CTU Economic Bulletin No. 40

August 2003

Comment

CTU policy is in support of progressive taxation both from an equity point of view and as a means of funding health, education and other vital social services. Government revenue overall including SOEs is $55 billion in an economy with GDP of $128 billion. Tax revenue is $43 billion with $15.6 billion (36%) from PAYE, $6.4 billion (15%) company tax, $11.6 billion (27%) from GST and $2.3 billion (5%) from excise taxes. In terms of PAYE, top marginal tax rates in most OECD countries range between 37% and 60%. There have been very large cuts here to the top income tax rate. It was 66 cents in 1986. It is 39 cents today. It was 33 cents from 1988 until 2000. Although broadening the tax base and having higher levels of economic activity and employment can significantly raise tax revenue, there is no doubt that higher marginal tax rates also increase government income. The increase in the top tax rate to 39 cents has realised just over $1 billion in extra tax revenue in its first two years.

Some would argue that the tax system is effectively redistributing income. For instance, a Treasury study for the 1997/98 tax year looked at who pays direct personal income tax, and indirect consumption taxes and also look at who receives social policy expenditures (health, education, social welfare transfers and housing expenditures). If individuals are ranked by equivalised household disposable income, then the top four deciles are from households that are nett payers of tax. In plain language this means that the top 40% of households pay more tax than they receive back in benefits or social expenditure.

But, many of the income studies show that major income disparities started appearing from the late 1980's. From 1984 to 1998 the top 10% of households increased income by 43% and the bottom 50% of households decreased income by 14%. One-third of the income gains from the tax cuts of 1996 and 1998 went to those in the highest income quintile. The tax cuts therefore relatively disadvantaged low-income workers (and beneficiaries were specifically excluded despite the $1.3 billion worth of benefit cuts in 1992).

Many other countries have higher levels of taxation associated with government superannuation. We have relatively high dependence on income tax. We have virtually no wealth taxes (e.g. capital gains tax) except for local authority rates since the abolition of Land Tax and Estate and Gift Duties in 1992.

Company tax is in a sense a withholding tax as the eventual income to owners/shareholders is taxed with an offset (imputation). Also the 1995 Census of Manufacturing showed that the actual level of company tax was just over 21% of net profit before tax. So the 33% nominal rate does not necessarily mean that is what ends up being paid.

There are many other tax options. There appears to be renewed interest internationally in a Tobin tax on financial transactions. There are environmental imperatives which could result in more regulation but also new taxes. The climate change policy announced by the Government includes the notion of revenue recycling from carbon taxes. There is a rich literature on universal benefit incomes and the concept of a negative income tax.

Given the $5.6 billion operating surplus the Government has, and the low levels of debt (net debt down to 14% of GDP and gross debt down from 36.1% of GDP in 1999 to a forecast 25.7% this year), the tax system could be made more progressive by targeting tax cuts to those on the lowest incomes. We need to be careful to ensure that the Government uses their strong fiscal position across a range of social services, infrastructure, education and training as well as improved pay and conditions for state sector workers. If there is a significant dip in economic activity, that will test the strength of this surplus as tax revenue will inevitably be affected. But there is clearly room for tax system to be more progressive than it is at this point.

In a recent speech (27th September) Michael Cullen said that "for now the role of Government needs to be reviewed over how it provides income support to lower income families. That is one area that we have not really tackled during this term of office". So we need to watch this space - and get involved.

Meanwhile we are now in another period where the domestic sector, (and in particular housing and construction fuelled by low unemployment, slightly higher wages, lower import prices, strong net migration and slightly lower interest rates) is performing strongly while the export sector is in decline due mainly to the exchange rate. This makes monetary policy particularly difficult. Another cut in interest rates is needed for the export sector (and several bank economists suggest there will be another cut this year), but the latest housing data could well deter the Reserve Bank from such a move in early September even though the inflation outlook for next year is still below 2%.

Economic Snapshot

This is a snapshot of key indicators for unions. Consumer prices did not rise in the June 2003 quarter and are up by 1.5% in the June 2003 year. Food prices fell by 0.4% in June and were up by 0.6% in the June 2003 year. Unemployment is at 4.7%. Ordinary time wages as measured by the Quarterly Employment Survey (May 2003) were up by 4.2% in the private sector and 2.3% in the public sector. The Labour Cost Index (June 2003) showed private sector wages up 2.2%, and public 2.6%. The key statistic for unions to note probably is that the LCI shows that for those firms where there were wage increases in the last measured quarter (14% of those surveyed), the average rate of increase was 3.8% and the median increase was 3%. The increase in GDP for the March quarter was 0.6% and 4.3% for the March 2003 year. The official cash rate set by the Reserve Bank is 5%.

Employment

The latest employment figures indicate where jobs are being created and lost. Comparing May 2003 with May 2002, manufacturing employment is down by 11,400 and business/finance is down by 20,900. But retail is up by 22,700, construction is up by 18,700 and education (6,000) and health (14,000) are both up also. Annual employment growth has been 2% and the Government has noted that 148,000 new jobs have been created since they have been in office. Meanwhile they announced the Jobs Jolt package of 10 initiatives to get another 22,000 people off benefits. The several good features in the package were overshadowed by some punitive elements and the lack of consultation.

