy.

That's why science and research gets such a high priority in the Budget - because our future economic performance depends to a considerable extent on generating and using new ideas.

That's also why we are investing in infrastructure like broadband, state highways, and the national electricity grid.

We've got an ambitious trade agenda, and we are looking at how to reduce barriers to growth across a number of different sectors of the economy.

The second objective of the Budget is reform of the tax system, which I want to talk about later in this speech.

The changes we are making to tax obviously fit with the first objective - that of lifting our long-term economic performance - but they also contribute to other goals, including making the tax system fairer and more sustainable.

The third objective in the Budget is better delivery of public services.

The challenge we are addressing in this Budget is to meet people's expectations of modern public services while at the same time recognising the pressures on taxpayers.

That will continue to be a challenge for many years to come.

The fourth objective is maintaining firm control of the government's finances, so we can return to budget surpluses and pull back our rising debt.

The Government is currently borrowing $240 million a week to fund deficits and roll over existing debt.

That was the appropriate response to the global crisis, but it cannot continue indefinitely.

Crucially, we have to keep a tight rein on spending increases, well out into the future.

We cannot jump back on the treadmill of unsustainable spending increases.

That is why the tax reforms we are introducing have been designed to be broadly fiscally neutral.

While there is an initial upfront cost, this is because the different elements of the package come into effect at slightly different times.

In time, the tax package actually results in a slightly lower net debt track for the Crown than would otherwise have been the case.

That means the tax changes are fiscally neutral once those timing effects have worked their way out.

The tax package is about the mix of taxes, not the overall level of taxation.

What we have done, in a nutshell, is to lower headline personal and company income tax rates, while at the same time broadening existing tax bases, increasing indirect taxation, and tightening up on the ways people have been able to reduce the amount of tax they pay.

In total, these tax changes constitute the most thorough and beneficial overhaul of tax rates in almost 25 years.

They will have a positive effect on economic growth, and therefore the living standards of New Zealanders, through the following routes:

* an increased incentive for people to work hard, increase their hours, develop their skills, and develop new products and services, because they can keep more of the extra money they earn
* lower income tax rates, which will attract skilled people - who are in demand all over the world - to stay in, or move to, New Zealand
* an increased incentive to save, because of the switch in taxation from income to consumption, and by reducing tax rates on savings
* a lower headline company tax rate, which will encourage productive investment in New Zealand, thereby increasing productivity and raising wages
* and a more neutral tax system, which has less effect on people's choices between different types of economic activities (for example, between investing in property and investing in other sectors).
I want to give you an example of the first of these effects, by comparing income tax rates when this Government first came into office, with the income tax rates announced yesterday.

Take a person who is earning $45,000 a year, has a spouse at home looking after their two small children, and who pays $300 a week in rent or mortgage payments.

If they are considering applying for a better-paid, but more challenging, job; or if they are thinking about studying for qualification; or if they are thinking about increasing their hours; or if they are looking at going into business for themselves; they need to take into account how much they would get in their hand from an extra dollar of income. Then they can work out whether the extra effort, commitment or risk is worth it.

In early 2009, a person in that situation who earned an extra dollar of income would get to keep only 47 cents of it in the hand, because of tax rates and Working for Families.

That is a big disincentive to getting ahead.

Our tax cuts on 1 April 2009, plus the Budget tax changes announced yesterday, have changed work incentives quite considerably.

A person on $45,000 with two kids will now get to keep 62.5 cents from an extra dollar earned.

That is because their marginal tax rate has almost halved in just 18 months, going from 33 cents in the dollar to 17.5 cents in the dollar.

As a result of this tax package, 73 per cent of all income earners will face a statutory tax rate of no more than 17.5 cents in the dollar. That is a huge improvement in our tax system, which makes people's choices about work, up-skilling and risk-taking, much more appealing.

I want New Zealanders to be aspirational - to want more for themselves and their families, and to know that they have opportunities to do that.

Right now, for many people, the tax system is telling people not to bother extending themselves because it isn't worth it.

Our tax changes deal with that issue head on.

They also give people more choices.

Consider the family on $45,000 again. After our two rounds of tax cuts they now get over $2,100 a year extra in the hand, or close to $1,500 once the increase in GST has been taken into account.

They can use that increase to save, or pay off their mortgage, without being taxed on it. The interest they earn on savings will be taxed, but it will now be at a rate of 17.5 per cent rather than 33 per cent as it was previously.

The tax package we announced yesterday reduces marginal income tax rates right across the board, so the labour supply effects, as economists call them, are quite significant.

The Treasury has allowed for a one-off increase in the level of GDP of around one per cent, phased over 7 years.

That forecast is largely based on estimates of the growth effect of reducing taxes on boosting labour supply, because a lot of the other beneficial effects of the tax package cannot reliably be quantified. In the long run, an impact of anything up to around two per cent of GDP would not be particularly surprising.

What may be surprising to some people, however, is that these changes have been done in a way that doesn't affect the broad distribution of income in New Zealand.

