Taxman Cullen gives ...and takes

Tax relief on investment income, depreciation and fringe benefits will be paid for in part by the planned carbon tax, Finance Minister Michael Cullen says.

The level of a tax on the carbon content of fossil fuels, due to come into force in 2007, would be announced at or around next year's Budget, he said.

"We are committed to making that revenue neutral."

But yesterday's comments were the first indication that the offsetting tax relief would be measures already foreshadowed, including scrapping the capital gains tax on the earnings of managed funds, and a faster depreciation rate for short-lived assets.

Cullen said this did not mean the depreciation changes would have to wait until the carbon tax was introduced.

To defer such a change would invite an investment strike.

On the contrary, the change would probably be backdated.

Cullen was briefing journalists and analysts on the Treasury's updated economic and fiscal forecasts.

They show a huge boost in the forecast for economic growth in the year to March - up from the Budget's 2.8 per cent prediction to 4.7 per cent now.

If that stronger-than-expected growth eventuates, it will leave Cullen with an embarrassment of riches, or as he prefers to call it, an "interesting conundrum".

But he said only $300 million of the additional $1.7 billion in revenue from that higher growth this fiscal year would become extra Government spending.

To spend more when the economy was running hot would risk having the Reserve Bank increase interest rates.

The Treasury expects that strong growth will have to be paid back in weaker growth later.

Gross domestic product growth is forecast to slow to 2.4 per cent next financial year and 2.6 per cent the following year before making a recovery.

The slowdown will come from weaker consumer spending growth reflecting higher interest rates, reduced immigration and slowing growth in incomes.

In the short term, the buoyant state of the labour market would help sustain the economy's momentum, the Treasury said.

The unemployment rate is forecast to fall to 3.6 per cent - from 3.8 per cent now - before creeping back to 4.4 per cent by mid-2007.

The balance of payments deficit would worsen as export commodity prices fell in line with weaker world growth.

Manufactured exports, which tend to be more sensitive to the exchange rate than agricultural commodities, appeared to be holding up despite the dollar's steep gain in value over the past two years, the Treasury said.

But the effects of the high dollar would be felt eventually as hedging at favourable rates ran out.

"In the near term, there is a risk that the New Zealand dollar could appreciate further against the United States dollar, particularly if there are growing concerns over the current imbalances in the US economy," its report said.

If that happened, GDP growth would slow to 1.3 per next year.