Hon Bill English
Minister of Finance
Lifting our economic game

Speech to Massey University and Auckland Chamber of Commerce business lunch

Good afternoon and thank you.

As newly-elected Prime Minister John Key said in December 2008: “The driving goal of the new Government will be to grow the New Zealand economy in order to deliver greater prosperity, security and opportunity for all New Zealanders.”

In his statement to Parliament last week, the Prime Minister outlined the Government’s next steps to achieve that goal and help Kiwi families get ahead.

I will pick up on some of them today.

Let me start by explaining why we need to lift our economic game. It’s great that we’re emerging from the recession in reasonable shape and that we’re seeing some welcome signs of recovery.

But for most New Zealanders, the real measure of recovery is not whether GDP is growing or the current account deficit narrowing.

The real measure of recovery for them is whether they have a job – or, if they lose their job, whether they can find a new one.

Unemployment has now been rising for over two years and is now above 7 per cent. Although today’s levels are moderate by both the standards of the past and compared with the major economies abroad, more needs to be done to create permanent jobs.

But I wonder if New Zealanders realise just how large that job is - or the scale of the impediments we face.

First, our growth rate in recent years has been poor. The perception that this economy was growing strongly before the global financial crisis is wrong.

Revisions to official GDP statistics late last year show New Zealand’s economy grew significantly more slowly than we thought in recent years. In fact, it is not much bigger now than it was in 2005 - and it was already in trouble before the global recession. I n the three years before the Lehman collapse in late 2008, the economy grew by less than 1 per cent a year. This was less than half our trading partner average, and less than one-third of Australia’s growth rate. It gets worse. During this time, the growth came from all the wrong places.

3. Output from exporters and export competing industries, often termed the tradeables part of the economy, is now about 12 per cent smaller than in 2005.

So we’ve had five years of severe export recession. In fact, the export sector has not now grown at all since 2002 – and in that time Government spending has accelerated and New Zealand’s indebtedness to the rest of the world has grown significantly.

That’s just staggering. Industries where New Zealand has competitive advantage, where we trade with the world and which generate our wealth, have been stagnant for almost a decade. This is despite the fact that we have terrific exporters in New Zealand. We are the world’s largest dairy exporter. We have an excellent climate for growing timber and our fisheries management regime is the envy of the world.

We have developed outstanding industries in areas as diverse as biotech, software and wine. And it’s a little known fact that oil and related products is our third largest export category.

We have other advantages: strengthening trade relationships with Asia, the emergence of China and a comparative advantage in water availability to name a few.

All of this should position New Zealand well for the future.

And yet, to repeat the point, total output of this group has not risen for almost a decade.

Some of the decline is concentrated in manufacturing, which has faced increasing competition from Asia. But the failure to perform is across the board.

In the year to last September, exports of services, including tourism, transport and business services, worth around $12 billion a year, were over 10 per cent below their 2002 level in real terms.

Output of the forestry and fishing industries is static to slightly down over the same period

Total agricultural output has shown no growth over the past four years.

In this time, New Zealand’s population has increased by 300,000 people, all of whom consume imports. Put simply, we have not generated enough export income to match this. 4 New Zealand’s habit of spending more than it earns has accelerated in the past five years.

External debt owed by households and government has grown from $130 billion to $165 billion over this period.

Government spending has ballooned, growing 50% in the five years to 2009, more than twice the nominal economic growth. As the tide of global growth went out, the costs of this have become all too apparent.

The property market soared, and is now in a long term correction. It has absorbed too much of New Zealand’s productive capital, for too little gain. No economy can long survive in this kind of fantasy land. We cannot continue with accelerated consumption based on the Government spending more and our house prices rising, while imagining that this is making us wealthy.

It felt good at the time, but it couldn’t, and didn’t, last. The challenge is simple: to produce goods and services the world actually wants. That is the only way we will create permanent, worthwhile jobs.

The fiscal costs of this legacy are well known. We face another six years of Budget deficits. The Government is borrowing about $240 million every week to roll over existing debt and to fund growing deficits. Net core Crown debt is forecast to more than treble to $65 billion by 2014. On current projections, in the years between now and 2014, public debt will keep rising - and taxpayers will then have to start repaying that debt, with interest. In the meantime, the Crown’s annual interest payments are forecast to double to $5.9 billion.

