Michael Cullen Address to International Fiscal Association Conference

Thank you for inviting me to speak to your twenty-sixth annual conference. Today I would like to touch upon a number of issues that may be of interest to those attending your conference: the economic outlook, developments in tax revenue flows, progress in a number of tax policy issues, and the impact on New Zealand of tax changes in other countries.

The New Zealand economy is looking reasonably sound, though a great deal of uncertainty lies ahead.

The economy recorded solid growth of 1 percent in the September quarter, taking annual average growth to 3.9 percent and placing New Zealand in the top rung of OECD countries over 2002.

Domestic demand has been strong and has helped to offset the impact of weaker world growth, with solid growth in consumption and particularly residential investment. So far indicators for the December quarter suggest that the domestic economy has continued to perform well.

The December Economic and Fiscal Update saw growth moderating from 4 percent in the current March year, to 2.5 percent in the March year 2004, as the effects of weaker world growth fed through into domestic activity, and drivers such as migration eased off.

Since December, a number of developments have added to the uncertainty surrounding the outlook for the world economy, and therefore for the New Zealand economy. The most obvious, of course, is the possibility of war in the Gulf, higher oil prices and global economic slowdown. Locally, the appreciating New Zealand dollar is affecting exporters, and falling returns for the agricultural sector are also clouding the picture. All these factors add to the strong head-winds that the domestic economy may face over the coming year.

At this stage, it appears to be evolving in line with the December forecasts, and if anything may be running a little ahead. But my personal view is that this will not persist.

The tax we collect is strongly linked to the performance of the economy.

Tax revenue flows are looking healthy, with the tax take, so far, considerably up on last year. The main growth is in GST and company tax.

The growth in goods and services revenue in recent years has been boosted by increased revenue from the farming sector, as well as higher retail spending. Latest forecasts have GST growing by $788 million this year, or over 7 percent. Likewise, net company tax revenue is expected to increase by $521 million, or 11.4 percent, over last year.

As I have stated publicly in the past, I am cautious about this revenue growth. The reason for the size of the increase in GST is not entirely clear. We have seen in the past that the company tax take can change rapidly if the economy deteriorates.

Nevertheless, the growth in company tax has been broadly based. One of the most significant contributions to growth in company taxes in recent years has been from the property and business services sector.

The finance and insurance services sector continues to contribute the largest percentage of cash payments to company tax, although its contribution has decreased markedly over the last three years. In 2000 it contributed about 29 percent. In 2001 it contributed about 24 percent. And in the 2001-02 fiscal year its contribution retracted to 18 percent, a tax take now close to that of manufacturing.

The result is a more balanced company tax profile than has appeared to be the case in the past, when the finance and insurance services sector dominated. The reduction in the contribution of the finance and insurance services sector is obviously in part a result of reduced income from the fall in world equity prices. Nevertheless, aspects of the sector such as banking remain highly profitable, and we are continuing to look at what is driving changes in company tax revenue flows.

Economic growth is very much at the forefront of the government’s Growth and Innovation Framework, which was announced just over a year ago. It aims to lift New Zealand’s economic performance, and – over time – to return our per capita income to the top half of the OECD rankings.

If we are to achieve this, New Zealand must become a source of high-value innovation in particular sectors of the global economy with high growth potential. We have identified these sectors as biotechnology, information and communications technology, and the creative industries.

Four private sector taskforces have been set up to work within the target sectors, to identify and consider measures that will help their sectors to grow. Tax issues are already emerging from the work of the taskforces, so tax policy officials are working closely with them to ensure that these issues are considered from different perspectives.

The government is awaiting the forthcoming final report of the Information and Communication Technology Taskforce, which in its draft report raised a number of tax issues, which will be considered. Reports from other taskforces are expected shortly.

It is not intended that tax recommendations arising from the taskforces necessarily or automatically become government policy. Instead, what the government sees happening is the identification of a number of tax issues that will then make their way through the normal policy process.

