NEW ZEALAND BUDGET Bulletin 2017-2018

This report is written for Chartered Accountants Australia and New Zealand by BusinessDesk. BusinessDesk is New Zealand’s most widely syndicated business and economic news service, supplying most New Zealand mainstream media and the Australian Associated Press. This year is BusinessDesk’s 10th anniversary of Budget coverage.

Election year budget spends down future surpluses for families and infrastructure Crown land for house-build to cost $100 million Mental health at centre of govt’s $321M social investment package Govt ups spending on science and innovation Govt targets $100M a year from closing offshore tax loopholes; moves on ‘black hole’ spending Rail gets better part of $1 billion Tax and benefits package targets low to middle income families Transport drives $32.5 billion infrastructure spend NZ economic growth seen peaking at 3.8% in 2019 Govt forecast surpluses narrow on family package, capital spending

Election year budget spends down future surpluses for families and infrastructure By Pattrick Smellie Tax cuts for every working New Zealander, targeted to low and middle income earners, more generous assistance for families and renters, and a massive spend-up on public services infrastructure mark Finance Minister Steven Joyce’s election year Budget. The package of changes to income tax thresholds, the Working for Families programme, and the Accommodation Supplement is the Budget’s political centrepiece and will cost $2 billion a year. But it does not kick in until April 1 next year as the eight-and-a-half year old National Party-led government spends down rising Budget surpluses forecast over the next four years, making a down payment with the electorate on a fourth term in power at the Sept. 23 election. “This is our opportunity to build on the economic platform we have all created,” said Joyce in his Budget statement. “The family incomes package will benefit 1.34 million families by an average of $26 per week.” That is achieved by raising the amount of income that can be earned at the lowest tax rate of 10.5 percent from $14,000 to $22,000 and for the 17.5 percent income tax rate to $52,000 from $48,000. There is no change to the 33 percent top tax rate income threshold of $70,000, reflecting the government’s sensitivity to be seen to be rewarding high income earners. However, all taxpayers will pay less on their first $70,000 of income from April 1 next year and Joyce told media he would like to move on that third threshold over time”. The Budget also includes a larger spend on public infrastructure than previously signalled, the effect of which is that instead of Budget surpluses rising to a forecast $7.2 billion by 202/21, “the government’s capital investment absorbs virtually all the cash generated from our operating surpluses over the next four years”, said Joyce. The spend-up runs slightly ahead of Crown income, with the government still running a small cash deficit in the next two fiscal years, followed by small cash surpluses in the following two years. Total capital spending in the next fiscal year will total almost $4 billion, compared with $1 billion forecast in the Budget last year, and $1 billion more than the government was forecasting just five months ago. A further $7 billion of new capital spending is available in the following three years. Likewise, operating spending allowances are $1 billion higher over the next four years than forecast last December. At the same time, government spending as a proportion of the total economy (GDP) continuing to fall, to a forecast 27.5 percent of GDP in the year to June 2021, compared with 28.8 percent this year and close to 34 percent when National took office in 2008. Net Crown debt also continues to fall, meeting the government’s target of 20 percent of GDP in 2019/20 and allowing contributions to the New Zealand Superannuation Fund to resume in 2020/21 following their suspension in 2009 in response to the global financial crisis. The most generous Budget since the last by Labour Finance Minister Michael Cullen in 2008, when a three term Labour-led government was making its last bid for re-election, today’s document includes a variety of other crowd-pleasers and political itch-scratchers These include unfreezing funding for Radio New Zealand for the first time in eight years, a $224 million package over four years to boost mental health services, commitment to ongoing investment in rail services, including passenger rail in Auckland and Wellington, and boosted funding for cash-strapped district health boards and over-crowded schools. The Budget largesse occurs against a backdrop of strong economic growth, forecast to average 3.1 percent annually over the next five years, with dairy exports recovering over the forecast horizon while other sectors continue to perform strongly. Unemployment tracking from 5 percent down to 4.3 percent of the workforce by 2021, with the participation rate remaining high at close to 70 percent throughout the forecast period. High net immigration is forecast to continue over the forecast period, although at a declining rate through to 2021, from around 72,000 in the year to June this year to 67,000 in the June 2018 year, 56,000 in 2019, 36,000 in 2020 and 20,000 in 2021. Those forecasts imply the Treasury has dropped its long-held forecast that net migration would fall to the long term average of 12,000 a year. High migration is a driver of current economic growth but also a top election issue because of its impact on housing and other infrastructure bottlenecks, which the increased tax, family and accommodation measures are intended to help offset. Accommodation supplement payments rise between $25 and $75 per week for a two person household, and between $40 and $80 a week for larger households, with higher payments available “in areas where housing costs have increased the most”. On the downside, EQC levies will rise by up to $69 a year to rebuild the national disaster insurance fund to $1.75 billion within the next decade.

