Announcements
PUBLISHED 16 August 2007

Speech: Tax & economic transformation

The government expects the proposed R&D tax credit to attract more international R&D to New Zealand as well as encourage more home-grown R&D, Finance Minister Michael Cullen said in a speech today to the Ernst & Young tax conference. In the speech he emphasized the role of tax policy in transforming the economy through increased international engagement, investment and savings. For more information see the speech.


Hon Dr Michael Cullen
Deputy Prime Minister
Attorney-General
Minister of Finance
Minister for Tertiary Education
Leader of the House

SPEECH NOTES

The role of tax in transforming the economy

Speech notes for address to Ernst & Young Tax Partners/Managers Breakfast, Clearwater Resort, Christchurch

Thank you for the opportunity to talk to your Partner/Manager Tax Conference.

I've been given a number of searching questions about current issues in tax to address with you. I'd like to address those directly. First, by way of background, I'll outline the economic environment and the context of our recent changes in tax and savings.

The government's vision for our economy is for a high-skill, high-value and innovative economy, well-connected to global markets. Reforms we have made this year to business tax are carefully designed to help realise our vision.

The only way to increase our real prosperity in the long term is to increase our productivity. High productivity is a matter of getting a lot of things right - from our skills and investment in knowledge and innovation, to capital markets and global connections.

The tax environment has a crucial influence on many of these. The government announced a $3.4 billion package of business tax reform this year. It's the biggest change to business taxation in twenty years. The aim of the package is to develop a more innovative and dynamic economy.

The business tax reforms will help our businesses to grow and compete in the global economy. The headline corporate rate was cut, and the tax treatment of savings vehicles brought into line. Market development assistance and skills training were expanded in the package.

The proposed tax exemption for active income from a controlled foreign company will also bring New Zealand into line with international norms.

New Zealand needs to prepare for a global economy that is becoming increasingly borderless. We need to be able to attract and retain capital and our businesses need to be able to compete effectively in foreign markets.

The international tax changes help to boost our competitiveness as a place in which globally connected firms can locate and expand.

Rising productivity also depends on innovation, and innovation comes from research and development. That's why the business tax reform package included the tax credit of fifteen per cent of allowable research and development expenditure. It will encourage more businesses to invest in more R&D.

You asked whether I anticipate an influx of R&D investment into New Zealand from countries with a less generous jurisdiction. I certainly hope so. If we attract more world class R&D that can only add to our knowledge base and stimulate more innovation.

Most countries offer some incentive, so our changes make New Zealand more competitive.

The case for locating greater R&D here is now more compelling. International companies will now look much more positively at this country, weighing up our existing clusters of R&D and world class universities where they can leverage off academic research.

The more international R&D we encourage to relocate, the better it will be too for home grown R&D. A greater pool of R&D should improve the rewards from research and help to retain our brightest researchers.

There is no doubt our new regime is far more generous than many other countries, including our close rival and friend, Australia. After the Business Tax Reform package was announced the Australian Financial Review began its story by saying,

"New Zealand is luring businesses across the Tasman..."

A senior tax partner quoted in the paper's story said,

"There are companies which in the past have relocated R&D facilities from New Zealand to Australia. This may well reverse that trend."

The Australian Financial Review thinks the New Zealand R&D regime is an improvement on Australia's. That's even allowing for changes made in the Australian budget this year, which made it easier for some multinational businesses to claim R&D concessions across the Tasman.

The Australian Financial Review reported that rules governing who could apply for the tax credit here are less restrictive than the rules concerning who could apply for an Australian credit.

To sum up our business tax package, the paper said,

"R&D investment could flow back across the Tasman."

It's not surprising, then, you asked my view of whether there is likely to be any policy intervention if R&D claims are significantly higher than forecast.

The government believes about two and a half thousand businesses could start claiming the credit. Their activity should help to lift our growth rate. More research and development spending will also lift the maximum speed at which our economy can sustainably grow - because R&D will help to make our processes more efficient and so our products more competitive. More R&D will therefore benefit the economy more widely.

Academic research is quite clear that, while wider economic benefits from R&D are difficult to observe, so called "spillover" benefits exist, might be quite large and may be even larger than the direct returns to the person doing the R&D.

That's the central point about the business tax reform package: there are widespread economic benefits from the sorts of activities the package encourages, namely increased investment from the lower corporate rate and increased innovation from the R & D tax credit.

This is ultimately all about lifting the sustainable rate of growth of the economy.

You've also asked for my comments on issues connected to the housing market and monetary policy - and the relationship between them and productivity in the economy.

The strength of the housing market has been undoubtedly fuelling inflation, the one factor continually noted by the Reserve Bank as its major concern. Recent data shows some flattening in activity though it is too early to say this is a trend.

There is no doubt rising housing prices are proving challenging for many, and we should be concerned. Home ownership is important because it strengthens social bonds and creates a sense of community belonging. The Labour-led government has long recognised this (unlike the Opposition which has only recently discovered the issue) which is why KiwiSaver provides considerable help for first home buyers. There is additional work underway by my colleague Housing Minister Chris Carter.

