Dialogue: Government leaves foot on fiscal brake

By ULF SCHOEFISCH*

Treasury projections show a rise in budget surpluses to more than $3 billion over coming years. That reflects the increasing fiscal drag imposed on the private sector as revenue growth continues to outpace the increase in Government expenditure.

Such belt tightening was necessary in the 1990s when New Zealand had to reduce public sector debt. With debt ratios in excellent shape now, fiscal policy should switch back to neutral, thereby adding momentum to a broad strategy for growth.

Such increased momentum is urgently needed. New Zealand's international economic ranking has suffered over recent years, productivity growth is disappointing, and the economy is experiencing a net outflow of people and companies.

Notwithstanding those realities, the Government has opted to not take the foot off the fiscal brake.

Rising surpluses are required to provide the capital for Dr Cullen's huge state-driven superannuation fund. The fund is designed to take pressure off the fiscal balance as the ratio of pensioners to taxpayers rises significantly several decades from now.

Unfortunately, policy is being driven by a focus on the level of pensions in 2025 rather than on enhancing growth. The positive effects of the Government's numerous micro policy initiatives are being offset by running overall fiscal policy overly tight. That approach is difficult to reconcile with the Government's vision of transforming the economy.

The pension problem could be solved as a by-product of a growth strategy, with a stronger economy generating increased fiscal revenue. While that would imply a reduction in the ratio of pensions to labour income, it would ensure at least the same level of future pensions as under Dr Cullen's scheme. That suggests that the economy as a whole would be better off.

Unfortunately, the Government decided to give priority to wealth distribution rather than wealth creation and raised the level of pensions again to 65 per cent of average weekly earnings, thereby significantly exacerbating the problem of funding future pensions.

Dr Cullen now argues that, with pension entitlements growing in line with wages and the economy, New Zealand cannot grow itself out of the pension problem. He must be reminded that such reasoning applies only because of the inflexibility his Government has re-introduced to the system.

A re-think of appropriate pension relativities must be a key part of the required change in fiscal strategy. That would free the fiscal surpluses up for more productive use, primarily the lowering of the tax burden people and companies face.

Dr Cullen argues that there is no urgency to lower taxes because New Zealand's ratio of overall tax take to GDP is around the OECD average. That misses the point that it is not good enough to be average. To advance on the international economic scale, or even to avoid falling further behind, New Zealand has to be better than the average.

There is scope to make significant headway towards lower tax rates. Following the Australian move to lower the corporate rate to 30 per cent, priority should be given to a review of company taxes in New Zealand.

Contributions to Dr Cullen's super fund are forecast to rise to $2.5 billion in 2005, equivalent to nearly 50% of the expected corporate tax take.

That suggests that there is room to gradually lower the corporate rate to 20 per cent or below over coming years, not taking into account the dynamic effects of lower taxes on growth and extra revenue.

Alternatively, the corporate rate could be lowered by less, accompanied by the introduction of special investment incentives.

According to Dr Cullen's budget projections, such bold policy moves are unaffordable.

However, that is only the case because the Government appears determined to force the economy into a fiscal strait-jacket that will limit other policy options for many years.

* Ulf Schoefisch is Chief Economist of Deutsche Bank NZ.

www.nzherald.co.nz/budget

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