Crown land for house-build to cost $100 million By Paul McBeth The government set aside $100 million to free up unused Crown land to help cater to its house-building programme announced before today’s budget. The Crown Land Development Programme is contributing land for 2,700 of the proposed 34,000 houses to be built. Social Housing Minister Amy Adams previously announced the house-building plan, which would see new houses built and 8,300 torn down, of which 20 percent would be priced as affordable and a further 20 percent set aside for social housing. Today’s capital will pay for 1,200 of the 2,700 houses tagged for Crown land. The announcement was one of several smaller announcements in the budget, which included the pre- announced $205 million boost to social housing places and wrap-around support services. The country’s housing market has been a thorn in the government’s side as various policy prescriptions to address years of under-supply take a while to ease the imbalance. Other initiatives announced today included a four-year $4.9 million boost to implement the National Policy Statement on Urban Development Capacity, which is seen as a key step in removing resource consenting obstacles for rapid house construction. The Crown expects to spend $2.7 billion on housing over the next four years, which includes part of the 10- year house building programme. Mental health at centre of govt’s $321M social investment package By Paul McBeth The government has put mental health at the centre of its $321 million social investment programme, which it touts as spending large up front to reduce the long-term costs of problems ailing society. Social Investment Minister Amy Adams set aside $100 million of that funding over four years to trial early interventions tackling the root of mental health issues, marking the biggest spend for the initiative championed by Prime Minister Bill English as a means of getting the most out of the public sector. “It’s one of our most complex social issues and it is having big impacts across the employment, housing, health and justice sectors,” Adams said in a statement. “Mental health issues can lead to much poorer outcomes for these people and their families.” That’s part of a broader boost in mental health spending which is often accused of being under-funded and is shaping up as a key battleground in this year’s election. All up, the government spending $224 million over four years, including an extra $100 million for district health boards’ health and addiction services, $4.1 million for the Ministry of Social Development to trial integrated employment and mental health services, $11.6 million for Corrections to manage prisoners at risk of self-harm, and $8 million to extend the Rangatahi Suicide Prevention Fund. Health Minister Jonathan Coleman said Cabinet will be considering a new mental health and additional strategy soon which will include the new approach. Social investment – which uses an actuarial approach to determine the long-term liability of various social problems to then target spending to reduce that cost – is a central piece in the government’s goal to achieve more from a smaller public service and Finance Minister Steven Joyce today tasked the Productivity Commission to investigate measuring and improving the core public service. English announced the social investment spend at a pre-budget lunch to a Business New Zealand audience, name-checking three of the 14 initiatives seen as benefiting from the actuarial approach. After mental health, the biggest ticket items on the agenda include $34.7 million to support children with behavioural issues, $32.9 million targeting burglary prevention, and $28.1 million to extend the Family Start home visiting programme. A new Social Investment Agency is being set up to support the approach, and has been allocated $25.8 million over four years to provide the tools, analysis and advice to implement the initiatives, and a further $12 million in two-year operating funding and $4.8 million of capital spending to set up a new data exchange platform to allow for safe and secure information sharing. “The new data exchange means using information and technology to better understand the people who need public services, and what works, and then adjusting services accordingly,” Adams said. “What is learnt through this process informs the next set of investment decisions.” Statistics New Zealand is an important cog in the investment approach, which draws on its depth of information. Some $4.5 million has been allocated over three years to let the department look at new ways of obtaining and providing census information without the cost of a full five-year census. “Census information is incredibly valuable to New Zealand,” Simpson said. “It helps determine how billions of dollars of government funding is spent in the community.” Census 2018 has been allocated $111.1 million