It's clear that the investment property boom is having some influence on keeping house prices rising at the rates they have been recently. Some concern has been expressed about the impact of the tax system on speculative activity. Under current law, trading in housing with the intention of making a capital gain is taxable. The government moved in the budget to underline the significance of the current tax position and to send a clear message to housing investors. An extra $14.6 million is being provided to Inland Revenue to strengthen its ability to audit property transactions.

A select committee is considering the topic of housing affordability at the moment.

Another committee is also looking at monetary policy. The finance and expenditure committee is examining what additional measures could support monetary policy in New Zealand.

The accepted consensus has been that our monetary policy framework doesn't have an impact on long run growth. In other words, monetary policy helps keep the economy stable by moderating economic cycles, without impacting on the sustainable rate of growth of the economy.

My overriding concern is that this view no longer holds. Despite the fall over the last week, the dollar is still well above a position justified by medium-term fundamentals and has been for a long time - much longer than in previous economic cycles. That can have an effect on how people see the long run returns to exporting and there's a risk that people decide that exporting or investing in exporting is simply not worth the effort.

I have to say I'm impressed at the resilience our exporting sector overall is showing. For example, the July National Bank Business Outlook showed that a net 15 per cent of exporters expect to increase export volumes in the next year. In times where the dollar has been reaching post-float highs, this could be much worse. But of course, the story differs between sectors, and exporters are wider than just dairy farmers.

So I think we need to look seriously at the monetary policy framework and whether it can be made more effective at curing the inflation disease without killing the patient in the process.

We should not be afraid of exploring new ideas and openly debating them.

It is useful to remember that the government has done its bit to support monetary policy.

The fiscal surpluses the government has run in recent years help to lean against domestic demand, and therefore against inflationary pressure. When you add up government spending and subtract taxation, and the investment we are making in the New Zealand Superannuation Fund, the government is removing demand from the economy. As I said in Parliament last week, we run the tightest fiscal policy of any political party.

Early indications are that the cash surplus for the last financial year is likely to be higher than forecast at Budget time, reinforcing the fact that the government has not been fuelling inflation.

KiwiSaver will also reduce pressure on monetary policy by removing demand from the economy. If we save more, we consume less.

You have asked me to comment on the Trans-Tasman effect of changes to savings habits here, through KiwiSaver and the Superannuation Fund.

Saving builds the wealth of New Zealanders and helps build the pool of assets needed for business investment.

Australians have been reaping the benefit of their compulsory superannuation scheme for some time. Every time an Australian private equity firm crosses the Tasman to invest in one of our innovative and growing enterprises, they are doing so with a trillion dollar deep pool of savings created by superannuation contributions.

As the size of our current account deficit shows we have been reliant on overseas savers rather than our own for a large proportion of the capital our businesses need. As KiwiSaver grows, I look forward to more of our own firms crossing back the other way.

The early signs of take-up rates for KiwiSaver are encouraging. Last week I announced that just five weeks after the KiwiSaver launch IRD has received 92,000 enrolments and just three thousand opt-outs. The most heartening aspect has been the number of workers – 80,000 – who have actively chosen KiwiSaver.

These savings will help our businesses by making more kiwi capital available.

It will also take some of the pressure off monetary policy. Saving more, instead of spending more, will help to ease inflationary pressure, taking pressure off interest rates and the exchange rate.

These concerns are relevant to the final point you asked me to comment on - my view of where personal tax rates are likely to head in future.

The room for changes to personal tax rates has been constrained by fiscal and economic conditions. In recent years there were considerations about our priorities for government expenditure; then, as the economy continued to grow strongly, we have had to be careful not to exacerbate imbalances that have built up.

In the seven and a half years since the Labour government was elected, we have invested heavily in priorities such as infrastructure and restoring the health system. Within the tax environment, the priority was to lift struggling families out of poverty - the Working for Families package, which came into full effect this year, made a very significant difference to families that needed it most. A recent OECD study showed that a family on the average wage with two children pays one of the lowest tax wedges in the developed world.

The Business Tax Reform Package, building on other business tax reform, was the next priority, because we need to lock in higher productivity and stronger economic growth.

For those who criticise the government for not cutting taxes, they should remember that tax relief since Budget 2004 – from business tax changes, Working for Families and KiwiSaver – totals $2.8 billion this year, rising to $4.5 billion in 2010/11.

As I noted in the Budget, if we had also attempted to cut personal tax rates this year the pressure on monetary policy would have been very serious. The Reserve Bank would certainly have responded with interest rate increases that would remove most of the value of any tax cut, and our exchange rate would have risen even higher.

As we look ahead we can expect some of those economic pressures to begin to ease as a rebalancing takes place between our strong domestic demand and the external sector. I have indicated previously that by the budget next year I expect to be able to outline the long term programme around taxation.

The priority will be to ensure that we continue to grow our economy, prepare for the challenges ahead of us and provide for our highest priority needs today.

I am confident that changes in the tax environment this year will help to prepare New Zealand to be a dynamic, connected economy able to meet those challenges.