Reducing the extent to which tax is a barrier to New Zealand doing business with the rest of the world is another way of promoting growth and innovation. This can be a matter of having good double tax agreements with trading partners and making sure that our tax laws are in line with those of other countries. It can be a matter of strengthening the Closer Economic Relations agreement with Australia and coming up with bilateral reforms, such as the trans-Tasman imputation changes announced just a few days ago.

It can also be a matter of making more radical changes. Several such changes were recommended by The Tax Review 2001, to rationalise the taxation of outbound investment and make New Zealand more attractive to overseas capital and migrants. The government has been considering these recommendations.

One of these recommendations was to introduce an 18 percent tax rate for new foreign direct investment. I announced at the time of last year’s budget that officials’ analysis of the workability of the recommendation would be made available for comment from interested parties. That has occurred, submissions were received late last year, and officials will be reporting shortly.

Another recommendation was to provide a temporary tax exemption for the foreign-sourced income of new migrants. Work is proceeding on the design of a possible regime.

A further McLeod Review recommendation was to introduce a risk-free rate of return method of taxing offshore portfolio equity investments, which would, in certain circumstances, replace the foreign investment fund rules. One of the difficulties with this recommendation is that it can result in people being required to pay tax even when their foreign investment has reduced in value.

There are, however, no easy fixes in this area and it may yet prove that the risk-free rate of return method is the best solution for some offshore investment. I am expecting a report on this shortly, and soon afterwards will make a decision on whether the proposal should proceed to become the subject of a discussion document.

To turn to a few further items on the tax policy work programme, earlier this year I signalled that I was interested in finding out whether the depreciation rules provide for depreciation of assets over their true economic life, accurately reflecting commercial reality. I have asked officials to look at whether this is the case.

The equitable taxation of savings for retirement remains a prominent issue on the tax policy work programme.

I do not believe that giving tax concessions for saving is a viable option. At the margin, in my view, you may bring about a behavioural change on the part of savers, but mostly it will be a matter of savers choosing tax-preferred savings over other types of savings.

On the other hand, current superannuation tax rules penalise this form of savings. Moreover, I am unconvinced that these tax rules recognise the special nature of retirement savings.

I am hoping that we will soon be able to introduce a progressive rate of tax on employers’ contributions to their employees’ retirement savings. This would deal with the current over-taxation of savings of those who earn under $38,000 a year

Another anomaly in current law is the flat rate of 33 percent applying to savings in private superannuation funds. This results in the over-taxation of the savings of people who are on lower marginal tax rates, and the under-taxation of people on higher rates. In the longer term I would like to see the introduction of a system that eliminates these inequities. I am not proposing to re-activate the TOLIS proposal of some years ago, because of the associated compliance costs, but I have asked the industry and officials to provide some advice on possible mechanisms to address this.

One option is a lower tax rate on superannuation funds but, if considered, it would need to be targeted at retirement savings.

Before turning to the impact of international tax matters, I would like to say a few words about the Inland Revenue Department. A tax system that can be relied upon to deliver the revenue the government needs is very much dependent on having a well-functioning tax administration, one that has the confidence and support of the community. Over the last decade or so, both governments and oppositions of different political parties have been concerned both about attacks on Inland Revenue and some aspects of its performance.

As Minister of Revenue I am not accountable for the detail of administration or, thankfully, assessments. The Commissioner of Inland Revenue is accountable for the delivery of the objectives and outcomes necessary to achieve government goals.

I am very happy with the evidence that I see of the major progress Inland Revenue is making. The feedback that I receive reflects the department’s renewed commitment to relationship building: with people like yourselves, with members of the Finance and Expenditure Committee, with the general public, and with its own staff. I am also very pleased by the way Inland Revenue is moving ahead in information technology, with its e-enablement and technology strategies.

Very importantly, these successes have not been at the cost of tax revenue. The government has provided more money for Inland Revenue to focus on evasion and aggressive tax schemes. We set revenue targets for this extra expenditure that Inland Revenue not only achieved but exceeded. Needless to say, I am happy with that.

