Domestic growth falls victim to safety-first strategy

By ULF SCHOEFISCH Chief economist Deutsche Bank

The Government is forecasting an impressive recovery in fiscal surpluses to $3.2 billion by 2004.

It pays to leave questions about the achievability of those results aside for a moment and focus on the medium to long-term fiscal strategy revealed by those projections.

The Government intends to pursue a fiscal strategy that is increasingly contractionary. There will be a growing gap between what the Government takes out of the economy through taxes and what it returns through expenditure.

Rising cash surpluses are supposed to go into a new state-run superannuation fund that will be established next year. Long-term projections suggest that the fund could grow to around $75 billion by 2030.

This long-term strategy makes the current Government more fiscally conservative than its predecessor. National planned to reduce net public debt to 15 per cent of GDP before shifting from a fiscal surplus strategy to a less ambitious target of zero Budget balances.

When adding the projected assets of the new super fund to the public sector balance sheet, it becomes clear that the Labour/Alliance Coalition plans not only to reduce net public debt to zero, but to establish a massive net asset position.

Michael Cullen's rationale for such a strategy is to generate a fiscal buffer for the future, when an ageing population will cause tax flows to fall behind the growth in expenditure on superannuation.

At first, this may look like a specific fiscal policy issue. However, the fiscal problem is a symptom of future income distribution issues that the country as a whole will face. Future working generations will have to carry an increasing burden in supporting a growing non-working share of the population.

The question is how an economy prepares itself for such a situation and what role the Government should play in facilitating such a strategy. Two broad options exist.

The defensive approach involves future retirees tightening their collective belt now, building up assets and consuming them in retirement. That would limit the support required from future working generations.

Alternatively, a more dynamic approach could be adopted. It would involve a focus on lifting the sustainable growth rate of the economy.

Future income distribution issues would become more manageable because the overall cake to be shared around would be bigger. That means that, in absolute terms, everybody would be better off.

Dr Cullen has decided to take the economy down the defensive route, with a strategy of forced savings through rising Budget surpluses. The alternative of reducing impediments to growth by distributing fiscal surpluses in the form of lower business taxes is considered less attractive.

As has become evident in other areas, the Government appears primarily concerned with the distribution of (future) income rather than with income generation.

Dr Cullen's concern that tax cuts would put additional pressure on the current account applies primarily to income taxes. Tax reductions for businesses, on the other hand, would contribute to strengthening New Zealand's productive base and aid the process of current account improvement.

Given the fiscal alternatives available to policy-makers, the Government's strategy can be described in simple terms as taxing the business sector and putting that money into a savings fund.

That approach can hardly be described as a strategy for faster domestic growth, particularly considering that part of the funds capital will be made available to other economies through investment overseas.

While Dr Cullen has raised the possibility of business tax cuts for the next legislative term, the amount available would obviously compete with the contributions to the super fund.

From a growth perspective, that means that Government action on the tax front will be too little, too late.

Budget 2000 feature

Minister's budget statement

Budget speech