Treasury's role to 'shake the debate', says Whitehead

Treasury secretary John Whitehead. Photo / Mark Mitchell.

The way John Whitehead tells it, New Zealand came uncomfortably close last year to earning the title "Iceland of the South Pacific".

"There was a period there where it wasn't clear that we could continue to raise the finance we needed to support the lifestyle we had," he maintains.

As head of Treasury, Whitehead is the Government's most senior economic adviser. And he is quite happy to state, for the record, that there were moments at the nadir of the crisis when senior officials began to wonder how much longer international financiers would continue to lend New Zealand money.

As the Business Herald has reported, at least one major local bank was unable to raise any cash through its usual overseas channels for 28 consecutive days, leading to concerns about the bank's ability to fund its existing loan book, let alone any new lending.

"[The crisis] raised some quite specific things like the way the banks borrow from overseas and the terms of their borrowing and so forth, but it really highlighted issues around our indebtedness as a country and what that might mean if we were to face future shocks," Whitehead elaborates.

"There certainly was [a point when things looked grim], which is one of the reasons we introduced a wholesale guarantee scheme. It looked pretty close for a while."

As in many other countries, the Reserve Bank's decision to open its own purse for local banks to dip into if necessary - with a few other measures - seems to have done the trick. But just because Australia and China have proved more resilient than expected doesn't mean we can all relax, he insists - as Dubai's problems so clearly show.

"I think what's happened is we've come through it, partly because of those policies and partly because internationally developments have been better than we thought ... That's great, but the risk is that people will assume that life can just go on as it did before."

If you've already made a resolution to ignore the doomsayers in 2010, stop reading now - but don't complain when your kids decide to move to Aussie, says Whitehead. Because, as he has repeatedly warned over the past few months, New Zealand still faces some very difficult decisions. And he would just love it if the public listened, for once.

It has to be said that Treasury has long been regarded as the Eeyore of the Eleven Acre Wood that is Wellington's parliamentary precinct.

Given his bounciness, that would make John Key the Tigger figure (Tigger, remember, claimed to like "everything", although it turned out he did not actually like honey, acorns, thistles, or most of the contents of Kanga's pantry). As for Eeyore's faithful friend Piglet, Bill English seems to fit that role rather well.

For as long as anyone can remember, Treasury's natural inclination has been to pour cold water on any warm fuzzies that politicians might feel about the way they are managing the economy, and to warn them of the dire consequences of not taking drastic steps to remedy the country's financial failings.

What appears to have changed in recent months, however, is Treasury's willingness to talk publicly about the issues - and the fact that National has encouraged it to do so.

"I must say the Government has supported me doing this," Whitehead confirms.

In July he warned a meeting of Government department heads that if they didn't come up with their own ideas for radical changes in the way they delivered services, then radical change would be imposed on them.

In his regular column, Herald political correspondent John Armstrong called the speech a "constitutional outrage", suggesting that "rarely, if ever" had a speech by a senior public servant been so politically loaded.

The previous month Whitehead had used an address to the Institute of Directors to suggest it might be time to look at a capital gains tax - knowing full well that Don Brash got shot down for making the same suggestion a decade ago. He happily admits that idea prompted more than a few emails of the Hone Harawira variety.

At first glance, Whitehead appears to be the antithesis of the Maori Party's feisty firebrand. Grey-haired, with wire-rimmed glasses that went out of fashion a decade or so ago, he bears a remarkable resemblance to Helen Clark's husband Peter Davis and comes across as a mild-mannered, earnest and genial chap who, given the opportunity to sell his grandmother for a grossly inflated price, would politely decline.

He not only looks like the stereotypical bureaucrat but sounds like one, too, using words such as "siloisation" despite trying hard, and mostly succeeding, to avoid jargon.

But like Harawira, Whitehead seems to have a robust backbone, and even a sense of humour. While he exudes the slightly weary, been-there-done-that attitude of someone who has worked in Wellington perhaps a little too long, he appears to be almost enjoying the fuss his public pronouncements have caused.

While he agrees it is constitutionally important for Treasury not to express opinions on political decisions and to zip its mouth when those decisions are imminent, it is certainly Treasury's role to help "shake the debate", he believes.

