Brian Fallow on the economy
Brian Fallow is the Herald's Economics Editor

Brian Fallow: No easy way to shake off our debt burden

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Brian Fallow writes that the Savings Working Group's report blames lousy savings for a problem which will require tough Budgets to solve.

Further changes targeting property interest deductions would have to be timed with care. Photo / Brett Phibbs
Further changes targeting property interest deductions would have to be timed with care. Photo / Brett Phibbs

One thing is abundantly clear from the Savings Working Group's report.

It is asking for trouble for a country already up to its neck in debt to the rest of the world to go forward with a chronically negative household savings rate on the one hand and structural fiscal deficits on the other.

The custodians of foreigners' savings, or as we prefer to call them the global financial markets, are looking through squinty eyes these days at small, heavily indebted countries.

Even if we manage to avoid the kind of crisis afflicting weaker members of the eurozone, the cost of servicing our net foreign liabilities, currently $162 billion or 85 per cent of GDP, creates an ongoing wedge between what we produce, which is nothing to write home about as it is, and what we get to keep.

The working group lays a lot of the country's economic ills at the door of our frankly lousy national savings performance, including systematically higher interest and exchange rates and a low capital-to-labour ratio depressing productivity and incomes.

But when it comes to the question of what is to be done about all this, the report gets a lot less convincing.

To be fair, some of the options that would contribute to a solution were left off the table from the outset, including the obvious extension of the tax base through a capital gains tax or reducing the cost of New Zealand Superannuation by, for instance, raising the age of eligibility. Never mind that a CGT and a higher retirement age are common elsewhere.

And they faced this dilemma: How can policy shift people's behaviour in a more provident direction without incurring a fiscal cost which would make it self-defeating from the standpoint of national savings?

One suggestion, a further shift from taxing incomes to taxing spending, was rejected outright by the Government. Clearly, it went as far in that direction in the Budget as it intends to.

It is a pity, because as the working group points out New Zealand is unusually heavily reliant on income tax for its revenue, and taxing the returns to savings when they are spent, rather than as they accumulate, would lower the real tax impost on savings.

It calls for a tidying up and extension of the portfolio investment entity (PIE) regime.

As it stands, some investors' investment income is taxed at their usual marginal rate, many at 28 per cent instead of 33 per cent, many at 17.5 per cent instead of 30 per cent and some at 10.5 per cent instead of 17.5 per cent.

It would like this rationalised so that all investors get a rate reduction of at least 5 and preferably 10 percentage points. It also recommends broadening the scope of the regime so that it applies not only to PIE incomes but to interest and dividends.

More radical is its recommendation to inflation-index interest payments, whether earned (for example by depositors or investors in fixed income securities) or paid and claimed as an expense by businesses and property investors.

The tax relief for savers would be welcome, especially right now when a spike in inflation has pushed real effective returns on deposits into negative territory.

The problem with indexation lies on the other side, or would if it were introduced now.

The economy badly needs a resumption in business investment.

There are some positive tentative signs lately, like a pickup in imports of plant and machinery and in December a $1 billion increase in business borrowing from the banks.

But it is too soon to be confident of a turning point and a tax change that would increase the effective cost to businesses of borrowing would be a risky signal to send. Likewise allowing property investors to deduct only their real and not nominal interest costs would have to be timed with care.

In much of the housing market property investors are the marginal buyers who set the price.

The last Budget introduced two changes that make highly geared property investment less attractive: dropping the top income tax rate and denying depreciation deductions on buildings.

A further move to significantly reduce deductions for interest costs could be the last straw for some highly geared investors and induce a wave of selling into a fragile housing market.

So far the decline in house prices from their 2007 peak has been modest, less than 6 per cent nationwide.

Were they to drop steeply from here the effects on household and bank balance sheets could be unpleasant, especially in the context of weak consumer demand and twitchy ratings agencies.

A measure which might have made sense in the early stages of the housing boom does not necessarily make sense once the damage is done; house prices have doubled and household debt soared accordingly.

Offsetting that consideration is the issue of housing affordability, however. The latest international survey by Demographia, which is based on comparing median house prices and median household incomes, rated Auckland, Christchurch, Wellington and Tauranga among the "severely unaffordable" cities.

The combination of that unaffordability and a weak labour market seems to be having an effect on borrowers' behaviour.

The Reserve Bank's December credit growth numbers recorded an actual drop in the total amount of households' mortgage debt compared with November. Unheard of.

It was only a decline of $50 million in a mortgage loan book of $171 billion and one month does not make a trend.

But is a sign of how much times have changed. How enduring the change will prove is the question with which policymakers have to grapple and they have little more than intuition to guide them.

The working group sees further gains from harnessing inertia to broaden uptake of KiwiSaver, by automatically enrolling all employees, not just new ones, and requiring them to make the effort of opting out if they want to, and perhaps increasing the default contribution rate to 4 per cent.

That would help, but it would not deliver the increase in national savings of $4 billion to $5 billion a year the working group considers necessary if we are, in the words of its chairman Kerry McDonald, to step back from the edge of a crumbling cliff. Like it or not, that will require tough Budgets.

But, as with household-targeting tax changes, timing is everything.

We only narrowly avoided dipping back into recession in the middle of last year even with the Government borrowing hand over fist and interest rates at historic lows.

Both the Government and the Reserve Bank need to be sure the bone has healed before taking off the plaster cast.

- NZ Herald

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