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Budget 2018 - Walking the Tax and Spend Tightrope

Budget 2018 - Tax

“Life is always a tightrope or a feather bed. Give me the tightrope” - Edith Wharton

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Balancing promises and expectations

“Life is always a tightrope or a feather bed. Give me the tightrope” - Edith Wharton

Amongst Edith Wharton’s fans must surely be our Prime Minister and Minister of Finance because with today’s Budget they have clearly relished the challenge of walking the tightrope between delivering on their promised social initiatives to improve New Zealanders’ wellbeing and being credible and prudent economic managers.
The Labour-NZ First Coalition Government’s first Budget focuses on its spending promises, addressing what it describes as “fiscal holes” left by the previous National Government as well as reinforcing the commitments announced in Labour’s “100 day plan”.

Balancing these spending promises against the expectations of the business community that budget surpluses will be maintained and that the debt track will continue its downward trajectory was never going to be easy. However, predicted continued economic growth, reversing tax cuts and reprioritisation of spending and extending the debt reduction track, has left the Government with head room to start that process.

No significant tax changes

Last year’s establishment of the Tax Working Group (TWG) means that any further announcements of significant tax changes are unlikely to be made until after the Government has had time to consider the TWG’s final recommendations. The TWG’s final report is scheduled to be issued to Ministers no later than February 2019. As a consequence, our pick is that Budget 2019 will have more of a tax focus. The Budget mainly reinforces and recognises tax revenue and spending from what has already been enacted or announced (over five years):

  • Reversing National's personal tax cuts to meet 100 day Plan commitments on the Families Package and extra spending in the areas of health, education, housing and police (largely net positive).
  • Extending the “bright-line” test taxing the sale of properties other than the family home from two to five years and introducing loss ring-fencing for property investors and “speculators” ($325m). 
  • Establishing the TWG, chaired by Sir Michael Cullen.
  • The proposed re-introduction of a 12.5% tax credit for R&D from 1 April 2019 ($1b).
  • The proposed collection of GST on low value imported goods from 1 October 2019 ($218m).
  • Proceeding with the previous Government’s changes to address tax Base Erosion and Profit Shifting (BEPS) risks.

The new items in the Budget are relatively modest – an increase for bloodstock deductions (c$5m) and increased funding for Inland Revenue audit activity (providing an approximately 7 times increase in revenue).

Of broader interest is the announcement of an Independent Financial Institution to provide assessments of Government policy on the budget responsibility rules, government economic forecasts and costings of political parties’ policies. It may also, we hope, provide independent assurance of tax policy.
 

 

The Australian Budget comparison

Our Budget is an interesting contrast to the Australian Budget announced on 8 May, which had tax as its centrepiece (along with significant infrastructure spending commitments). This included:

  • The introduction of a rolling program of personal tax adjustments over seven years. Starting with tax relief to address so-called “bracket creep” for low and middle income earners in 2018-19, it will culminate with tax cuts for higher income earners by 2024-25. The proposed 0.50% increase in the Australian Medicare levy will also not proceed.
  • A commitment to ensuring Australian federal tax revenues as a percentage of GDP do not increase beyond 23.9% (this compares to New Zealand, which has forecast tax to GDP of between 27% and 28% over the next four years).

This is in addition to the progressive reduction in the Australian corporate tax rate from 30% to 25% tax rate by 2027. That was announced in 2017 but its full implementation is proving politically elusive across the Tasman.


These are all changes that will only be fully realised a fair distance in the future, and in a country that has not been shy about changing its leadership. So there is still a lot of water to go under the bridge.


It does highlight a difference in approach between the two Governments’ focus though. The Australian Government’s immediate focus is on inflation adjusting its lower and mid personal tax bands. This is in stark contrast to our Government, which reversed the Budget 2017 tax cuts for low and middle income earners in favour of more targeted family assistance and investing more in infrastructure and social policy programmes. This perhaps reflects the fact that next year is an election year in Australia, whereas the Labour-NZ First Government is still relatively new and working through its long term economic and social policy objectives.
 

Show me the money

The Budget reinforces the Government’s commitment to the spending promises already announced, albeit phasing in some areas. Key amongst these include:

  • $2 billion allocated to Kiwibuild over a 10 year period to fund the construction of 100,000 homes
  • $1 billion a year to the Provincial Growth Fund (including regional rail investments and the Billion Trees programme)
  • Progressively introducing free tertiary education for three years and increasing student financial support
  • The “Families Incomes” package noted above, at a cost of approximately $1.2 billion annually

 

To some, the announcements may seem like a bit of a lolly scramble, with insufficient detail about how all of the increased spending is going to be paid for.

This Budget is the first opportunity for the Government to do so. So, how has it fared?

The Budget forecasts continued surpluses. It also confirms that net Core Crown debt is on track to be paid down to 19.1% of GDP by 2020/21 and that Government expenditure will be below its 30% of GDP gap.

Budget 2018 also sees spending in others areas, including more funding pushed into health, education and law and order. While less headline grabbing than what has been announced in the past six months, this is nevertheless consistent with the Government’s commitment to its programme of increased infrastructure and social spending.

So can we afford it all? Our ability to afford this spending is based on three key assumptions:

  1. The economy is forecast to continue to grow strongly – at around 3% in real terms on average over the next four years. This growth is expected to increase the tax take.
  2. The Government is also planning to borrow more in the short term.
  3. Reversing the last Government’s tax cuts and reprioritising of previously budgeted expenditure.

 

From the Budget documents, this is shown as:

So in short, the Government is expecting to collect more tax but also borrow more than was forecast last year.

Good first steps, but take care and don’t forget the tax burden

The Government’s first Budget should be greeted with cautious optimism. It does not contain any big surprises. There are no more key tax changes due to be announced until at least next year’s Budget. There is a commitment to implement the Coalition’s policies. The Budget signals that this might result in rephrasing of capital expenditure particularly.

Critically, we expect business will be relieved that Treasury’s projections continue to show that the Government’s borrowing and spending promises will remain within its self-imposed fiscal limits. Indeed, the fact that projections demonstrate that this can be achieved while also investing significant amounts into new infrastructure will be welcomed by many, including ourselves.


However, we are concerned that there are multiple economic risks on the horizon. These include a possible slowing NZ and global economy. These provide downside risk to continued revenue increases for the Government.

We are also concerned about the different paths Australia and New Zealand may head down. While the net outflow of Kiwis to Australia has halted in recent years, the Australian economy does seem to be getting back on track. With greater availability of higher paid and lower taxed jobs across the ditch, this could restart the exodus across the Tasman. This would not be ideal when the Government is looking to cut immigration, the jobless rate is at a nine-year low, and there thousands of new houses to be built, billions of trees to be planted and critical infrastructure to be constructed.


On the tax front, we hope that the TWG’s recommendations will take note that New Zealand workers have not enjoyed any form of tax break (let alone adjustments simply to keep pace with inflation) since 2010, despite continued strong economic growth. Similarly, business have had more requirement imposed on them, with little respite or relief. We hope they are not forgotten about in future Budgets.
 

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