Budget 2010: Economy to get a shot in the arm

Bill English, congratulated by John Key yesterday, says that from October anyone earning less than $48,000 will have a marginal tax rate of at most 17.5c in the dollar. Photo / Mark Mitchell

Both near-term and medium-term boosts to economic growth are forecast from the tax package at the heart of yesterday's Budget.

The Treasury estimates that fiscal policy will be stimulatory to the tune of about 1 per cent of GDP in the coming June year, following a cumulative boost of 5.5 per cent over the past two years.

The deficit is set to widen, by $2 billion to $10.4 billion, before shrinking again as the economy strengthens and the robbing-Peter elements of the tax package catch up with the paying-Paul bits.

Nearly a quarter of the increase in the deficit reflects the initial cost of the tax changes.

Over the next three years the Treasury forecasts the economy to grow by a cumulative 0.4 per cent more than it would have without the tax package, and by 0.9 per cent over the next six years.

That is in line with IMF estimates of what a shift in the tax mix from taxing incomes to taxing consumption would yield over a similar timeframe.

The main effect is through the labour market, encouraging more people into the workforce, and an increase in hours worked.

Finance Minister Bill English stressed the incentive effects, pointing out that from October anyone earning less than $48,000 would have a marginal tax rate of at most 17.5c in the dollar, compared with 33c two years ago.

Two-thirds of the income tax cuts goes to those earning less than $48,000, and that is nearly three in every four taxpayers.

The Treasury estimates employment will grow a scant 0.2 per cent over the year to March 2011 but then by a brisk 2 per cent a year for the three following years, making for a cumulative increase of 174,000 in the number of people employed, enough to bring the unemployment rate back down to 4.6 per cent by 2014.

It reckons the tax package can be credited with 10,000 of those new jobs.

It assumes businesses will invest more as a result of the tax package, if only because they will need to provide those additional workers with equipment to use.

Overall it expects firms to pay more tax, as the reduction in the company tax rate does not fully offset the impact of the base-broadening measures, particularly the tougher depreciation and thin capitalisation rules.

But business investment is expected to benefit from a switch in investment from the property sector. Combined with the normal progress of the cycle after a deep recession, that is expected to see business investment grow by 6 per cent in the year ahead and 10 per cent the year after, having fallen by 10 per cent in the current year.

English emphasised the parlous state of New Zealand's external accounts and the need for a rebalancing from debt-fuelled consumption underpinned by the wealth effect from rising house prices, to saving and investing in businesses that help the country pay its way as a trading nation.

But BERL chief economist Ganesh Nana points out there is not much evidence of that rebalancing evident in the Treasury's forecasts.

Net exports remain negative for the next three years, and the current account deficit is forecast gradually to reverse its recent improvement, pushing the country's net international liabilities to 100 per cent of GDP by 2014, from 90 per cent now.

The forecasts have the inflation rate jumping to 5.9 per cent by next March, more than half of it the result of Government policies; 2 percentage points from the increase in GST, 0.4 percentage points from the emissions trading scheme's impact on energy prices, 0.5 percentage points from a steep rise in the tax on tobacco (even though it represents only 2 per cent of the CPI) and 0.1 percentage points from a rise in ACC levies on motorists.

With nominal wages only forecast to rise 2.4 per cent in the year ahead, the net effect would be a steep drop in real wages - before tax.

Beyond 2010/11, as the base-broadening measures kick in the tax package gets close to revenue neutrality and the overall stance of fiscal policy flips from expansionary to contractionary.

"The Reserve Bank shouldn't be upset at all," said BNZ economist Stephen Toplis.

The net Government debt track is now forecast to peak earlier (in 2014/15) and lower (at 27 per cent of GDP).

By international standards the fiscal outlook is impressive.

"There are few governments, especially in the Western world," Toplis said, "that could announce a reduction in personal and corporate tax rates, increased government spending and ongoing infrastructure expenditure, yet a medium-term improvement in the fiscal outlook with operating surpluses returning [in 2016] three years earlier than previously forecast and debt peaking at very low levels by global standards."