Bernard Hickey: Cut the middle class welfare

The International Monetary Fund has warned that New Zealand's net foreign debt to GDP ratio will rise from 90 per cent to over 100 per cent in the next 5 years.

This is another reason for us to kill off our middle class welfare boondoggles in Working for Families and interest-free student loans.

New Zealand's foreign debt levels and its national savings rate are among the worst in the developed world, the IMF warned in a working paper published on Thursday.

The comment came in the paper titled "The Potential Contribution of Fiscal Policy to Rebalancing and Growth in New Zealand" by Werner Schule. He used the IMF's model to show that that a 1 per cent improvement in government savings was likely to improve the current account balance by around 0.5 per cent.

Schule concluded that a reduction in "transfers to middle income households" was the least cost way for the government to lower spending because it would lead to lower interest rates. He recommended a shift in taxes from capital and income to consumption as a way to boost national savings.

He said that government investment in national infrastructure, rather than consumption, would lead to better economic performance and national savings.

"New Zealand's key policy challenge is to rebalance the economy and reduce external vulnerabilities," Schule said, adding that New Zealand's current account deficit had improved but was likely to deteriorate again soon.

"Shifting taxes away from labour and capital, reducing the size of the state, and making public spending more productive raises long term output," he said.

"Increasing the share of investment spending in overall government spending has a direct impact on growth, as it adds to a publicly provided infrastructure capital stock and raises the productivity of private capital," he said.

"Reducing taxes on labour increases incentives to work, and shifting taxes from capital to consumption increases incentives to invest, whereas tax-financed transfers reduce incentives to work."

So what?

The IMF's warning should remind any New Zealanders feeling a little relaxed about our relatively painless progress since the Global Financial Crisis that we are not out of the woods. Anyone with a debt level over 100 per cent of GDP is seen as vulnerable to a fatal debt spiral if interest rates rise sharply. The bond vigilantes are hunting the globe looking for borrowers who are too indebted.

Luckily for us our foreign debt is held by our banks, which are in turn guaranteed by the Australian government and savings system. Australia, in turn, is backed by demand for commodities from China, the world's most dynamic economy.

But we can't rely on this 'luck' for long. New Zealand needs to reorient its government spending and taxation to encourage investment by both the public and private sector while removing incentives for both to consume.

The 2010 Budget went some way to following the IMF's prescription of shifting taxation from capital and income to consumption. But the IMF's suggestion of government cuts to transfers to middle income earners is most interesting.

This suggests the government should be cutting Working for Families and interest-free student loans. I'd agree.

The long term problems remain. We must save more, invest more, spend less, become more productive and repay our foreign debts. That requires a fundamental restructuring of the way our government taxes, spends and incentivises savings and investment.

Bernard Hickey