13 June 2005

Cullen: Address to Waipukurau Rotary Club

Waipukurau Club, 10 Russell St, Waipukurau

You know it must be election time when the snake oil merchants start to circulate. Most New Zealanders are immune to their messages, especially in a rural community like Waipukurau where you know that money doesn’t grow on trees and that most of the things that drive our prosperity go through cycles and need to be managed over the long term.

Some myths do not die easily, however. Generally they are variations on the idea that you can have your cake and eat it too. That is perhaps because a small section of the population dearly wants this to be true and continues to believe it against all evidence.

In the reaction to last month’s budget there has been some confusion over the link between taxation, government spending and the economy. We have at the moment an economy that is strong, but coming under pressure. That pressure takes several forms, but the two most obvious ones are:

A strong exchange rate, driven mainly by the persistent weakness in the US economy; and

A strong labour market with shortages across the whole spectrum of skills.

That translates into pressure on interest rates as banks seek to match their returns to the level of risk they perceive and as the Reserve Bank seeks to keep inflation within the target band.

There is no sign of immediate relief, and in these conditions governments need to be very careful to avoid creating additional pressure by poor fiscal management. It would be very easy to spark a vicious cycle of higher inflation and higher interest rates.

The key to keeping a lid on that pressure is credibility, and that means keeping taxation and spending in balance and lowering our public debt. This is where the snake oil merchants come in, with their promises that we can make deep cuts in tax while maintaining or even increasing government expenditure on public services like hospitals, schools and police.

The truth is the only way to do this would be to borrow large amounts of money, which increases our debt, lowers our credit rating and increases interest rates. At the end of the day we cannot defy gravity.

This government has set New Zealand on track towards financial security for the long term. That means lowering debt and building up the Superannuation Fund so we can manage the impact of population ageing. If we squander that opportunity by borrowing to fund tax cuts or new expenditure then we will live to regret it.

What I think keeps the snake oil merchants in business is a series of lesser myths about tax and government, things that are commonly believed but manifestly untrue. There are two of these I want to focus on tonight:

The myth of big government; and

The myth of high tax.

Any telephone survey will reveal that most New Zealanders think that government spending is increasing, and that that most think they pay high rates of tax. That does not make these things true.

The facts are rarely given the chance to speak for themselves, so I would like to do that tonight.

According to the facts, there has been no spending blowout in New Zealand under the Labour-led government, and indeed we have reduced government spending in relative terms whilst maintaining and enhancing public services.

The size of the total public sector in New Zealand compared to the size of the economy as a whole is significantly smaller than for the rest of the OECD.

In 1999, central government spending (that is, excluding state-owned enterprises and local government) was 33.3 per cent of GDP. It is now 30.1 per cent. That means there has been a three percentage point decline, or a ten per cent fall in the relative size of central government.

And if we add in state-owned enterprises and local government the same pattern emerges. The figures show that total government outlays were 41.0 per cent of GDP in 1999, which was slightly over the OECD average. In the last five years we have managed that down to 38.2 per cent in 2004, while the rest of the OECD has stayed more or less the same.

In other words, over the last five years, the public sector in New Zealand has shrunk in relation to the economies that we compare ourselves to.

Of course, government spending has been increasing in nominal terms, but the economy has been growing, with the result that the relative size of the public sector has been falling relative to the tax base.

That has also meant that Crown debt has been falling relative to GDP, from 35.4 per cent of GDP in 1999 to 25.3 per cent at 30 June 2004 and an estimated 22.6 per cent in 2005. That means we now pay less in debt servicing and that resources are freed up for spending on health, education, defence and so on.

Even if the opposition parties concede on these figures, they argue that it is still possible to cut government spending. Despite that, they are already committed to extra spending on areas such as roading, prisons, law and order, policing, defence, and aged care.

Indeed, the tally of National’s additional spending promises amounts to something in the region of $5.5 billion per annum. That means they will need to cut spending in other areas by that amount, plus another $2 billion plus per annum to pay for the tax cuts they have led people to expect. Yet they still claim that basic services will not suffer.

The most polite response one could give to that idea is: baloney.

The facts are that almost 80 per cent of government spending goes on social security (including NZ Superannuation), health, education, defence and law and order. Core government spending, what one might call spending on the bureaucracy, is only 4.3 per cent of total spending.

By any standards that is not an excessive amount to spend on ‘head office’. Besides, it is frankly absurd to think that we can keep nurses on the wards and police on the beat without having a team of professional administrators providing the essential backup. There are no frontline staff without others organising their pay and conditions, providing training, purchasing and managing their equipment and so on.

