Finance Minister faces tax dilemma

By BRIAN FALLOW

Between the lines

In the coming year the new Government has the opportunity, while the cyclical going is good, to start addressing some of the economy's structural weaknesses.

Raising incomes and living standards in a sustainable way will require lifting labour productivity from the dismal levels prevailing in the 1990s.

That, in turn, will require adjusting the split between consumption and investment towards more investment.

It is not just the quantity but the quality of investment that has to improve. At the moment, too little goes into research and development, infrastructure and upskilling, and too much into bricks and mortar.

Stating a vision will not be enough. Getting down and dirty with tax policy changes will be required as well, if people are to be encouraged to: (a) save more of their hard-earned but generally unimpressive incomes; (b) invest it in New Zealand rather than overseas; (c) invest it in ways that will enhance our ability to earn a living in the global economy.

But this creates a dilemma for Finance Minister Michael Cullen.

A more liberal tax treatment of research and development spending, say, or retirement savings may be positive for economic growth and therefore tax revenues in the medium and long term, but is likely to involve a fiscal cost in the short term.

The option of running fiscal deficits has been shut off by the hideous state of the external accounts.

With the current account threatening to reach, on the Treasury's estimate, over 8 per cent of gross domestic product, any backsliding from fiscal rectitude (as the Washington consensus conceives it) would risk a hostile reaction from international money markets.

So, in the short term, how much is affordable in the way of tax policy to encourage investment and savings will depend on relatively modest revenue increases from the moderate forecast for economic growth.

In the longer term, it will depend on a more fundamental redesign of the tax system, to broaden the tax base. Labour has said that any substantial changes recommended by its planned tax review would be put to the electorate first.

Meanwhile, on the infrastructure front, new ways of funding the massive investment required in Auckland and elsewhere will be needed.

Infrastructure is more than roads and water mains. Equally daunting challenges for public policy arise in ensuring the telecommunications platform for the vaunted "knowledge economy" is there.

How can we make sure any regulatory regime does not inhibit investment but is not so light-handed as to permit monopoly rents either?

Finally, there is the problem of lifting returns, lousy for the past few years, on the huge investment in the primary sector. In that connection it would be a shame if producer-board reform went off the boil.