Hon Dr Michael Cullen

Budget 2007 – dealing with today and tomorrow

Presentation to No. 48 Staff Course at the New Zealand Defence Force Command and Staff College, The Lecture Theatre, NZDF Command and Staff College, Trentham Military Camp, Upper Hutt.

I've been asked to give you an overview of the economy, some comment on the challenges we face and the steps being taken to address them.

Fortunately, this opportunity comes very close after last week's budget - so we have a very up-to-date picture of the economy.

In military terms, Budget 2007 directly trains our guns on clear targets: our low household savings rate; and it encourages greater investing by business to help lift productivity. It continues our progress in building world-class infrastructure and in lifting the skills of our workforce. And it maintains a prudent fiscal policy to support monetary policy.

These measures take place against an economic picture that is overall very sound.

Since 1999, we have experienced the longest economic expansion in 30 years.

Average growth rates since 1999 have been over three per cent - faster than the average of developed countries, faster than Europe, Japan, the US and the UK and as fast as Australia.

More Kiwis than ever - 2.1 million of us - are in jobs.

Our unemployment rate is lower than at any time in the last twenty-five years.

We've gone from having mass youth unemployment in the early nineties to a job market where numbers of under-twenties on the dole have fallen by 92 percent. There are now 28 Work and Income Centres in New Zealand where there are no young people on the dole at all.

Business has enjoyed good years as a result of our growth.

According to company tax returns, profit growth averaged over twenty percent a year in 2003, 2004 and 2005 (those are the most recent years for which data is available.)

By comparison the average for the previous eight years - which is about as long as we have comparable data for - was profit growth of five to seven percent.

The government's fiscal position is strong. The Labour-led government has run fiscal surpluses every year. Gross debt is now at prudent levels and forecast to be around twenty per cent of GDP over the next ten years.

We no longer carry any net debt at all, taking into account the New Zealand Superannuation Scheme. New Zealand has better public finances than nearly all other OECD countries.

That is a matter of some fiscal discipline of course.

The alternative of higher debt levels would mean that we all have to pay more tax to pay the interest, or we have to switch cash away from other services like schools and hospitals.

And because the government would be competing for borrowing, hard working small businesses would pay more in interest.

This is a kind of money market version of Think Big.

In the old days, the Muldoon government indebted the country to build dams and oil refineries and the like.

Increasing our debt levels amounts to consuming today and sending the bill to our children and grandchildren.

Our strong fiscal surpluses over the last seven years have been one of the main ingredients in our run of growth.

Just as the Clinton administration in the US, and the Blair-Brown government in the UK discovered, strong fiscal surpluses underpin a strong economy.

But along with our economic successes, imbalances have built up.

There are worse problems for a finance minister to have than a domestic economy growing too fast. But growth depends too much on demand.

Persistent inflation is a concern, especially in the non-tradeables sector.

The consequences via tight monetary policy and a high exchange rate are making the external imbalances worse.

Household savings have continued to fall, both by comparison with our own modest performance in the past and compared to other countries.

Statistics NZ data shows on average households spend $1.15 for every dollar earned. Poor household savings have helped to push the current account deficit to around nine per cent of GDP.

We have an appetite for debt when we should be hungry for savings.

No government can ignore the imbalances, nor fix them by squeezing our eyes shut and hoping they go away.

Budget 2007's emphasis on saving and investing targets the imbalances and puts in place measures that will make the economy more dynamic and innovative.

The enhancements to KiwiSaver are a central part of the shift. We need to help Kiwis save more.

The enhancements to KiwiSaver I announced last Thursday will increase household savings without exacerbating short-run demand and inflation. In fact over time shifting the savings/consumption balance towards saving should reduce demand pressures.

The government is supporting savings to the tune of $40 a week. Everyone who signs up to KiwiSaver will get up to $20 a week by way of a tax credit which is paid into their KiwiSaver account.

In addition each employer will be required to make matching contributions of four percent phased in over four years.

Employers get a tax credit of $20 a week tax credit per employee, so much of the cost of the employer contribution is met.

In the first year the employer tax credit will meet the full cost of the contributions for 95 per cent of the workforce.

Overall, the net additional costs to employers by 2011/12 should overall be no more than about one per cent of the national wage and salary bill at that point - and it will be offset to some extent by wage bargaining.

NZX CEO Mark Weldon commented "the matching tax credits for employer contributions will give businesses a competitive edge in attracting and retaining high value employees. There's no doubt we're swimming in a global talent pool. Now employers will be able to contribute to their employees' savings in a low-cost, tax-efficient way, adding a degree of flexibility to structuring pay packages that will help them attract and keep the best people."

