Don Brash - Address to PricewaterhouseCoopers National Tax Conference, Wairakei

Achieving Economic Growth

Mr Chairman,

I am delighted to have this opportunity to address you. As a long-standing customer of PwC, and of Price Waterhouse prior to the merger, I am always glad to see PwC partners hard at work in such a delightful setting!

You have asked me to address the theme "Achieving economic growth" and it is a particular pleasure to be able to do so free of the constraints which inevitably limited what I was free to say when I was Governor of the Reserve Bank.

A former Secretary to the Treasury once likened the conduct of economic policy to steering a supertanker. It takes a very long time to change course, and the ship's momentum will carry it along for a considerable period even if the engines are shut down and the captain is dozing on the bridge.

This seems particularly relevant as a picture of the New Zealand economy. The power may well be turned off this winter; the impetus from earlier reforms has been keeping us going; and the PM does seem to be asleep at the wheel.

I have several concerns about New Zealand. Our little South Pacific supertanker is gradually turning in the wrong direction, we are losing momentum, and recently we even seem to be sailing with the wrong navy.

What the French have done to deserve our standing shoulder-to-shoulder with them rather than with the US, UK and Australia is beyond comprehension. One of the most depraved regimes of modern times has just been overthrown, and New Zealand supported not those liberating the Iraqi people, but instead those few countries blocking progress through the UN Security Council - those who had the strongest links to the regime and supplied it with many of its weapons. There is nothing to be proud of here.

But today I want to focus not on foreign policy issues but on the economic issues facing New Zealand, particularly on the domestic causes of our gradual loss of momentum.

In the last few years, we have been complacently riding the wave of growth flowing from the economic reforms of the late eighties and early nineties, but the momentum is fading.

Many people need myths to sustain them, and the Labour Coalition Government is no exception. Their internal political myth is that those reforms were a failure, and they have been remarkably successful in persuading New Zealanders that the myth is reality. But almost none of the big changes of the late eighties and nineties have been reversed: not the Reserve Bank Act with its requirement that monetary policy deliver low inflation; not the Fiscal Responsibility Act, with its focus on fiscal prudence and reduced public sector debt; not the abolition of import controls, or the reduction of tariffs; not the corporatisation of government-owned trading operations; not the de-regulation of the transport, retail or financial sectors; not even a reversal of the reductions in benefit levels introduced in 1991.

So what has changed? One exception occurred in respect of privatisation, where a panicky response to the consequences of Labour's earlier total failure to accommodate Air New Zealand's restructuring plans led to re-nationalisation. And the Government's astounding commercial naivety could yet see them get entangled with Tranz Rail. Another misstep was the Kiwibank sop to old political warrior Jim Anderton to sustain support from his latest political vehicle.

Two other reversals come to mind: one was the moderate re-regulation of the labour market. It was not as big a move backwards as the unions had hoped, and just as well, as there would be fewer jobs available if they had got their way. The Employment Contracts Act was certainly a big part of the employment growth of the 1990s, and that growth flowed on to strong growth in real wages. The other reversal was nationalising ACC, thereby lifting costs to the business community.

In spite of these set-backs to rational economic policy, we find that the bulk of the reforms introduced during the 15 years which preceded this Government's arrival on the scene remain intact. In spite of the myths that the political left live by, in the end we see that sound policies, no matter how controversial at the time, tend to endure.

And I can assure you that most of this Government's innovations will not endure.

Let's come back to why the NZ economy is losing momentum.

It is self-evident that we need a fast-growing economy if for no other reason than that, without rapid growth, we have not the slightest chance of reducing the large gap in living standards which has emerged in recent decades between New Zealand on the one hand and the other countries with which we like to compare ourselves - Australia, the United Kingdom, the United States, and the countries of western Europe - on the other. And unless we reduce that gap, we run the serious risk that the New Zealand society in which most of us have grown up - with reasonable access to good schools and healthcare for all and with a high degree of social and racial harmony - will simply not survive.

For several decades, we failed to grow as rapidly as other developed countries, falling from near the top of the international league tables for average income per person in the fifties to being well behind the leading nations by the end of the eighties. In large part because of the admittedly tough period of reforms in the late eighties and early nineties, New Zealand for the first time in several decades has broadly kept up with the international pace since the early nineties. But the consequences of that earlier period of relatively slow growth live on, with Australia's per capita income some 30 per cent ahead of ours, and America's per capita income well ahead of Australia's. We have stopped falling further behind, but we are not closing the gaps - to resuscitate a phrase the Government has wisely dropped, as their policies can only widen them.

