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Dr Muriel Newman

Planning our Future

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As a result of the global economic crisis and growing concerns about its impact on the New Zealand economy, the Reserve Bank is now required to issue a Financial Stability Report twice a year. These reports are designed to not only provide details on the soundness and efficiency of our financial systems, but enable a more open assessment on whether the Reserve Bank is achieving its statutory prudential purpose.

Anyone concerned about the global financial situation in general and New Zealand’s position in particular should certainly read the first Financial Stability Report, published two weeks ago.[1] The report explains how our banking system is in better shape than many others, outlining the new measures that have been introduced to increase liquidity in the banking system and describing the progress that has been made in implementing the government’s temporary bank deposit and wholesale funding guarantee schemes.

But the report also warns that the ongoing disruption in financial markets is likely to more than halve global growth from the average of 5 percent over recent years to 2.2 percent in 2009. For a country like New Zealand, that is so highly dependent on the export of commodities, that is worrying news.

Having been in recession all year, New Zealand is less resilient than other countries as we face up to the economic storm. In their latest Economic Outlook report, the OECD put it this way: New Zealand has entered recession ahead of other OECD countries, a victim of simultaneous domestic and foreign shocks. The outlook remains subdued because the large macro-economic imbalances which have built up over the past decade – inflation, housing overvaluation, high household debt and a huge current account deficit – will take some time to unwind.[2]

What a dreadful legacy for a new government to inherit. Nine years of a tax and spend philosophy with year on year surpluses squandered by the previous government rather than being returned as tax cuts, kept inflation high, and caused New Zealand to have the highest interest rates in the OECD.

Despite this house prices soared, due largely to a poorly managed immigration bubble post 911 that created excessive demand while at the same time, overly restrictive planning rules choked supply.

As a result of these dynamics it is little wonder that New Zealanders have excessively high levels of household debt and shamefully low rates of domestic savings. This means that we have an over reliance on overseas borrowing, a key contributing factor in the huge current account deficit.

In their 2007 Economic Survey of New Zealand, the OECD highlighted the urgent need to improve our productivity growth in order to raise our living standards. They identified the importance of tax reform to boost savings and investment, suggesting that taxes should be lower and flatter.

They also pinpointed concerns over the distortions created by Labour’s “Working for Families” package, accusing the government of increasingly using the tax system as a tool to deliver on other policy objectives, which has complicated the system and created adverse effects on individual economic behaviour: “The Working for Families package provides assistance to families with children. But changes in the last Budget extended the income range over which assistance is withdrawn, which has raised the number of families for whom working additional hours becomes less attractive financially because of higher effective marginal tax rates. Alternative ways of supporting families without these negative effects on incentives to work could do more to raise living standards and should be investigated further. The negative effects could also be partially reduced by cutting the top personal marginal rate.”[3]

Dr Daniel Mitchell, a Senior Fellow with the Cato Institute and a top international tax reform expert is this week’s NZCPR Guest Commentator. In light of our current economic difficulties – caused in no small part by government spending having grown to a massive 42 percent of gross domestic product – I asked Dan what recommendations he would make to our new government. In his article Boosting Prosperity in New Zealand, he explains:

“New Zealand is not well-positioned to endure such a heavy burden of government. Unlike European welfare states, New Zealand already faces the difficulty of geography and a relatively small population, both of which are an obstacle to competitiveness in certain areas. Another problem is the brain drain, with tens of thousands of bright and ambitious Kiwis moving to Australia and other nations. Yet why should young people stay when New Zealand has the second-highest burden of taxes on income and profits, measured as a share of GDP, of all OECD nations?

“Reducing the tax and spending burden should be a top goal for the new government. The platform of the National Party does indicate some positive reforms will be forthcoming, but it is unlikely that the proposals are sufficient. The new government is committed to reducing the top tax rate from 39 percent to 37 percent over the next couple of years, but that only erases one-third of the rate increase imposed earlier this decade by Labour.

“Ideally, the National Government should drop the top tax rate to 30 percent as part of a long-run goal of a low-rate flat tax (matched by similar reductions to the corporate tax rate). There are now 25 jurisdictions around the world with single-rate tax regimes and they have been remarkably successful”.

Dan recommends that New Zealand should aim towards a flat tax rate of no higher than 20 percent, combined with a cap on government spending to restrict growth to the rate of inflation. He believes the long-term goal should be to get government spending down to 30 percent of economic output.

There is no doubt that a combination of lower, flatter taxes and reduced government spending would significantly improve the underlying strength of our economy and provide a massive boost to the productive sector.

The new government has already outlined its commitment to increased living standards in order to catch up with Australia by 2025. That means growth of 3 percent or more a year. The initiatives to achieve that goal – put forward by National and ACT – include an ongoing programme of tax cuts, a cap on government spending and a reduction in government waste, and the setting up of a Productivity Commission similar to that in Australia which will maintain a strong focus on improving New Zealand’s productive output.

While there is a great deal that needs to be done by the new government at the macro level, at the individual level, households are also taking steps to cushion themselves from the economic downturn. For some time now, real disposable incomes have been under pressure from rising fuel and food prices, and high interest rates. Fortunately, these pressures have eased of late as the price of fuel continues to fall, food prices drift down, interest rates are lowered, and tax cuts boost take-home pay. But falling house prices, credit rationing, and general concerns about the state of the economy and job security, have resulted in a retrenchment in household spending.

This is issuing in a new era of frugality as families search for new ways to stretch their weekly budget, digging out their aprons and baking tins, resurrecting their family garden, and generally living off the smell of an oily rag (if you need some inspiration check out our website at www.oilyrag.co.nz).

The next few months will be critical for the future of New Zealand. New threats to our economic wellbeing are emerging with calls from many nations for increasing protectionism, the erection of trade barriers under the guise of climate change, and a new government that may be reticent to deviate from its pre-election plan – even though the reality of the economic situation we find ourselves in today is much worse than was ever predicted.

If bolder action than was previously envisaged is needed, the government would do well to heed Dr Dan Mitchell’s recommendations for a low flat tax and limited government.

1.Reserve Bank, Financial Stability Report
2.Herald, Subdued Economic Outlook for New Zealand 
3.OECD, Economic Survey of New Zealand