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Inland Revenue

Tax Policy

PUBLISHED 20 June 2002

Minister on the economy, tax policy work programme

In a speech last night, Finance and Revenue Minister Michael Cullen outlined the government's economic priorities and key items on the tax policy work programme. For more information see Dr Cullen's speech to the ANZ Client Function.

Address to ANZ Client Function

Hon Dr Michael Cullen, Minister of Finance

Wednesday 19 June 2002
St James Theatre, Wellington

I would like to focus my remarks today on the territory the economy has traversed in the last three years, and the economic priorities - including taxation reform - for the next three years.

Without doubt the economic situation we inherited in 1999 was fragile and somewhat unbalanced. The outlook published the Pre-election Economic and Fiscal Update in 1999, was for subdued economic growth of 2.3 percent in the year to March 2000, and employment growth at a modest 1.1 percent. Unemployment was forecast to remain at an uncomfortable 7 percent, inflation at 2.7 percent, and the Balance of Payments a very unhealthy 8.3 percent of GDP.

This situation has been largely turned around in the last three years. The budget this year forecast growth to March 2003 at a much healthier 3.1 percent, employment growth nearly doubled compared with 1999 at 2 percent, and the unemployment rate a more respectable 5.4 percent. Forecast inflation is largely unchanged at 2.5 percent, and the Balance of Payments deficit dramatically lower at 4.4 percent of GDP.

The economy has advanced on a broad front, and all the key indicators have improved.

It is particularly pleasing to see that 100,000 new jobs have been created, the bulk of them full time. The unemployment rate has fallen, and the better prospects for finding jobs have meant that more and more people are looking for them. As a result, the participation rate - the proportion of people looking for work out of the working age population - is now at its highest level since this survey started. Ironically it is only this increase in the numbers seeking work that is stopping the unemployment rate falling even faster.

It is particularly gratifying for me as a Labour finance minister to see that this growth has been achieved alongside better protections for workers through increases in the minimum wage and the passage of the Employment Relations Act.

It is also salutary to note that, despite the dire prophecies from economic commentators on the right, higher wages and better protections have not fuelled inflation. Instead, more people working their hours of choice in better paid jobs has seen a lift in the total value of wages - by more than ten percent above the rate of inflation.

A lift in the real incomes of working New Zealand families of this order has not been seen in many decades. This is without doubt a major contributor to the persistently robust levels of economic confidence recorded in opinion surveys.

Through this period the government's own fiscal situation has been prudently managed. We have managed major spending initiatives - raising the floor for New Zealand Superannuation, reintroducing income related rents for low-income state house tenants and easing the student loan burden of students - without weakening the government's finances.

Compared to 1999, the government's finances are in a very strong position. The 1999 PREFU envisaged a balanced budget in the year to June 2000, alongside a gross debt of 34.1 percent of GDP and net debt of 22.4 percent. In the year to June 2003, the operating surplus is forecast at 1.8 percent of GDP, gross debt is scheduled to fall to 28.6 percent and net debt to 16.8 percent.

Thus we have materially improved the public accounts, and in addition have put aside money to protect the future of New Zealand Superannuation: by 30 June next year there will be $1,890 million in the New Zealand Superannuation Fund.

Of course, our critics and opponents have been quick to label this government as "lucky". This claim is without justification. It is true that the New Zealand economy has benefited from high commodity prices, good growing conditions and a low dollar. But in fact just as much of the luck has been running the other way.

The world economy has been in one of its longest and most broadly based stagnations since the oil crises of the 1970s. The events of 11 September jolted confidence and disrupted tourism. There was a winter drought that reduced electricity-generating capacity. The rapid decline in the New Zealand dollar led to accusations that investors had lost confidence in New Zealand.

History would have suggested that the conjunction of both external factors, impacting on trading, and internal factors, impacting on confidence, would lead to a sharp downturn in activity, such as occurred after the 1997 Asian economic crisis. This did not occur, and luck had nothing to do with it.

The government knew it had to go onto the front foot in a range of areas:

  • We amended the Policy Targets Agreement with the Reserve Bank Governor to require the Bank to be more sensitive to output volatility.
  • We made a conscious decision to allow the automatic fiscal stabilisers to work to avoid exacerbating fluctuations in the business cycle.
  • We initiated a detailed policy dialogue with business, local government and other stakeholder groups to shore up confidence and develop a shared analysis of the problems confronting the economy.
  • We reinforced confidence in the export orientation of policy through an ambitious approach to bi-lateral closer economic partnerships.
  • We moved to a more active immigration policy to address short-term skill gaps.
  • We indicated an intention to deepen capital markets through the diversification of the GSF and NDF, and the establishment of the NZSF; and
  • We upgraded regulatory regimes to bring them into line with best commercial practice.

There were also some pragmatic, problem solving solutions to specific issues:

  • Facilitating the Fonterra merger to permit that industry to evolve along the lines sought by its farmer owners.
  • Recapitalising Air New Zealand.
  • Initiating a save electricity campaign to head off potential power outages.
  • Engaging on options for Auckland's traffic congestion problems, and
  • Financing programmes to leverage the advantages to be reaped from Lord of the Rings and America's Cup attention.