That is for a number of reasons.

One is that we have reduced income tax rates across the board and by a considerable amount. Two-thirds of the cost of our income tax cuts have gone to reducing the lowest two rates - that is, to taking the current 12.5 percent rate down to 10.5 per cent, and taking the 21 percent rate down to 17.5 per cent.

Second, the package contains upfront GST compensation for beneficiaries, Superannuitants, and people getting Working for Families, among others.

And third, higher-income earners will bear the brunt of the revenue-raising measures in the tax package. Base-broadening measures like the depreciation changes will affect asset owners who are predominately higher income earners. Many of the fairness and integrity measures will also disproportionately affect higher income earners.

As a result, the tax changes when considered as a whole are broadly neutral in terms of their effect on income distribution.

When all the effects of the package are considered, it does not unfairly favour one household income group over another.

Furthermore, low to middle income earners, particularly those with children, have been the biggest proportional winners from tax changes over the past decade, including the changes announced yesterday.

High income earners, on the other hand, have had the lowest proportional increases of all.

The tax system has therefore become significantly more progressive since 1999.

For example, after our tax changes are implemented, a person on the average wage of $50,000 with two kids will effectively pay no income tax whatsoever, because of Working for Families.

However, the same person earning just over $80,000, and still getting Working for Families, effectively pays 20 per cent of their income in tax.

So I reject criticism that the Budget tax package is unfair.

Our tax package actually makes the tax system fairer, for a number of reasons.

It ensures that wage and salary earners in the top tax bracket - like many teachers, nurses, doctors and police officers - do not pay higher rates than people who can structure their business affairs for tax purposes.

It makes the taxation of different investments more equitable, for example by decreasing taxes on savings vehicles and increasing the effective tax rate on property investments.

It closes Working for Families loopholes, makes sure qualifying company shareholders pay the right amount of tax, and prevents abuse of the GST system.

It gives IRD the resources to crack down on people who are not paying their fair share of tax, or evading it altogether.

That adds up to a very fair tax package.

Some people think we should have kept the top rate at 38 per cent but made it apply from $100,000 onwards.

I don't agree.

To begin with, such a move would raise very little tax in the scheme of things - around $450 million a year.

To put that in context, it would, for example, enable a future government to reduce GST from 15 per cent to 14.5 per cent. That would hardly be noticed.

It would also wreck the integrity of the tax system.

Aligning the top tax rate and the trustee rate at 33 per cent is the most important thing we are doing to improve the coherence and integrity of the tax system.

It is not fair, for example, that a wealthy property owner can structure their affairs so they face a marginal tax rate of only 33 per cent, whereas a hard-working salary earner has to pay 38 per cent.

Introducing a high top tax rate would simply increase taxes on people like doctors, engineers, and other skilled, experienced professionals this country needs, who earn a salary and pay PAYE.

It wouldn't affect the really wealthy people who earn business or investment income and who for the most part are not paying high rates of tax on their income at all.

Furthermore, a top personal tax rate of 33 per cent is not low by international standards.

A recent KPMG survey showed that the average top personal tax rate in 86 countries, including the high tax countries of Western Europe, was just under 29 percent.

A top rate of 33 per cent therefore helps our international competitiveness It helps attract skilled people to live and work in New Zealand, including our own graduates, one-sixth of whom now work abroad.

In particular, it means we have a very competitive tax system compared to Australia.

From 1 July, Australia will have personal income tax rates of 37 per cent, for income between A$80,000 and A$180,000, and 45 per cent for income over A$180,000.

On a straight dollar-for-dollar basis, Australians earning over $55,000 will pay more income tax than New Zealanders on the same salary.

In addition, we are reducing our company tax rate to 28 per cent, three years earlier than Australia.

And for those who may have been wondering, I can confirm that Cabinet decided to lower the company tax rate before the Australian Government announced its intentions and before the Henry Review was released.

The fact that both countries ended up choosing a 28 per cent rate means we have similar opinions on the balance between improving our international competitiveness and finding the revenue needed to do that.

Ladies and Gentlemen

As the economy continues to pick up, the Government's economic focus has shifted from managing through a crisis to creating opportunities.

Creating opportunities is all about incentives and giving people the confidence to believe they can get ahead.

That is what this year's Budget is all about.

Tax is an important part of that because it affects everyone's decisions about how much they spend or save, how they invest, whether they're doing overtime or not, whether there's a second earner in the house, whether they take on more employees, whether they increase their hours of work, or whether they stay working here in New Zealand.

Tax is a pervasive influence in the economy and one of the biggest levers any government can pull to increase economic growth.

I said in my Statement to Parliament in February that the Government had a number of objectives for the tax system:

* we need a tax system that creates incentives for people to work hard, improve their skills and get ahead here in New Zealand.

* we need a tax system that encourages saving and boosts the productivity of investments.

* and we need a tax system which is not difficult to comply with or administer, which is regarded as fair, and which limits opportunities to divert income and reduce tax liabilities.

That is precisely what the Budget has delivered.

Thank you


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