As far as a capital gains tax goes, it got people talking, he notes.

"There's been lots of different views on it expressed since, which is great. That's really what I was after. So then you get a better result if you have that public debate."

There is plenty more where that came from, it seems.

As well as a "fundamental rethink" of how the state sector delivers services, and major reform of the tax system - possibly including a hike in GST, land taxes and "substantial reductions" in income tax - Treasury has flagged other key issues it is keen to see addressed, including "sound and realistic pricing regimes" for water and carbon, the sustainability of superannuation, further reform of the Resource Management Act and the Building Act, at least partial privatisation of some state-owned enterprises, and "providing leadership" on the thorny issue of how to pump more outside money into the dairy and meat industries.

Calls for belt-tightening are never going to win you friends. But given that his own salary increased from around $510,000 to about $550,000 this year, and Treasury's own restructuring is expected to result in the loss of just one job, couldn't Whitehead be accused of not practising what he preaches?

Not at all, he insists. He is quick to note that his own salary increase was decided last year and was based on performance. All state sector bosses, and senior managers at Treasury, have since agreed not to seek any further pay increases in the short term.

As for Treasury's own budget, its staff has increased by just 2 per cent over the past decade, compared to a 38 per cent increase across the wider public sector. Given the increase in its workload, in real terms its budget has been cut by about 20 per cent, he argues.

Whitehead insists his public profile is nothing new and that he made similar speeches when Labour was in power.

"I guess it's probably attracted more attention since the change of Government because it's been more to the forefront," he muses.

In fact, he is keen to see Treasury become "much more engaged" and also hints he'd like to see it take more risks with its advice "because sometimes you can't wait for 10 years for research to be done."

And he refuses to acknowledge that English, at least, appears to have been using Treasury to do his own dirty work by floating controversial ideas to see how the public reacts.

"I've never found ministers particularly keen to hide behind us," he chuckles. "Sometimes things we'll say ministers will welcome as gospel truth and sometimes they'll distance themselves pretty rapidly from it ... Sometimes we get caught in the political flak and at that time I pull my head in a bit and see what happens, but we try not to get involved in the political debate wherever we can. That isn't part of our role."

Until this week both Key and English have, indeed, shown a distinct lack of enthusiasm for some of these ideas - in the short term, anyway.

But as far as tax reform goes, English is now acknowledging that very little is being ruled out at this point in the political process, other than taxing capital gains on the family home.

Nevertheless, some observers believe the stage has been set for some potentially interesting tensions between Tigger and Piglet, as the Government grapples with how to please its twin constituencies - those who are growing impatient for some major reform, and those who are only slightly unhappy with the world the Nats have inherited.

Of course Treasury is not the only cook in the Government's policy kitchen right now. There is hardly a prominent businessperson who hasn't been invited to take part in at least one of the many teams competing in the latest season of Policy Masterchef.

This week Don Brash's 2025 Taskforce served up its own recipe for economic success. Although the taskforce was a sop to the Act Party, it has to be said that many of the ingredients it chose are remarkably similar to Treasury's.

There is more to come in the next few weeks, including the conclusions of the Capital Markets Development Taskforce and the Tax Working Group.

The Regulatory Responsibility Taskforce, headed by former Treasury Secretary Graham Scott, has already reported back, although you could be forgiven for not noticing. That's almost certainly because it recommended the courts be allowed to make binding decisions on the meaning of legislation - a move MPs are not likely to even consider.

What could be more interesting, though, is whether National has yet another go at redrafting Rodney Hide's Regulatory Responsibility Bill in the hope of cooking up something that might be more palatable to Parliament.

Whitehead, who has worked for Treasury on and off since 1982 and has witnessed first-hand the vagaries of various finance ministers' economic agendas, from Muldoonism to Rogernomics, seems philosophical about the process. It's healthy for a government to get different perspectives, including from the private sector, he agrees.

"You don't always agree, but maybe you get a better decision process as a result of that."

Of all the groups, it is probably the Tax Working Group whose recommendations are most eagerly awaited. The group has already dropped heavy hints about its thinking.

A similar review in Australia, headed by Australian Treasury chief Ken Henry, is also due out before Christmas. Henry is widely expected to recommend that company and capital gains taxes be slashed. The Henry review is "wholly relevant" for New Zealand because of the gradual move towards a Single Economic Market with Australia, says Whitehead.