Economic Outlook - CPI, Wages, GDP and Unemployment

The latest Reserve Bank survey of expectations indicate CPI of 1.9% for a year ahead, and 2.2% by June 2005. Private sector hourly earnings were forecast to increase by 2.8% over the year to June 2004 and 2.7% for the June 2005 year. GDP is expected to increase by 2.4% over the next year. Unemployment is expected to rise to 5.1% in June 2004 and 5.3% by June 2005.

Housing

House prices have grown significantly (14.2%) in the June 2003 year. Increases of more than 15% were recorded in Auckland City, North Shore, Napier and Dunedin with Nelson up by more than 40%. The median house price in Auckland (city) is now $298,000, Wellington $237,000, Christchurch $184,750, and Dunedin $134,000. There were 2,621 new dwelling consents in July - the highest figure on record.

Interest Rates

Someone asked me the other day about the effect of lower interest rates. There are several effects. Basically if interest rates are lower, then those paying household mortgages have a bit of extra disposable income. They could use that for more expenditure, or pay off the mortgage quicker, or in some other way. But it can also make it easier to buy a higher priced house as you can borrow more if interest rates are lower. This is one of the main reasons why the Reserve Bank is cautious about lowering interest rates - particularly if there are other pressures on housing which are also driving up prices. The Reserve Bank also tries to assess what spare capacity there is in various markets to gauge whether extra disposable income will be inflationary. Another effect of lower interest rates is that it is cheaper for firms to borrow to finance a new investment (or to service existing loans). This means that firms also have extra revenue, and a greater incentive to invest. In the export sector, lower interest rates means that financial speculators find the NZ dollar less attractive to buy and therefore the exchange rate can fall. A lower dollar means that for the same price in (say) US or Australian dollars charged by the NZ exporter of an item into USA or Australia, the exporter receives more than before in NZ dollars. It can get a bit more complicated that this, but these are some of the basic effects of lower interest rates.

Trade

The annual trade deficit for the year to July 2003 was $3.12 billion compared with a surplus of $317 million in the July 2002 year. Export returns have declined by 9.7% in the July 2003 year. Commodity prices are down 11% in the year. The NZ dollar (TWI) was 14.3% higher in July 2003 than a year earlier. The effect of lower export returns has been delayed by exporters hedging against a higher exchange rate and there is some hope that when the real effect is being felt, the international outlook may have improved. Meanwhile the current account deficit is estimated at 4.5% of GDP.

International investment - and debt (including households)

Australia, USA and UK are the three biggest sources of foreign investment in NZ with 62% of the $178 billion as at March 2003. Net international investment shows a deficit of $101 billion or 83% of GDP. Servicing charges to overseas investors is $8.9 billion annually which is about 21% of export income. And average household debt as a proportion of household annual disposable income has gone from 47% in 1990 to 114% in 2002.

Food Prices

Food prices are up 0.7% in both July and for the July 2003 year.

Capital Goods Price Index

Capital goods prices rose by 0.5% in the June 2003 quarter and 0.7% in the year. The main factor in the quarterly rise was from increases in the cost of building materials.

Retail sales

Retail sales were up by 0.5% in June and 6.5% in the June year. Volumes were up by 1.5% in the June quarter partly reflecting more car sales.

Migration

In the year ended July 2003 there were 96,800 permanent and long-term arrivals, up 2,900 or 3% on the July 2002 year. Over the same period permanent and long-term departures fell by 4,600 or 8% to 54,700. The overall result was a net migration gain of 42,100 in the July 2003 year - 22% higher than the net inflow of 34,600 people in the previous year. Compared with the July 2002 year, New Zealand citizen departures were down 6,200 and non-New Zealand citizen arrivals were up 1,000. There were significant net inflows from China (14,300), India (5,900), Japan (2,300), South Africa (2,000) and Fiji and Korea (both up 1,900) in the year ended July 2003. There was also a substantial net inflow from the United Kingdom (8,800), 66% higher than the July 2002 year figure (5,300). Conversely, there was a net outflow to Australia of 9,400 in the July 2003 year, compared with net outflows of 13,400 in the July 2002 year and 30,000 in the July 2001 year. This is the first July year since 1995 that there has been a net outflow to Australia of fewer than 10,000 people.

Key Indicators Report

The Government released a report using 17 indicators to measure growth and innovation. They are grouped under 5 headings - Productivity, Material standard of living, Talent and skills, Innovation and Global Connectedness. These indicators are intended to complement the Social Indicators report.

Regional Growth

Annual figures on growth by region show a league table of Bay of Plenty (4.2%), Canterbury (4.2%), Nelson/Marlborough (3.8%), Otago (3.5%), Hawke's Bay (3.4%), Gisborne (3.3%), Northland (3.3%), Wellington (3.2%), Auckland (2.9%), West Coast (2.9%), Manawatu/Wanganui (2.7%), Taranaki (2.6%) and Southland (1.3%).

For further information contact Peter Conway on 04 802 3816 or peterc@nzctu.org.nz