That large income difference is pretty much all we need to know to understand why many of our most able and energetic citizens have left the country in recent years - why indeed our net loss of New Zealand-born people to greener pastures abroad has almost exactly offset natural population growth over the last five years. And for that reason it should be clear that another decade of relative decline would be catastrophic for this country.

Obviously the more wealthy a society, the better able people are to look after themselves. They have to work fewer hours to feed themselves; fewer weeks to buy a car; fewer years to buy a house. And the higher our incomes, the more able we are to pay our teachers, nurses, and police well, the more we can invest in maintaining the environment, and the better able we are to look after the least well off.

So all New Zealanders have a stake in good economic policy.

What worries me is that, even with the favourable circumstances of recent years, we have only just been keeping pace with the rest of the world. That is not good enough, because in less favourable circumstances it suggests we will again be falling behind. If Australia's per capita income went from being 30 per cent above ours to being, say, 50 or even 60 per cent above ours, we would be in huge trouble - if we aren't already.

We need to do better, if we are to narrow the gap. Under current policies, we will undoubtedly start to fall behind again.

I want to come back now to the fundamental reasons our incomes are lower than in countries we aspire to match.

Quite simply, incomes are higher in most other developed countries because they are more productive than we are: they get more output per worker. They do so not because their labour force works harder than ours, but because on average their workers: * Work with more and better capital, the source of which is business investment; * Are surrounded by better physical infrastructure (more efficient utilities, better transport systems and so forth - think of Auckland roading); * Have (or at least had, prior to the late eighties and nineties) lower cost regulatory environments, including labour market regulation; and * Are better educated.

Take this list - the stock of capital in our businesses, infrastructure, regulation, and education - and consider any government policy change. If you ask yourself whether the change is likely to improve productivity growth, the answer will tell you whether we are going backwards or forwards.

Consider some easy questions. Will higher tax rates and increased regulatory compliance costs encourage business investment? Does the RMA expedite infrastructure planning? Will making employers potentially liable for huge costs if an employee feels stressed encourage employment growth?

That is what the National Party means by saying this Government is taking New Zealand in absolutely the wrong direction. It is surely worrying that, when the Treasury issued its projection for growth over the next 10 years last December, they concluded that the highest growth rate over the decade would be that in the year to the March which has just gone. To be sure, nobody should take a 10 year projection too literally, but what that projection does show is the Government's primary economic advisers see nothing on the horizon which will lift this economy's trend growth rate over the next 10 years.

Clearly there are many things I could talk about in relation to this list of factors influencing the productivity of a nation.

But I want to focus on just one aspect: how the tax system influences productivity growth. And I choose this focus both because tax policy directly impacts two crucial aspects of productivity - business investment and work incentives - and because I strongly suspect that Dr Cullen's Budget next week will be totally silent on any changes in tax policy which might lift our growth rate.

Undoubtedly the dominant factor in the differing productivity levels we see around the world is the amount and quality of physical capital that the average worker uses, although the quality of human capital - the skill of the workforce - is vitally important also.

To take a simple case, it is the difference between what can be achieved by one worker with a shovel and another with a bulldozer. Or in terms of infrastructure, the difference between one community with an efficient roading system, and another continually plagued by traffic jams.

But it is not just the quantum of capital that we work with that matters. At this time of unprecedented technological change, the age and quality of the capital is crucial also. We know that a computer has two to three years' life before it is obsolete - if we're lucky. The difference between a 20 year old sawmill and a modern one is huge. The productivity gains to hospitals from using the latest medical technology are enormous. And the same can be said for pretty much every part of a modern economy.

Take as an example one of the success stories of the past decade, the most traditional of sectors - agriculture. The agricultural sector has achieved very strong productivity growth as a result of exposure to tough market disciplines, careful application of technology and first-class farm management practices. Agriculture is a tremendous example of the innovative application of physical and intellectual capital. We don't necessarily need a Silicon Valley - you can work smart in any activity.

To have a fast growing economy delivering the higher incomes that people want, we need strong business investment, and this in turn means that businesses need strong free cash flow, together with the incentive to reinvest that cash flow.

So it raises the obvious, billion dollar, question: if we want businesses to invest in New Zealand, what on earth are we doing with one of the highest corporate tax rates in the Asia-Pacific region?

