Cut spending, don't tax more, to balance books after earthquake

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The toll from the Christchurch earthquake is enormous. The loss of lives has shocked the nation. The extent of the damage to people’s livelihoods is still unfolding.

The government has wasted little time in providing support that goes beyond the everyday social safety net. This was necessary. But there is no need to rush into decisions on how to fund the costs of the support and rebuild package.

It is still unclear what the financial impact will be. But it is large. Only some of it will be covered by insurance. On current estimates the Government has to find about $5 billion to pay for repairs to infrastructure and the financial support to people and businesses. This fiscal cost comes at a time when a faltering economy means tax revenues are disappointing.

The Government has indicated it will borrow in the short term to meet the extra costs, and will reprioritise government spending and investment programmes to repay it a bit later.

Borrowing more is possible; the government balance sheet is up to it. But extra borrowing can only be a short-term stop-gap solution until more sustainable solutions to funding the extra costs can be found. The Savings Working Group concluded just over a month ago that New Zealand’s level of net overseas debt at 85% of GDP is far too high. The group pointed out that the New Zealand economy was vulnerable to international investors being spooked by unexpected events – like a major earthquake. Rating agencies have so far not raised their red flags.

There have been proposals for a time-limited tax to raise the funds. This could cancel out any economic stimulus from rebuilding Christchurch, if not smother an already fragile economy if timed badly.

Rather than looking for ways to tax people more, I think we should look at ways of bridging the funding gap that can also help to address New Zealand’s longer term fiscal and economic challenges.

Other options to be considered are to divert some of the $10 billion or so funds for planned infrastructure projects – roads, ultra fast broadband – by delaying or scrapping those with poor returns, or find funding partners. A partial sale of state assets beyond the SOEs already proposed could also be considered.

Another approach is to reduce public spending on programmes that are not very effective, are poorly targeted, or are just poor policy. The 2009 Treasury Statement of the Long Term Fiscal Position highlighted that government spending was growing at an unsustainable rate now that the baby boomers are starting to retire. The cost of the quake has made the job of containing and then turning around the growth in government spending an even bigger challenge.

Three policies I question whether taxpayers are getting value for money are Kiwisaver, Working for Families, and interest free student loans. Better targeting, if not abolishing, these three programmes would allow the government to pay the $5 billion earthquake bill in a couple of years, and then leave the long term fiscal balance in better shape.

In 2010 the government paid almost $1 billion in subsidies to people with Kiwisaver. These subsidies are on top of the employer contribution incentives, and the uptake initiated by automatic enrolment when people change jobs. An evaluation published by IRD found that subsidies are a factor in joining Kiwisaver. But their specific effect on raising actual saving is not known: much of the money in Kiwisaver is just people changing where they save, not how much they save. Both the level and the targeting of the subsidy should be re-evaluated.

Better targeting of Working for Families could achieve saving of up to $1.5 billion per year. An evaluation published on the IRD website shows that between 2004 and 2008 an extra 110,500 families received some Working for Families subsidy or tax credit, and that 90% of these families earn well over $50,000 per annum. On that measure these $1.5 billion of extra subsidies and tax credits seem poorly targeted.

It is difficult to think of any sound public policy rationale for the costly interest free student loans policy. The interest bill on just today’s outstanding balance of student loans would be around $0.5 billion. Scrapping this policy would also remove the need for the bonuses that now need to be given to encourage borrowers to pay off their student loans.

There is no need to rush to decide how to pay for the cost of the Christchurch earthquake, but there are some clear options. We need to make sure that the timing of unwinding low value spending does not damage the economic recovery. We can take the next few months to evaluate the cost and benefits to find out what options will be in New Zealand’s longer term interest.

 


Jean-Pierre de Raad, Chief Executive of the New Zealand Institute of Economic Research.

NZIER is an independent economic research and consultancy group.  Part of its responsibility as a non-profit Institute is to promote debate on New Zealand’s economic challenges.  More on this issue and other topics can be found on the NZIER website www.nzier.org.nz.

An occasional column for the Dominion Post newspaper.