If we are to attribute the current state of the economy to luck, then I can only remind you of the old golfer's adage, that the more skilful players are the ones who attract all the lucky breaks.

So to the medium term outlook. The Budget 2002 forecasts are for economic growth to remain robust, with GDP growth forecast to be 3.1 percent to March 2003 (up from 1.9 percent forecast in the December update). Growth of 3 percent is also expected in the year to March 2004 as trading partner growth accelerates to 3.6 percent in 2003.

That outlook was developed around an assumption that economic activity would rebalance with the significance of domestic activity increasing relative to export led growth. The forecast increase in domestic activity reflects the combined effects of the net migration turnaround, a rebound in construction, continued consumer confidence and growing business investment.

The only material change in the short time since the budget has been a marked appreciation in the exchange rate. Two risks are starting to appear on the forecasters' radar screens. One is a risk of a more substantial correction - or even an over-correction - in the US dollar with uncertain consequences. The other is the prospect of a summer drought.

There is no evidence that either of these factors has impacted on confidence or economic activity in New Zealand, although the Treasury will be reviewing its budget forecasts for the publication of the Pre-election Economic and Fiscal Update on 25 June.

One thing we have learnt in the last two and a half years is not to be panicked by risks that might not materialise, and which we may well be able to trade through anyway. The panic responses to the 1997 Asian economic crisis worsened its impacts here. Our own response to the US and Japanese recessions and the events of 11 September confirmed the value of cool heads and calm nerves. We do allow the fiscal stabilisers to work, and we have found that a small economy can reposition itself to ride out international economic turbulence.

So we are moving forward into the next three years with significant economic headroom: unemployment is low by historical standards, the participation rate is high, the budget surpluses are strong and government debt is moderate. Interest rates are above prevailing rates in the rest of the developed world. This means that there is some capacity in macroeconomic settings to respond to any adverse shift in circumstance, but I have to stress that there is no intention to do so at the present time.

The challenge for the next three years is to make use of the economic headroom to prepare New Zealand to move progressively into the top half of the OECD. This will require business and government to work in partnership to invest in initiatives which will transform our economy.

We need to invest in skills to enhance the productivity of the New Zealand labour force. This is the overriding aim of our reform of the tertiary education sector, and of our significant increases in funding for industry training and apprenticeships.

We need to support innovation, in particular in those areas - such as information technology, bio-technology and the creative industries - where there is a good strategic fit between our natural capabilities and our ability to sell into world markets. This is why we are investing in collaborative research programmes which focus public and private sector resources on areas of specific business opportunity.

We need to attract foreign direct investment to New Zealand, in particular in those areas of strategic fit. And we are merging the Investment New Zealand arm of Trade New Zealand and Industry New Zealand's Major Investment Service into a single world-class investment promotion agency operating under the wing of Industry New Zealand, with an initial budget of $14.5 million.

There is also work to be done on improving the tax system. Key items on the tax policy work programme for the next three years include international taxation, the taxation of superannuation and reducing tax compliance costs for small to medium-sized businesses.

The recommendations of the McLeod Tax Review are under intensive study. It is important to remember that the Review's principal recommendation was that our tax system was basically sound. It wasn't broke and we shouldn't try to fix it. That recommendation has guided our responses to specific proposals, which were to fine-tune the tax system around the edges, not at the core.

We are currently exploring the introduction of a time limited exemption for overseas earnings for new migrants and the application of the risk free return method to the broad area of offshore equity investment on capital account outside a business context. This is being done in full consultation with the private sector.

I will also be looking at the two tax options available to stimulate employment based superannuation - on the one hand, aligning the Superannuation Scheme Contributions Withholding Tax for those earning under $38,000 to their statutory marginal tax rate, and on the other hand, extending the present 6 cent concessional rate to all taxpayers. Consultation on detailed design is proceeding.

The initiative on Small and Medium Enterprises is well underway. Officials are currently considering the merits of a number of options to reduce tax compliance costs; for example, whether taxable income can be calculated on a cash rather than an accrual basis.

On trans-Tasman taxation issues, both governments have recently made substantial progress towards removing impediments to trans-Tasman business. Work is progressing well on cross border recognition of imputation credits; and officials are due to report back shortly on submissions on the proposed pro rata allocation of Australian and New Zealand imputation credits.

Of course, any greater harmonisation of tax policies needs to be considered against fiscal impacts. However, New Zealand is committed to resolving trans-Tasman tax issues and discussions at both the ministerial and public official levels continue.

In short, there is a very full work programme for the next three years, not only in taxation, but also in reforming our business and securities law - in particular with a view of better harmonisation with Australia.

No doubt we can expect our share of good and bad luck. However, compared with the state of the economy in 1999, we are, at the mid point of 2002, now much better prepared to weather economic storms, and - most significantly - much better placed to take advantage of the opportunities in world markets, and secure the prosperity that is our shared goal.

Thank you.