"The question is how far you go in terms of Australian and New Zealand harmonisation. What we're trying to do with a Single Economic Market is make as little a bump as possible. And I don't think that necessarily means you have to harmonise everything, but it does mean you need a degree of lookalike, because it makes it a lot simpler to do business."

In April last year New Zealand dropped its company tax rate from 33 per cent to 30 per cent to match Australia - the first such cut in two decades. Henry has signalled he wants to see the Australian rate drop further, possibly to as low as 25 per cent.

The only one of Australia's 125 different taxes Henry has not been asked to review is GST, presumably because the Australian Government believes both the public and business won't stand for it. However some observers expect him to recommend an increase anyway.

The argument that is increasingly finding favour on both sides of the Tasman is that consumption taxes are far harder for rich people to avoid, and make more sense as the population ages. It is also argued that the evidence is now overwhelming that lower company taxes are an effective way of boosting productivity growth.

GST has already been upped to 12.5 per cent here, and Whitehead is on record as saying we should consider increasing it further. The quid pro quo would be lower personal and corporate taxes.

Based on current revenues, lifting GST to 15 per cent could raise an extra $2.1 billion a year - a handy sum at a time when revenue is actually falling, largely due to the fact that most businesses are making much lower profits than they have in the past.

But as English has acknowledged, the conundrum is that raising GST would hurt people on lower incomes the most. Although there are already ways of mitigating that, through benefit indexation for example, Whitehead acknowledges it's a tricky issue.

In any case it is the big picture - how New Zealand competes with Australia and other well-developed countries - that is more important, he believes.

"What I've been saying in terms of trying to set the debate a bit is that if we have aspirations to be a growing economy which perhaps converges on Australia over time - and you can debate how long that takes - then we wouldn't want to continue to be too far behind Australia for sustainability reasons."

And it's not just Australia we need to keep an eye on. Even against most Asian countries, New Zealand is in danger of falling far behind, he argues.

"It's interesting to see South Korea has now reached our standard of living. In the space of 50 or 60 years they have done what it has taken some of the Western countries a couple of centuries to do. So the message I'm giving is that if we are keen to keep up with the pack in some kind of way and not have too big a gap with Australia then, over time, we will have to shift a number of policies."

While there is no silver bullet, tax and regulation are crucial parts of the equation, he argues.

"How do you reform taxation in a way that gives you acceptable distributional outcomes and is reasonably robust, but is much more growth friendly? Actually I think there's a lot of room to do that but what there is not a lot of room to do is to have a strongly fiscally negative tax reform, so you're giving away a lot of money with it - and that's quite hard.

"What it means is you're really talking about changing the mix. Is it robbing Peter to pay Paul, or sometimes robbing Paul to pay Paul? I think the answer to that is: 'Don't underestimate the importance of incentives.'

"We're a country at the moment that frankly consumes more than we earn, and we're poor savers. It's the same way of saying the same thing, I suppose. So, a tax system which gives more rewards to saving and less to consuming makes some sense in a growth sense because it helps tackle some of those vulnerabilities."

English has indeed confirmed he wants any such changes to be fiscally neutral - but hasn't yet clearly explained how as a country we are going to tackle some of our other problems, such as the massive amount we borrow each week just to pay our bills.

As far as monetary policy is concerned, Treasury has ruled out any return to a fixed exchange rate, believing New Zealand wouldn't stand a chance against currency speculators such as George Soros, whose famous raid on the pound nearly broke the Bank of England, says Whitehead.

It is also sticking to its view that the recent surge in house prices will probably be short-lived. But it is still keen to help exporters, he insists, given that they are our only hope of increasing our wealth as a nation.

"One thing that does make a difference is government spending," he argues. "Borrowing a lot of money, that pushes up interest rates and makes the job of monetary policy a lot harder. So taking some of the pressure off means you can have a slightly looser monetary policy, which over time will help on the exchange rate. But that's a medium to long-term thing. It won't stop the cycles."

Ultimately, there is no avoiding the fact that the Government simply does not have the money to deliver on present expectations, let alone future expectations. And that households, businesses and farms have accumulated an extraordinary amount of debt that could yet cause some serious problems.