Therefore, most Government operations will receive no budget increases over the next few years. Not because they don’t deliver worthwhile services, but simply because we cannot allow debt to escalate further. This legacy has both an economic and a human cost. The economic cost is obvious. The human cost is everywhere: New Zealanders who have lost their jobs, have decided to live abroad, or families who are struggling. So we have a clear choice: We can continue to muddle along, handicapped by these imbalances and falling further behind other countries. Or we can set our sights higher and create the kind of country the Prime Minister spoke of soon after taking office.

5 Addressing the economic challenge

We need a much better performing economy to reverse these trends. That’s why this Government’s focus in 2010 is significantly and sustainably increasing economic growth.

We need to change the incentives so resources go towards productive investment, savings and exports and away from the unsustainable consumption, borrowing and government spending increases of the past decade.

That’s what we will start doing this year and continue in the years to come. I believe it would be futile to launch a one-off package of big-bang reforms that pleases a few commentators, but sparks an overwhelming public backlash.

We’ve seen this happen in New Zealand before. History shows this approach has been followed by extended periods of economic policy inertia and – most damaging of all – economic underperformance.

This Government does not want that for New Zealand. Instead, we’re embarking on a consistent programme of considered, broad-based reform, year after year. This is what Australia has done over many years. Six main policy drivers are at the heart of the Government’s programme: a growth-enhancing tax system; better public services; support for science, innovation and trade; better regulation; investment in productive infrastructure; and improved education and skills. The common thread is better use of our resources; directing our energies into areas New Zealand is good at; and allowing New Zealand firms and families to get ahead.

We have made good progress. Today I will touch on three of the policy drivers: productive infrastructure, better regulation and tax reform. Productive infrastructure investment One of our goals is to ensure that New Zealand’s competitive industries are not hamstrung by infrastructure bottlenecks.

For this reason, the Government has increased its capital allowance by $7.5 billion over the next five years. Much of this is earmarked for infrastructure projects such as the roll-out of ultra-fast broadband, better hospitals and more modern schools.

In addition, the Government will spend $7 billion on improving State Highways in the coming five years and $3.3 billion to strengthen the national electricity grid. 6 Combined, this amounts to productive investment of about $3.5 billion a year for the next few years.

This is supporting thousands of jobs across New Zealand – quite apart from the wider benefits to the economy. This year, construction will begin on the Te Rapa Bypass in Waikato, the Christchurch Western Corridor and the Te Atatu-Lincoln section of Auckland’s Western Ring Route.

We will continue work on the Christchurch Southern Motorway, the Victoria Park Tunnel, the Kopu Bridge, the Hawkes Bay Expressway extension, along with others.

And this year we will complete the Manukau Extension and the Manukau Harbour Crossing in Mangare and progress electrification of the Auckland commuter rail network.

This year will also see the Government beginning to lay fibre as part of its $1.5 billion ultra-fast broadband initiative, and further investment will improve broadband across New Zealand.

Ultra-fast broadband is also vital to encouraging private sector investment if growing new types of businesses.

The Government wants to learn from the private sector. In particular, we need to improve management and decision-making for the $110 billion of infrastructure assets the Government holds. This is a huge investment. But asset management disciplines within Government are weak. Even a 1 per cent efficiency improvement would be worth over a billion dollars.

We believe the public sector can lift its game is through greater exposure to private sector techniques, including better risk assessment, tighter fiscal discipline, as well as a strong focus on better design and service. Public-private partnerships, or PPPs, are one option for doing this. I hesitate to use the term PPP, because in it covers a wide range of approaches. The Government is considering the merits of two such partnerships – one for the construction of schools and the other for the construction and management of a new prison. We expect to make decisions around the middle of the year. 7 Next month, I will release the first National Infrastructure Plan. It’s a snapshot of existing projects, planned investment and the Government's priorities. It will clearly show the breadth and scale of investment already underway.