If we were serious about lifting New Zealand's growth rate, we would be encouraging business investment by cutting the company tax rate for all businesses and, since many businesses are unincorporated and the company tax rate is in any case just a withholding tax, the top personal tax rate to match.

As it happens, the Government may well eventually get around to cutting tax rates, but it looks as if those tax cuts will be focused on the political hot-spot of lower to middle income groups. It is affordable. New Zealand does have a very large fiscal surplus - which in the current environment is another way of saying that everybody is being grossly overtaxed.

It seems clear that this surplus will be used to try to buy the public's votes as we approach the next election. It was George Bernard Shaw who observed that "a government that robs Peter to pay Paul can always depend on the support of Paul". That in fact is the only sign of long-term strategy that is evident from this Government.

But is this really the most sensible way to reduce taxes? At the moment, low-income families pay almost no income tax, because of Family Tax Credits and similar schemes. A person earning $25,000 a year with a dependent spouse and two children under the age of 13 effectively pays only $27 each year. By contrast, somebody in the same family circumstances who earns $100,000 pays more than one thousand times as much income tax.

If, instead of reducing the taxes paid by low income New Zealanders still further, Government were to reduce the company tax rate and the top personal tax rate, to give New Zealanders maximum incentive to grow their businesses, invest, take entrepreneurial risks, and so on, and if as a result we could increase our rate of economic growth by even a relatively small amount - say ½ per cent a year - the benefits to all New Zealanders, whether low income or high, would be substantial very quickly.

Some of you will have heard the US story which was circulating on the internet recently. It told how an American was having lunch in New York with an academic friend from New Zealand when the conversation turned to the idea of tax cuts. "I'm opposed to those tax cuts", the New Zealander declared, "because they benefit the rich. The rich get much more money back than ordinary taxpayers like you and me and that's not fair."

"But the rich pay more in the first place," the American argued, "so it stands to reason that they'd get more money back." The New Zealander was unimpressed by this argument. Even university lecturers are a prisoner of the myth that the "rich" somehow get a free ride in New Zealand. Nothing could be further from the truth.

The American offered to explain tax cuts more simply.

Suppose 10 men go to a restaurant every day for dinner. The bill for all 10 comes to $100 (they get a special discount as regular customers!). If it was paid the way we pay our taxes, the first four men would pay nothing; the fifth would pay $1; the sixth would pay $3; the seventh $7; the eight $12; the ninth $18; and the tenth man, the richest, would pay $59.

The 10 men ate dinner in the restaurant every day, quite happy with the arrangement until the owner offered them a further discount on the cost of their meals. "Since you are all good customers", he said, "I'm going to reduce the cost of your daily meal by $20. Now dinner for the 10 of you only costs $80."

The first four men were unaffected. They still ate for nothing. But the remaining six had to calculate how to divvy up the $20 savings so that everyone got his fair share. The men realised that $20 divided by six is $3.33, but if they subtracted that from everybody's share, then the fifth man and the sixth man would end up being paid to eat their meal.

The restaurant owner suggested that it would be fair to reduce each man's bill to some extent so proceeded to work out the amounts. So the fifth man paid nothing, the sixth paid just $2, the seventh paid $5, the eighth paid $9, the ninth paid $12, leaving the tenth man with a bill of $52 instead of $59. Outside the restaurant, the men began to compare their savings.

"I only got one dollar out of the $20," declared the sixth man pointing to the tenth, "and he got $7!"

"Yep, that's right," exclaimed the fifth man. "I only saved a dollar too. It's unfair that he got seven times more than me!"

"That's true," shouted the seventh man. "Why should he get $7 back when I got only $2? The wealthy get all the breaks."

"Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"

The nine men surrounded the tenth and beat him up. The next night he didn't show up for dinner, so the nine sat down and ate without him. But when it came time to pay the bill, they discovered something important. They were $52 short!

And as you all know, that's how the tax system works. The people who pay the highest taxes get the most benefit from a tax reduction - or at least they would unless the Government carefully skews the system so they don't. But tax them too much, abuse them for being wealthy, and they just may not show up at the table any more. There are lots of good restaurants in Switzerland and London. National has no quarrel with cutting taxes on lower to middle income groups. Indeed, we cut exactly those tax rates most relevant to low and middle income earners in 1996 and 1998, and at this stage low income people with dependents pay very little, if any, income tax, as I've noted. But we do have a quarrel with leaving it at that.