Govt ups spending on science and innovation By Rebecca Howard Finance Minister Steven Joyce announced a $373 million increase in spending for science and innovation in a bid to help diversify the economy support more jobs and higher wages. “It’s all about adding more value to our export volumes. Investment in innovation is hugely important for lifting our productivity and providing for our future prosperity,” said Joyce in a speech while presenting the 2017 budget. The increase – part of the Innovative New Zealand programme – includes the previously announced $74.6 million increase for Callaghan Innovation research and development grants. The government has also earmarked a further $81.9 million for the Endeavour Research Fund, which supports mission-led programmes of science. It increased funds for higher tertiary fee subsidies by $69.3 million and has earmarked a further $52.5 million for university research funds. The extra funds also include $40.5 million of new money to help reduce the risk to life from natural disasters and hazards and to explore the Antarctic environment. “An innovative New Zealand will use the skills and knowledge delivered by our tertiary system and the high- quality, high-impact science to help innovative Kiwi businesses to be successful on the world stage,” said the minister of science and innovation Paul Goldsmith and Simon Bridges, minister for economic development in a joint statement.

Govt targets $100M a year from closing offshore tax loopholes; moves on ‘black hole’ spending By Pattrick Smellie The government expects to raise at least $250 million over the next three years from closing foreign tax loopholes exploited by both multi-national corporations and New Zealand companies with offshore activities. The gains are expected from three initiatives put out for discussion in the last nine months covering transfer pricing and permanent establishment avoidance, interesting limitation relating mainly to related party debt, and hybrid financial instrument mismatches. The latter allow companies to pack their New Zealand entities with tax-deductible debt arrangements and reduce tax here and have been subject to a string of successful challenges in the courts by the Inland Revenue Department in recent years. The forecasts, said to be conservative, assume $50 million of additional tax paid in the next financial year, rising to $100 million a year in the following two years. Meanwhile, the Budget does away with the contentious treatment of so-called ‘black hole’ expenditure, relating to expenses borne by a company exploring a commercial initiative that is later abandoned. The issue was the subject of unsuccessful appeals all the way to the Supreme Court by electricity generator Trustpower, which sought relief for expenses related to a wind-farm development that did not go ahead. “Tax consequences should not be an obstacle to businesses innovating and pursuing opportunities for growth,” said Revenue Minister Judith Collins. “Where no asset is created on the balance sheet, feasibility expenditure would be immediately deductible for income tax purposes. “Where an asset is created, we are proposing that the feasibility expenditure would be capital expenditure for tax purposes.” An exposure draft on the initiative is available from today and will be open for discussion from July 6. While tax forecasts include a contingency for possible lost revenue from the initiative, the sum is not disclosed in the Budget documents.