We will give infrastructure providers certainty about the Government's plans and ensure that planners and stakeholders have a clear sense of what is happening across a range of sectors.

The plan will be updated regularly with future versions focusing more on identifying emerging bottlenecks and investment gaps in a fast-growing economy. Regulatory reform

The next policy priority I want to discuss today is better regulation. Across all portfolios, the Government has looked carefully at where overlyrestrictive regulation may be getting in the way of doing business.

Again, we’ve made significant progress.
In the Government’s first 100 days, it got underway the first phase of reforming the Resource Management Act. These amendments were largely about streamlining and speeding up the Act’s processes.

The Government last year established the Environmental Protection Authority to streamline and expedite decision-making on projects of national significance.

A number of organisations have indicated they are likely to lodge significant proposals with the EPA this year. The NZ Transport Agency is one of them – for the Waterview Connection here in Auckland. The second phase of RMA reform is underway. It is much broader than the first stage and deals with more complex issues.

This phase will reduce the cost of achieving good environmental outcomes. It will include:

Considering a fairer and more efficient water management system, including issues around water quality and inefficient allocation. Developing the scope, functions and structure of the Environmental Protection Authority.

Reviewing how aquaculture is managed and what changes are necessary to stimulate the industry. 8 Looking at better ways for managing and planning New Zealand’s infrastructure.

Streamlining and removing duplication between the RMA and other legislation.

Looking ahead, we want to complete a large number of other significant regulatory reviews by the end of this year, including the Electricity Industry Bill and the Food Act.

In addition, we’re working on the Building Act, the Holidays Act, the Overseas Investment Act and legislation covering aquaculture, telecommunications and weather tight homes. We will also introduce the Regulatory Improvement Bill, which will improve the wider regulatory framework and reduce the compliance burden on business.

We will carefully review all new legislation to ensure that it passes a high hurdle in terms of its likely effectiveness.

Problems with the Tax System

Let me now turn to taxation.

Public discussion since the Prime Minister’s statement to Parliament has focused on the merits of switching between personal income tax and GST, and making sure that sectors such as property bear their fair share. But the debate about taxation needs to go much deeper – and recognise the scale of our economic imbalances and the need to create higherpaying jobs.

Remember: we’re faced with an economy where we’re spending more than we earn. Tax is one way to change people’s choices and turn that around.

The Government agrees with the Tax Working Group that that the tax system needs reform.

In particular:

We accept that New Zealand relies heavily on taxes most harmful to growth such as corporate and personal income taxes

There is a hole in the tax base around the taxation of property.

The tax system lacks integrity and fairness because it treats different entities differently. 9 There are significant risks to the sustainability of the tax base.

The best way address these issues is to define all tax bases as broadly as possible and to impose low rates across all economic activity.

Some of the obvious failings highlighted by the Tax Working Group included:

New Zealanders have $200 billion invested in rental properties - nearly four times the size of the entire New Zealand sharemarket. In 2008, it produced a negative taxable return of $500 million and $150 million in tax revenue losses.

The top 10 per cent of income earners pay 76 per cent of net tax when the impact of Working for Families, New Zealand Super and benefits are included.

Only half of the 100 wealthiest New Zealanders in a sample Inland Revenue survey are paying the highest marginal rate of personal income tax.

Options for reform

So where will this lead us?

First, the Government is very clear: Any tax changes need to contribute to a better-performing economy, more jobs and higher incomes for families. Any changes must also be fair and equitable.

And, given that we face another six years of budget deficits, our tax package must be broadly fiscally neutral.

From a political perspective, any package of changes must generate reasonable public support so it endures through time.

The starting point for the Government is that lower personal taxes across the board are a good thing because they give people incentives to work hard, improve their skills and get ahead here in New Zealand.

At an economy level, we must encourage more productive investment, savings and exports, and have less borrowing, consumption and government spending.

We are carefully reviewing the Working Group’s proposals and decisions will be announced in the Budget on May 20. Some options will not be progressed, as the Prime Minister confirmed last week. 10

But we will make changes to the way property is taxed, which will increase our revenue from that sector and be fairer for all taxpayers. One way of doing that is removing the tax depreciation allowance on buildings that do not, in fact, depreciate.