Unless tax cuts also include the corporate tax rate and the top personal tax rate, we will have done precious little to influence the key drivers of business investment, thus done little to increase the quantity and quality of capital that the labour force work with, and therefore done little to boost real incomes in the future.

Happily, the extent of Budget surpluses is such that there is currently scope to cut the company tax rate and the top personal tax rate to, say, 30 per cent and cut the middle income tax rate to some extent as well, though I would myself be reluctant to go as far as one of the other centre-right parties is proposing to go in cutting tax rates in a situation where the longevity of very large fiscal surpluses is by no means obvious at this stage.

But whatever the merits of reducing tax rates more generally, it is now very clear that this Government's move to increase the top personal tax rate from 33 per cent to 39 per cent in 2000 was driven by nothing more than the politics of envy. There was certainly no need for the extra revenue to fund any of the Government's increased spending programmes. The increase sent absolutely the wrong signal to New Zealanders aspiring to raise their standards of living and, while it no doubt generated lots of extra fees for tax accountants, for most of the community it simply added to compliance costs (which of course is the obverse of increased fees for tax accountants!).

Part of the problem I suspect is that the political left have a hopelessly out of date, static, view of society. They see the community as divided into rigidly defined antagonistic groups: the wealthy versus the poor; high income versus low. But the reality is that these are all highly fluid categories.

A professional rugby player will be a high income earner for a few years, but not many, and injury or illness could end his career at any time. The owner of a business will have good years and bad. And with bonuses becoming more widespread as a tool of remuneration, so will ordinary wage and salary earners.

The now-higher top personal income tax rate effectively takes an extra slice of tax from people at just the time when their years of hard work are finally paying off. Some incentive to make it!

Most of us start with not much more than our talents and personal drive; with hard work that will develop to a period of peak earning ability, probably in late middle age (unless we work in the IT industry); and we know that in retirement our income will drop abruptly and we will start to use up our savings. We call it the life cycle.

If we take a look at the income distribution at any point in time, much of what we see is no more than groups of people at different stages of their life cycle.

Of course there are people who, through bad luck, ill health or disability, remain permanently stuck at the bottom of the heap, and none of us would question our need to support them. But that segment of the community is much smaller than that suggested by a snapshot view of the income distribution at any point in time. Most people are capable of looking after themselves, and most do.

The Government's own review of the tax system, undertaken by a committee under Rob McLeod, suggested a cap of $1 million on the amount of tax any individual should pay in a year. Frankly, I would have thought that if somebody has paid tax on that spectacular scale the appropriate response from the community would be garlands of flowers, a street parade, and the minting of a medal. But it is not hard to guess how much support this idea had on the political left. And thus another good idea from one of New Zealand's foremost tax experts (sorry to say this at a PwC conference!) bit the dust. And we are all the poorer because of it.

Of course it is not just taxes that influence business investment and growth. The regulatory environment matters as well. The quality of the work-force matters. The generosity of the welfare system is highly relevant. The quality of infrastructure matters. Those are all matters for another time.

But let me just briefly refer to the regulatory environment. Now that the allure of socialism's commitment to public ownership has faded, those on the political left have found an alternative way to ruin an economy - regulation. The New Zealand statute book now runs to 89 volumes and about 65,000 pages, and it's growing. We must be approaching 10,000 regulatory commandments.

Amongst these, the Resource Management Act stands as one of the greatest productivity killers yet devised. The current Act slows or prevents many investments, especially in infrastructure; it encourages a climate of corruption and blackmail; it severely strains race relations; and it plays a part in pushing up the price of residential sections. Alas, a Bill to amend the RMA currently before Parliament looks very likely to make the situation markedly worse. It is quite simply madness - a riot of political correctness rampaging through our statute books.

Just imagine the cost of the delays caused by the RMA; just think of the projects deferred because of it, and thus the physical capital that would have existed but never got past the planning stage. We are all the poorer because of it.

When you consider the diligence with which the factors that drive income growth have been attacked by this Government, it is a wonder the economy grows at all.

While trying hard to kill the goose that lays the golden egg, the Government seems to routinely shoot us all in the foot.

If this is the sort of New Zealand we continue to build, we will assuredly meet with and deserve the final indignity - as we limp to the nearest hospital - of being promptly placed on a very long waiting list.

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