Treasury warns of growing deficit

The 2012 year has had a turbulent start – from the increasingly chaotic state of the European economies and proliferation of geopolitical unrest to the on-going aftershocks in Christchurch.

If this is a sign of things to come, we had better make sure our seatbelts are tightly fastened as we may be in for a bumpy ride. The government could be in for a rough ride as well.

In October 2011, when the Pre-election Economic and Fiscal Update was published, the government’s books did not look that good, although the longer term forecasts showed that things were on track to improve.

The update showed that by the end of the June financial year, the deficit is expected to be at $10.8 billion (5.1% of GDP), gross Crown debt at $79.8 billion (37.7%) and government spending at $74.5 billion (35.2%).

While that spending figure is significantly higher than the level of 29% identified by the 2025 Taskforce as optimal, the longer term forecasts show that by 2016, spending would fall to 30.4% of GDP, the deficit turned into $3 billion surplus, and gross debt reduced to 34.9% of GDP.

Treasury warning

The Treasury has warned that our economy faced a serious downside risk.

“The risks to our main forecasts are skewed to the downside. In an illustrative downside scenario in which we assume a sharper slowdown in trading partner growth and lower terms of trade, we estimate that New Zealand’s nominal GDP could be a cumulative $35 billion lower over the five-year forecast period to the year ending June 2016.

We estimate that there is at least a one-in-five chance that the New Zealand economy performs worse than in this scenario.”

This more pessimistic view was reinforced in December 2011 in National Bank’s Business Outlook survey, which said that business confidence was slipping.

While Europe is not New Zealand’s main export market, the Asian economies that are our key markets, depend heavily on European consumers to buy the goods that they manufacture.

The domino effect

If there is a downturn in European sales, the fall-out would impact heavily on Asian businesses, wages and employment. As a result, Asian households are less likely to buy goods from New Zealand, especially if there are cheaper local alternatives.

The domino effect of falling demand in our crucial export sector would be serious, not only on businesses that service the export sector, but retailers and other downstream ventures as well.

It would also impact heavily on the government through lower company tax, income tax and GST returns. With less income but potentially greater welfare outgoings, the chance of the government moving back to surplus by their target of 2015 would be under threat.

But it is not only international developments that are threatening the government’s ability to balance the books.

Christchurch shakes

The fact that Christchurch is continuing to experience sizable aftershocks will have a significant impact as well. The rebuilding of Christchurch was expected to generate substantial growth in jobs and economic output for New Zealand. But that cannot be realised until the earth stops shaking.

The situation in Europe is continuing to worsen with the credit rating agency Standard and Poor’s downgrading France, Austria, Italy, Slovakia and others. Portugal has been relegated to junk status. Germany retains its triple-A credit rating but is on negative watch.

Germany and France are spearheading a bid to introduce a financial transaction tax across the European Union as a way of collecting additional revenue to help fund their bailouts.

The tax impact

According to the 2001 Tax Review, a financial transactions tax, levied on withdrawals from financial institutions affects not on the withdrawal transactions but on goods or services purchased with those funds.

Since the system does not allow credits to be allocated on inputs along the production chain, a cascade occurs, where tax is levied at each stage on the tax, which has already been levied at previous stages.

As a result, the tax levied on products of equal value can end up varying greatly, depending on the number of stages in the production chain.

Prices of some goods will be artificially inflated, distorting production and purchasing decisions. In addition, the amount of tax likely to be raised by any given rate is very hard to estimate.

Rather than even contemplating new ways of raising more taxes, the best thing our government could do to help New Zealand get ahead with its small domestic market and huge distance from trading partners is to get out of the way of innovators and wealth creators.

Wealth creation is driven by small business, which is the backbone of the country.

Small businesses provide the jobs that keep New Zealanders employed.

Yet the central and local governments spend much of their life creating new rules and regulations that act as barriers to progress.

Dr Muriel Newman, Director of the New Zealand Centre for Political Research.

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