There is no doubt greater savings will help us better deal with the imbalances we face.

First, greater local savings deepen capital markets. That means more options and a lower cost of capital. It means less reliance on the savings of foreigners to finance business expansion in New Zealand. In effect we end up retaining ownership in New Zealand.

A shift away from consumption to saving will see a reduced current account deficit and a lower exchange rate.

We can see the advantages when we look across the Tasman at the trillion dollar-deep pool of savings generated by Australia's compulsory scheme. Every time an Australian private equity firm crosses the Tasman and invests here, they are doing so with money saved by Australians who have been encouraged to save through active government policies for well over a decade.

The choice was to expand KiwiSaver or to give personal tax cuts that would inevitably be quite small - worth no more than a few dollars a week for most people.

But the effects on the wider economy would be damaging.

It would be inflationary. The Reserve Bank would certainly increase interest rates.

For many people any gain in reduced tax would be taken away in higher mortgage payments.

Higher interest rates would drive the dollar higher still; Ask exporters how they would like that.

You cannot spend your way to prosperity.

Trying to spend your way to prosperity is like trying to eat yourself thin.

We need to save more.

That's why saving and investing are the centerpieces of Budget 2007.

I've just talked about saving; investing is the other side of the coin.

It is the focus of the Business Tax Reform package.

The package is aimed at raising productivity and improving competitiveness by providing incentives for our businesses to increase investment in innovation and to expand overseas.

The headline corporate tax rate is being cut from 33 per cent to 30 per cent. The company tax rate cut alone will cost $2.1 billion over four years.

The overall business tax package builds strongly on the $1.4 billion package of depreciation and other measures announced in Budget 2004.

The corporate rate cut will help businesses reinvest their profits. It improves the rewards for risk taking. And it puts us in a more competitive position with other OECD countries. For some overseas investors there is no doubt the headline rate does matter, we are now putting our hand up in the crowded marketplace and are saying take a closer look at us.

That is backed up by the other measures.

Tax credits for research and development are also about attracting more R&D from overseas. But they are fundamentally about encouraging home grown businesses to invest in research and development. R&D helps develop products capable of meeting demand and commanding a premium in export markets. If you are investing in research and development you will be eligible for a tax credit of fifteen per cent.

Perhaps more important than both of these is possible reforms to the international tax regime

The exemption allows businesses with international operations to remain in New Zealand and compete more effectively in foreign markets. Until now, kiwi companies were taxed on their worldwide income. Other countries distinguish between the active and passive income of controlled foreign companies. Income from manufacturing and income from investment is treated differently by tax law in those countries. We will join the international norm, and active income earned for example from manufacturing by New Zealand resident companies from their controlled foreign companies will be exempt from New Zealand tax. Only 'passive', or investment income, will be taxed.

This is an active measure in every sense to encourage our companies to grow their global connections.

We simply need to export more.

The current account deficit illustrates we have an appetite for consuming far more than we sell.

While we are addressing the consumption side through the expansion of KiwiSaver, we also need to sell more to the world to allow us to consume more.

But our share of world trade is falling as globalisation gathers pace.

For all the changes to our economy over the last twenty years, exporting's share of GDP is about the same.

There is a further support for New Zealand businesses to grow their global business. Budget 2007 will provide additional funding of nearly $88 million over four years for the Market Development Assistance Scheme.

The Budget is also investing heavily in two other areas that are a high priority for increasing our productivity and the speed at which our economy can grow: skills and infrastructure.

We are strengthening the ability of tertiary institutions to better fulfill our economic and social needs and at the same time provide better value for money for taxpayers and students.

World-class infrastructure is also critical to achieving higher growth and sustaining it.

The Labour-led government has done much over the last seven years. Annual investment in state highway improvements has risen seven fold since 1999. We are spending over $2 billion a year on roading improvements. Investment in public transport has increased ten- fold.

And we are doing more. Transport, especially in Auckland but also here in Wellington, is holding back the development of our economy and Budget 2007 opens the way for new projects. It makes possible regional fuel taxes for specific capital projects that would otherwise not attract funding as quickly.

Overall the Budget deals with our economic priorities without compromising our fiscal objectives.

In running the economy there is no equivalent to a military strategy of reaching a target, because there is never a day when we can declare "mission accomplished".

The search for a stronger economy never ends. That is what makes being Minister of Finance such an interesting job.

Thank you.

ENDS

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