Although the Government's net debt is currently around 16 per cent of GDP, Treasury has projected that could climb to 223 per cent by the middle of the century. If that happened, the interest bill would be more than $100 billion a year.

"That's the issue - how you stop what might be a slow decline, into something that delivers on people's aspirations."

Whitehead maintains none of the issues he has raised is necessarily "hugely radical or dramatic", but perhaps that demonstrates why it is probably a good thing that he is getting out of his office a bit more these days.

While it hasn't yet become a big public issue, you would have to think that the potential privatisation of water, for example, could prove far too hot an issue for a pragmatist like Key to handle.

"I've heard stories about, 'Well we can't charge for water, because that would be privatisation'," Whitehead volunteers.

"Well in actual fact we allocate water privately already, and people use it. So there are delicate and difficult issues to work through there, but what you do want to ensure is that water ends up getting appropriate protection from an environmental perspective but then ends up going to the highest value uses, because otherwise we are depriving ourselves of growth prospects - and I think we can do that much better."

There are plenty of other areas where New Zealand could do much better, he believes, and this is where the doom and gloom comes in.

Our dismal status within the OECD, the significant gap between how much Australians and Kiwis earn, the continuing desire of many of our best and brightest to take their skills overseas ... we've heard it all many times before.

We've also been told ad nauseam that we've got to stop spending more than we earn, but that message, more than any other, seems to bring on an acute attack of temporary public deafness.

A fortnight ago Treasury released a report it wrote for the Government in August, called Getting Started on Closing the Income Gaps. It is thoroughly depressing reading.

It talks, for instance, about "serious and longstanding challenges", "severe" accumulated imbalances, and debt coming not just out of our collective ears but out of our eyes and noses as well.

In April, when this year's Budget was drafted, the books looked pretty grim and the Government was seriously worried about a credit downgrade. Since then, the long-term situation has worsened, the report warns.

"In probably no other developed country are the persistent income gaps so pressing," it claims. And so on and so on.

Whitehead confirms that some of the options canvassed in the report - many of which have been heavily censored in the public version because they are still being considered by the Government - have since been firmed up as Bill English's second Budget draws closer.

Like the 2025 Taskforce, Treasury is recommending drastic action. In August, for example, it argued that Government spending cuts will have to be "materially stepped up" from those outlined in this year's Budget.

But that is not the message that Tigger and Piglet seem to be endorsing. This week English ruled out any "big bang" tax changes in the next Budget, and even denied there was any "state of emergency" with respect to revenue.

The clear inference is that National is not prepared to make changes that will threaten its chances of winning the next election.

Shortly before this year's Budget, Whitehead took it upon himself to do the rounds of business and media organisations, suggesting it was going to be one of the most important Budgets in more than two decades.

In the event, the business sector was somewhat underwhelmed and Whitehead agrees he may have oversold it.

It appears he is not going to make that mistake again.

The 2010 Budget will be "potentially important", he suggests, but he is also keen to stress that it is the long-term plan that matters.

Treasury's current advice to the Government is that delaying hard decisions will only make them harder, "but in saying that you don't have to decide everything tomorrow", he concedes.

The popular public image of Treasury employees as right-wing ideologues is "exaggerated", he maintains.

"If you had witnessed the debates within Treasury, you would think we come from every part of the spectrum possible. I think it's a convenient line for some but, for example, when I talked about capital gains taxes, it wasn't the left of the spectrum that was attacking me."

And Treasury has sometimes argued strongly against special privileges for businesses through the tax system, or through government spending, he protests.

As for himself, Whitehead insists he's actually an optimist. After all, his family emigrated to New Zealand from England when he was a boy because they believed it would give him a better life. More than four decades on he's still here - unlike many colleagues who have since gone in search of a more dynamic environment.

"This is a great wee country - we've got so much going for us if we can just get a few things right," he enthuses.

The main message he is trying to get across to the public is that to achieve the kinds of incomes and choices and jobs that he believes most Kiwis want, we need to have a debate about what's important to us, and how we are going to achieve that.

"And I think there's no better time for that debate than right now."

So, pin the tail on the donkey anyone? Don't worry - Eeyore's up for it, too.