Dialogue: Govt must focus on right kind of equality

By ADRIAN ORR

The Labour-led Coalition has produced its third and last Budget of this election term.

Most people have praised the Government's effort as prudent. Operating surpluses have continued and net debt is below the target level of 20 per cent of GDP.

This is great fiscal progress compared with the 1970s and early 1980s, but is it enough to accelerate economic growth and confront the costs of an ageing population?

The 1990s appear to be an opportunity lost. There is more to being fiscally prudent than producing surpluses. The level and quality of spending, the type of taxation, and the design of Government policies is what matters for economic growth.

Focus must be given to the underlying trends in Government spending and taxation. That is, removing the cyclical swings and roundabouts from the accounts. The operating surplus for this fiscal year was 2.2 per cent of GDP and is projected to rise to 3 per cent by fiscal year 2006.

However, adjusting the current operating surplus for the favourable business cycle and reduced interest costs sees this surplus fall to about 1.7 per cent of GDP (and less than 2 per cent of GDP by the end of the forecast period). In short, the current cyclical upswing accounts for a significant part of the operating surplus - not prudent Government policy.

The effect of fiscal policy depends on many other things:

The efficiency of the tax system

The level of Government spending

The quality of spending

The effect of policy on individuals to save, invest and be entrepreneurial.

The Treasury in this Budget forecasts growth at about 3 per cent a year over the next three years.

That will not return NZ to the top half of the OECD per capita income ladder - ever. A per capita GDP growth rate of about 6 per cent per annum is needed for the next 10 years to achieve this objective.

This growth rate falls to 4 per cent per annum if we are prepared to wait 20 years. NZ has fallen far behind.

There is always an opportunity cost in terms of higher taxes and/or public debt. These factors crowd out private sector spending and reduce the incentives to be entrepreneurial or participate in the economy.

Since the early 1990s, the Government's budget has been in surplus and net debt has been halved. But progress on lowering expenditure as a percentage of GDP has been almost non-existent. New Zealand still sits at the high end of the spend-to-GDP ratio.

In its first Budget Policy Statement in 2000, the Labour-Alliance Government lifted spending plans.

They widened the role of government in the economy and increased the long-run expenditure target to 35 per cent of GDP (from 30 per cent). Most of the extra spending was funded by cancelling a proposed tax cut and raising the top marginal tax rate. In last year's Budget, the Government increased its (self-imposed) spending cap further.

In this Budget, the Government has removed its spending cap. This is concerning for future Government borrowing and fiscal disciplines.

Even though the Government is running a surplus, it is still a net debtor and must continue to borrow each year to fund its spending - once public investment is included.

The Government yesterday announced its borrowing intentions - a princely sum of $3.4 billion this coming fiscal year and a cumulative $16.7 billion over four years.

If we are going to reduce the burden on tax and interest rates and increase the incentives for entrepreneurs to exist, more effort on the design of policy is needed.

Policies to enhance growth include clarifying property rights and ensuring tax is efficient. A focus on private-public partnerships is needed in health, education, infrastructure, and retirement income.

The bottom line is that New Zealand is not meeting the challenge of most other OECD economies. Crucial social cohesion is crucial.

Middle income tax churn and state dependency only generates equal outcomes - which destroys the desire to take part in the economy.

* Adrian Orr is chief economist at Westpac Trust.

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