Reducing Government spending needed to boost growth and tax system unfair on workers – new Treasury boss

Treasury Secretary Iain Rennie during his appearance at the Finance and Expenditure select committtee hearing at Parliament. Photo / Mark Mitchell

Cuts to Government spending are probably helping the economy recover over the medium term by reducing inflationary pressure and allowing the Reserve Bank to cut the Official Cash Rate (OCR).

That was the opinion of Treasury and its new secretary Iain Rennie, who stepped up on Wednesday for a three-hour grilling before the Finance and Expenditure Committee as part of Parliament’s scrutiny week.

Those comments were a boon to Finance Minister Nicola Willis, who yesterday faced off against the Greens’ finance spokeswoman Chlöe Swarbrick over whether spending cuts were choking growth.

However, the meeting did not go entirely Willis’ way. Rennie made a frank critique of the high levels of tax paid by people who earn a living through labour compared to the low levels of tax paid on income derived from capital, noting that New Zealand’s tax settings were an outlier in this regard. The obvious solution to that problem, a capital gains or wealth tax, is something the Labour Party is currently ambling towards and something National and its support parties have sworn off.

Both positions have previously been articulated by Treasury, although it is significant Rennie and the people who now report to them, restated them.

Cutting your way to growth

In response to questions from Swarbrick about how “shrinking the size of Government positively or negatively impacts GDP growth”, Rennie said that while the growth in the size of New Zealand’s Government during the pandemic was relatively normal by international standards, the amount of spending stayed high for a long time.

“New Zealand kept spending relatively high compared to some of our comparators who unwound that spending relatively higher than we have – so that is important context,” Rennie said.

Treasury’s chief economist Dominick Stephens told the committee the issue of the Government’s impact on economic growth should be distilled down to its impact on the short run and the long run. In the short run, he said, it was actually the Reserve Bank and its OCR that had the biggest impact on the speed at which the economy was growing or shrinking.

“In the short run, the pace at which the Government moves from deficit to balanced budget does matter for the fiscal impulse [an indicator that partly measures whether government spending is stimulating or not stimulating the economy], but we would normally consider the Reserve Bank and interest rates to be the main vehicle for ensuring overall stability,” Stephens said.

Finance Minister Nicola Willis has made returning to surplus a priority. Photo / Mark Mitchell

“The faster the Government consolidates and returns to surplus now, the faster the Reserve Bank is able to reduce interest rates to ensure a balanced economy overall. If the Government delays the return to surplus, the Reserve Bank will keep interest rates higher for longer.”

Stephens said Treasury’s rule of thumb was that a 1% of GDP contraction in Government consumption affected interest rates by about 30 basis points.

Reducing Government consumption would allow the Reserve Bank to cut rates faster and allow the private sector more space to drive the economy.

Even with almost all Covid-19 spending unwound, the size of New Zealand’s Government is still 20% larger now as a share of the economy than it was before the pandemic. In 2018, core Crown spending was 28% of GDP. The same figure was about 33.5% for the most recent fiscal year.

By way of comparison, in 2008, the last year before the Global Financial Crisis and Christchurch earthquakes, core Crown spending was 30% of GDP. The Government was able to reduce spending back to 30% of GDP by 2014 and return to an Obegal surplus by 2015. A return to 2019 levels of Government spending and a surplus looks to be some years away, with the Government hinting the surplus forecast for 2027/28 could be pushed back in the next set of forecasts.

Low taxation of capital income means NZ ‘looks a bit different’ to other countries

The first exchange was a victory for the Government, which has made returning to surplus and reducing pressure on the Reserve Bank a key tenet of its economic policy.

However, Rennie had some good news for the parties of the left, too, restating that New Zealand was an outlier when it came to the taxation of income derived from labour versus income derived from capital.

In response to questions from Labour’s Barbara Edmonds about whether the tax system was “distortionary”, Rennie said.

“If you think about the tools Government has to improve productivity, we would certainly see tax as an important lever.

“There are a number of structural issues that will need a conversation over time. We rely a lot on taxing labour income in New Zealand relative to some of the other bases.

Treasury Chief Economist Dominick Stephens.

“There is a global issue about to what extent do you tax labour incomes differently to income from capital and it is probably fair to say New Zealand looks a bit different on several counts than some of our partners and that is a big issue for us,” Rennie said.

Stephens noted Treasury was now able to model the changes to economic incentives that would arise were different revenue tools deployed, hinting it would be incorporated at the next triennial briefing on the long-term fiscal position, due next year. The last such briefing said a capital gains tax was one way to raise revenue needed to meet future challenges.

Both Rennie and Stephens noted the challenge of an ageing population and the pressure this put on the tax base.

One potential solution was to encourage greater savings through KiwiSaver, but this could put pressure on younger earners who would be paying higher KiwiSaver contributions to pay for their own retirement while also paying higher taxes to pay for the retirement of current generations. That would reduce their disposable income unfairly compared to generations that had gone before.

Rennie’s predecessor Caralee McLiesh recommended a capital gains tax and trimming superannuation entitlements to redress some of these issues.

Waititi called out for non-attendance

Te Pāti Māori co-leader Rawiri Waititi criticised “whoever came up with the agenda” for the meeting, noting the section of the meeting at which Māori issues were set to be discussed was near the end.

“It always seems like Māori are sellotaped to the back of any initiative, we need to think about that,” he said.

Act MP Todd Stephenson and other MPs on the Government side noted that the committee itself was responsible for the agenda, but that Waititi had not turned up to the meeting where the agenda was set. The criticism was part of a long-running critique from the Government side of Te Pāti Māori’s intermittent attendance at Question Time and on select committees when MPs tend to be present.

Labour Finance spokeswoman Barbara Edmonds asked questions on tax. Photo / Mark Mitchell

“We [the committee] came up with it together,” Stephenson said.

“Well, we need to think about how we do that a lot better,” Waititi said.

“Come to the meeting,” said chairman Stuart Smith.

“I understand it a lot better,” Waititi said.

Treasury pivots to climate adaptation

While Treasury has set a climate change “strategic priority” for some time, Treasury said today it had pivoted towards adapting to the effects of climate change rather than mitigating its impact.

This is quite contentious and formed a major part of the political battle between the right and left of politics in 2023 with right-leaning parties tending to elevate the importance of adaptation and leftwing parties elevating the importance of mitigation.

Labour’s climate change spokeswoman Megan Woods asked whether this shift in priorities was a change “signalled by ministers” or made by Treasury itself.

Treasury confirmed it had shifted its priority independently of ministers.

Thomas Coughlan is Deputy Political Editor and covers politics from Parliament. He has worked for the Herald since 2021 and has worked in the press gallery since 2018.