As I have previously mentioned, we are living through uncertain times. Distance does shelter New Zealand a bit from international developments. Nevertheless, we are not isolated from the rest of the world and, as our growth and innovation strategy makes clear, we do not want to be.

Australia is our closest economic neighbour. We do need to follow closely developments in that country. Anything significant on the tax side that Australia does needs to be assessed for its impact on our tax system and on New Zealand business.

As you will be aware, last month I met with Peter Costello, the Australian Treasurer, and we announced the trans-Tasman tax proposal. Those discussions reinforced to me that the tax challenges we face are similar. For example we both want to attract foreign investment, especially venture capital. When Australia alters its tax rules to encourage such investment we need to consider how we should react.

The area that Australian tax reforms are most likely to affect us is in the international area. Australia has recently negotiated a new double tax agreement with the United States that significantly lowers withholding taxes between the two countries. As a result, Australia is required to enter similar negotiations with a number of other countries. Until now the Australian and New Zealand tax treaty models have been much the same. It would seem unwise to assume that this will continue to be the case unless New Zealand were to change its approach. To date, we remain unconvinced that it would be in New Zealand’s best interests to do so.

The Australian Board of Taxation is shortly expected to present to the Treasurer its proposals for the reform of Australia’s international tax rules. My understanding is that a key concern is whether tax law should be amended to make Australia more attractive for foreign investors and to remove impediments to the growth of Australian companies with large offshore investments. As yet it is unclear what the final outcome will be, but we will be following developments closely.

One of the outcomes of my meeting with Peter Costello is that we agreed to have annual meetings at ministerial level on a number of issues, including tax. A useful by-product of this arrangement is that officials on both sides of the Tasman are then required to liaise in preparation for those meetings. This should improve trans-Tasman understanding of where each of us is going in the tax area.

Another major economic influence on us is, of course, the Untied States of America. I have already mentioned the double tax agreement between Australia and the United States. Another development is President Bush’s proposal to substantially change the American tax treatment of dividends. If the measure is implemented, and given the significance of investment flows -- both ways -- between our countries, we will need to consider the impact this could have on us. For example, what will it mean for US dividend non-resident withholding tax?

At the same time as the United States may be moving away from the classical company tax system, many European Union countries have moved in the opposite direction. The United Kingdom, Germany and Ireland are examples of countries that have moved away from imputation. This in some case is for reasons specific to the European Union -- the difficulties of discriminating between the treatment of residents and non-residents within the EU. But it is a development we have to consider. For example, the move away from imputation has been matched in many cases with reductions in company tax rates.

The biggest tax issue in Europe is probably whether the EU will move to greater harmonization of its income tax laws along the lines of its VAT rules. The European Council savings agreement of January this year was part of this. That agreement has already raised questions about the OECD harmful tax project. In that project New Zealand has been a supporter of the need for international standards under which countries are expected to exchange information so that each can run its own tax system. Tax havens are likely to resist entering into information exchange agreements if it is not required of a number of OECD European jurisdictions.

Some proposals for European tax harmonization go well beyond the savings agreement. One of the options recently raised by the European Commission has been that the company tax laws of all EU countries should be based on a common set of accounting standards. In other words, the rates of company tax might vary between different countries but this would be applied to a European income figure calculated on the basis of financial accounts. Needless to say, this has met with varying degrees of enthusiasm, and its opposite, within the EU. Any moves in this direction have the potential to affect international tax standards, including transfer pricing.

These are just some of the international tax developments we are following with interest. You will be far more aware of them than I am. The International Fiscal Association is a group with considerable tax expertise and international contacts. I am interested in your views as to how New Zealand best fits into the changing international tax world.

My main caveat is that this government is totally committed to social investment. Our social commitment means that in broad terms we will need to maintain tax at broadly current levels. This does not allow us to meet international challenges by giving away large parts of our tax revenue, but there is some room to alter aspects of our tax system to better meet our economic objectives.

I hope that you are able to consider some of these issues over the next couple of days.

Thank you.

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