It is inevitable that National’s spending cuts will have to go beyond the core government departments and attack social services like pensions, health and education. There is no alternative if they are to find the $7.5 billion of cuts they would need.

No-one should be under any illusion as to where these cuts would bite: pensions, health and education.

And no-one in our rural communities should be under illusion as to where those cuts would bite first, since the obvious way to cut public services is to centralise them in larger population centres. That means downsizing or withdrawing them from smaller communities.

So, contrary to myth, our public sector is small in relative terms, and that is due largely to good stewardship by this government. The fact is that New Zealanders value their public services and understand that the vast bulk of their taxes provide the tangible services that sustain communities.

The second myth I would like to explode regards tax. There are two main parts to this myth:

First, the contention that New Zealanders pay high rates of tax relative to other countries, with Australia the comparison most often cited; and

Second, the contention that tax cuts would deliver a significant boost to the disposable incomes of ordinary New Zealand families.

Again the facts suggest otherwise. Even after the tax cuts announced in the recent Australian federal budget, Australians pay more tax than New Zealanders. The top New Zealand rate is 39 cents in the dollar and applies to incomes above $60,000 per annum. By comparison, Australians pay 42 per cent on incomes between A$58,100; and 47 per cent on incomes over A$ 70,000.

The Australian budget announced that these thresholds would rise in two steps, from 1 July 2005 and 1 July 2006, but the 42 and 47 per cent tax rates remain.

In addition, they pay a 1.5 per cent Medicare levy, which is in essence a dedicated health tax.

Someone on the average New Zealand wage of just over $40,000 would pay tax of 20.6 per cent in New Zealand and 20.9 per cent in Australia, including the Medicare levy. This is after the 2006 Australian tax cuts.

For someone on NZ$62,000 the comparison is unchanged: average tax of 25 per cent in New Zealand, and 25.1 per cent in Australia, including Medicare levy.

In short, if anyone tells you that Australians pay less tax, your best response is: baloney.

The same picture emerges if we compare ourselves with almost any other developed nation.

As for the question of who would benefit from tax cuts, that is again answered by looking at the recent Australian changes.

The Australian tax cuts have an estimated cost in lost revenue of A$21.7 billion over four years, or an average A$5.4 billion a year. For that expense, Australian taxpayers earning up to $58,000 a year receive a measly $6 a week. Meanwhile, those earning $125,000 or more receive an extra $87 a week.

In New Zealand the numbers look the same. A tax cut that delivers anything significant to ordinary business people and ordinary workers would be extremely expensive. Every cent knocked off the bottom rate of tax of 15 cents would cost $215 million; every cent knocked off the middle rate of 21 cents costs $325 million; and every cent knocked off the 33 cent rate costs $95 million. Finally, knocking a cent off the 39 cent rate would cost $115 million.

It is not surprising that in all of the proposals for tax cuts put forward by opposition parties, the primary focus is on reducing the higher rates. The fact is that the kitty runs out well before any changes can be contemplated to the lower rates. That is what happened with the tax cuts of the 1990s. They had little or no effect on lower income groups, and had their greatest effect on incomes several times the average wage.

The lessons from both sides of the Tasman are that tax cuts are very expensive, and produce very small gains for the bulk of taxpayers. Inevitably the lion’s share of any tax cut would go to those with the highest taxable income, since they benefit from all of the rate and bracket changes.

Tax cuts are like a buffet meal where the guests can all see and smell the food, but are summoned to partake of it one table at a time, starting with the wealthiest table and moving down the scale. By the time the table of small business owners or of families on the average wage gets their turn, everything has been eaten bar a few crumbs and scraps of gristle around the bone.

That is not the end of the story, for, to continue the analogy, at the end of the meal everyone is presented with the same bill to pay, regardless of whether they come out feeling full after a hearty meal or still hungry because they were last to the table. That bill has three components:

Rising interest rates for those with mortgages or business loans;

Higher public debt which places an additional impost on our children who will have to repay it; and

Cuts in services such as health care, education, police or any of the other things we value as New Zealanders, like border control, civil defence, or public broadcasting.

It is a bill that New Zealanders do not need to pay.

We have worked hard rebuilding our economy and strengthening our public finances so that we carry less debt and impose less risk on the economy. If we squander that because of a combination of cherished myths and unscrupulous promises then we will all be losers.

Thank you.

ENDS

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