Another is to improve the definition and policing of existing capital gains tax rules. Both of those things are still on the table. Most members of the Tax Working Group supported increasing the GST rate to 15 per cent because it would reduce the tax bias against savings and investment.

Accompanied by moves to address the gap in property taxes, this would be a worthwhile step towards addressing the savings and investment imbalances that have been so costly to New Zealand. A lift in the GST rate would raise the CPI by just over 2 per cent. This is less than actual CPI inflation in six of the last eight years.

Let me stress that any increase in GST would be accompanied by compensation for low and middle income earners, beneficiaries, superannuitants and people receiving Working for Families. Company tax, personal tax and imputation I’ll now turn to the interaction of company and personal tax.

The Government agrees with both the Tax Working Group and the Capital Market Development Taskforce that the current imputation system is worthwhile. Therefore it will be retained.

Both New Zealand and Australia have this system and imputation plays an important role in our overall tax system.

Think about a company that pays tax on its profits and afterwards distributes those profits to shareholders.

A New Zealand resident shareholder on the current 38 per cent top personal tax rate pays only an extra 8 per cent tax on any dividends they earn, because company tax of 30 per cent has already been paid on their behalf.

This means that for New Zealanders, the most important tax rate in the whole system is, generally speaking, the personal tax rate. That is what they ultimately pay on their earnings, whether through wages, interest from the bank or dividends from owning shares. That is why the Government is keen to reduce personal tax rates across the board. 11

I say “generally speaking” for an important reason. For New Zealanders, company tax is effectively an interim payment until their own personal tax rate applies. But trustee tax rate is not an interim tax. Trustee tax, which is currently 33 per cent, is a final tax. That is why some people can use trusts to permanently avoid paying the highest personal tax rate.

While the Government has decided to retain the imputation system, the question remains as to what the company tax rate should be and how it should relate to the top personal tax rate and the trust rate. We are still considering this issue – mindful that our company tax rate needs to be competitive internationally.

Alignment of the company rate, the top personal rate and the trustee rate is, in theory, the best arrangement. This therefore remains the Government’s medium-term goal.

However, the Government is considering whether that is affordable and whether it fits with other equity considerations. Our early advice is that aligning the trust and top personal tax rates is the most important issue, because they are both final taxes.

By contrast, company tax is an interim tax until a taxpayer’s own personal tax rate applies – although it does need to be competitive internationally. There are two other important considerations.

First, complete alignment may not be necessary to eliminate many of the integrity problems with the current system.

Substantial gains could be made by aligning the top personal tax rate and the trustee tax rate, which are both final taxes, and having a company tax rate not too far below this.

Second, complete alignment may not be sustainable over time. Around the world, company tax rates are generally falling and, at 30 per cent. New Zealand’s company tax rate is on the high side compared with many other developed countries. Remaining competitive with other countries may be more important than alignment – if not now, then at some point in the future.

This is a complex area with many competing considerations. For example, cutting the company tax rate may just give a windfall gain to foreign business owners who would have invested in New Zealand anyway. 12

The Government has asked for more work to be done on these issues. What we do know is that New Zealand’s company tax rate can’t get too far out of line with Australia’s. Currently they are both at 30 per cent, but Australia is reviewing its own tax system and may consider dropping its company tax rate. The Government will watch events across the Tasman with a great deal of interest.

Conclusion

Before I finish today, I’d like to leave you with three messages: First, there is a real need for change in this country if we are to deliver the jobs, the higher incomes and the better living standards New Zealand families deserve. We can continue to muddle along – or we can aim higher and deliver the opportunities this Government wants for hard-working Kiwis.

Second, the economy is front and centre stage for the Government in 2010. We have set out our significant policy programme framework for this year and beyond, so we can tackle the big economic issues that have been left unaddressed in recent years.

Finally, it’s important to understand that our economic programme will not end with the Budget in May. This is not a one-off exercise. We’re embarking on a consistent programme of considered, broad-based reform, year after year.

Thank you.

ENDS

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