Budget 2006: More Spending and Less Growth

Budget 2006: More Spending and Less Growth

Last December the government released its latest Budget Policy Statement (BPS). It gives the government’s assessment of the medium-term outlook for the economy and outlines the broad shape of the 2006 Budget. The first striking point about the BPS is that it projects the economy’s medium-term performance to deteriorate sharply. New Zealand is not on track to lift its average living standards relative to Australia or the OECD average.

The projected annual average rate of growth in real GDP is only 2.8 percent during the five years to March 2010. This is far below the annual average rate achieved in the last decade and well below the 4 percent per annum rate of growth that the minister of finance has said would be the test of whether the government's growth strategy is working. Economic growth depends, among other things, on high levels of economic freedom – modest levels of government spending, taxation and regulation.

New Zealand greatly improved its rankings for economic freedom as a result of reforms that were implemented 10-15 years ago. Since then governments have lost their way. The 2006 rankings, just published by the Heritage Foundation in conjunction with the Wall Street Journal, saw New Zealand fall from 5th equal position in 2005 to 9th equal with Australia. Both government spending and taxation are continuing to surge. By 2010 government taxes and levies are projected to be $14,400 per capita, nearly 70 percent higher than the 2000 level of $8,500. A very large proportion – around 60% – of the ‘growth dividend’ is being appropriated by the government.

The government has denied that it has been fiscally imprudent. It points to the fact that core Crown spending has fallen slightly as a percentage of GDP since it assumed office in 1999. However, this outcome is due mainly to growth in GDP (the denominator of the ratio) rather than to spending restraint. Moreover, the claim overlooks the fact that the spending ratio was projected in 1999 to decline even further (as the economy recovered from the effects of the Asian recession) and that it is now set to increase by nearly 2 percentage points by 2010.

This increase in planned spending, and the dubious quality of much of it, can only be negative for growth. Likewise the government points to World Bank research on business regulation suggesting that New Zealand scores highly as a place to do business.

That outcome is a direct and welcome result of earlier economic reforms, but little has been done to build on them for over a decade. The World Bank research relates mainly to developing countries and largely measures factors that are easy to measure (eg how many days or steps it takes to set up a business). The need in New Zealand is to review the issues that are at the heart of our regulatory environment and problems with it such as labour law, the Resource Management Act and electricity industry regulation.

The BPS states that the key initiatives in Budget 2006 will be interest-free student loans, an expanded Working for Families package, and lifting the married couple rate for New Zealand Superannuation to 66 percent of the net average wage. These involve huge increases in spending and limit the scope for reducing taxes. They involve redistribution of income to favoured groups and do little to create wealth, whereas the Treasury has recently reaffirmed that “Tax policy is a major tool that can assist in promoting economic growth.”

With excessive taxation, the more productive sectors are likely to be squeezed as the state outbids them for people and other resources. This is happening at present. Employment in agriculture, hunting, fishing and manufacturing fell by 5 percent in the five years to the year ended June 2005 whereas employment in education, health, community services and other services rose by 17.5 percent.

It would be wrong to blame monetary policy for the present high real exchange rate. A high real exchange rate arises not because the overall rate of inflation is too high or too low but because inflation in the sheltered sectors where government spending is concentrated is higher than inflation in the exposed sectors – those facing international competition. Hence the saying that "monetary policy needs mates". A fiscal policy that was more supportive of monetary policy in current circumstances would see much more constrained spending by the government and lower taxation. Business organisations will be expressing serious concerns about the outlook for growth and the economic and fiscal policy settings foreshadowed in the BPS.

There is an urgent need to rein in spending, improve its quality, reduce taxes in ways recommended in the 2001 McLeod tax review, and cut back regulations. Devices like a Taxpayer Bill of Rights and a Regulatory Responsibility Act to constrain government and expand economic freedom would help make New Zealand a more prosperous place.

Roger Kerr is the executive director of the New Zealand Business Roundtable

ENDS

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