Rail gets better part of $1 billion By Paul McBeth New Zealand’s rail infrastructure will get the better part of $1 billion from the government with money set aside to upgrade KiwiRail’s rolling stock and infrastructure, and Wellington and Auckland’s rail networks. Some $450 million was set aside for KiwiRail over the next two years to help restore the southern trunk line destroyed by last year’s Kaikoura earthquake and improve its rolling stock, ahead of a planned review of the state-owned rail operator’s capital needs in the current year. “The government wants to put the rail network on a longer-term sustainable footing,” Transport Minister Simon Bridges said. “In the year ahead we will be conducting a wider review of KiwiRail's operating structure and longer-term capital requirements.” Budget documents show the accounting treatment of KiwiRail may need to change if its freight business no longer meets certain criteria, and that would increase the value of its assets by $4 billion, reversing earlier impairment charges of between $1 billion and $2 billion. Another $98 .4 million will be invested in Wellington’s metro rail network, while the first tranche of the government’s commitment to the Auckland City Rail Link was allocated $436 million. The government expects to cover half the cost of the network, which is estimated at between $2.8 billion and $3.4 billion. (BusinessDesk) Tax and benefits package targets low to middle income families By Pattrick Smellie The Budget’s $2 billion a year package of tax and accommodation benefit changes is skewed deliberately towards the lowest income families and areas where rents are highest in an election year pitch by the government to be seen to respond to concerns about social inequality. “The measures in this Budget are expected to lift 20,000 households above the threshold for severe housing stress and reduce the number of children living in families receiving less than half the median income by around 50,000,” said Finance Minister Steven Joyce. The interaction of the changes will differ from household to household, but the overall effect would be felt by 1.34 million families by an average of $26 per week, according to Budget documents. While there are no changes to the current four-step personal income rates, the amount of money that people will be able to earn in the bottom three thresholds increases. From April 1 next year, the 10.5 percent tax rate will apply on all income up to $22,000, instead of the current $14,000 threshold. The 17.5 percent rate will apply between $22,000 and $52,000, instead of $48,000 at present, and the 30 percent tax rate will apply on a narrower income band up to $70,000, after which the 33 percent rate will apply as at present. The lowest income threshold tax change is worth $10.77 a week to anyone earning more than $22,000 a year, rising to $20.38 a week for anyone earning more than $52,000 a year. While the Budget had no specific news for pensioners, retired people will benefit from the income tax threshold changes. Joyce said he would like to move on the top tax rate threshold at some time in the future but the Budget documents make no comment on the future for the corporate tax rate, currently set at 28 percent. Tax treatment of savings, however, was on his radar for attention at some stage in the future. On the Working for Families front, the Family Tax Credit is simplified from four child age bands to two, with the eldest child eligible for $5,303 of credits annually, irrespective of age, effectively bringing children under 16, currently receiving $4,822 in credits to the 16 to 18 year old rate. Subsequent children will all be eligible for $4,745, the current 16 to 18 year old rate, instead of rates that were as low as $3,351 for children under 12 years of age. An estimated 310,000 families will benefit from the changes. However, there is a sting in the tail for families earning incomes towards the top of the WFF income scale. WFF credits will start abating once income exceeds $35,000 a year instead of $36,500 and the rate of abatement will increase from 22.5 cents in the dollar to 25 cents. The move “now targets assistance toward lower income families with children,” Budget documents say. The Accommodation Supplement for two person households will increase between $25 and $75 a week, depending on whether they live in a high-rent area, while larger households will gain between $40 and $80 a week, depending on where they live. “The make-up of the four Accommodation Supplements will be updated so families in areas where housing costs have increased the most will receive further gains,” the Budget says. Some 136,000 households are estimated to benefit from these changes by an average of $36 a week. Some 41,000 students in high rent areas who are eligible for the Accommodation Benefit of $40 a week will be able to claim up to $60 a week. There will be overs and unders for some low income families and renters. For example, the increased Accommodation Supplement may cut entitlement for people in hardship who get Temporary Additional Support payments. Single, childless earners are least advantaged as a group by the tax changes because of the abolition of the Independent Earner Tax Credit, although the change to the bottom tax rate income threshold will fully compensate them for this change.

Transport drives $32.5 billion infrastructure spend By Paul McBeth New roads and rail upgrades will suck up about a third of the government’s $32.5 billion infrastructure spending over the next four years, draining the coffers for the foreseeable future. Finance Minister Steven Joyce confirmed the $4 billion of new capital spending in the budget, calling it the “single biggest investment of new capital in one budget by any government in decades”. That takes the total infrastructure spend over the coming four years to $32.5 billion, including $1.7 billion via public private partnerships, with the capital allowance raised to $2.5 billion in the 2019 and 2020 fiscal years from $2 billion. “The net result is that the government’s capital investment absorbs virtually all the cash generated from our operating surpluses over the next four years,” Joyce said. Transport is the biggest target for investment with $9.2 billion over that timeframe, of which $4.8 billion will go into the National Land Transport Fund, $1 billion to rebuild links through Kaikoura, and $1.4 billion for the central government’s share of Auckland’s City Rail Link. Joyce pre-announced the boost to infrastructure spending and name-checked the $812 million Kaikoura rebuild as a beneficiary of the capital spending, and today announced an extra $576 million to boost the New Zealand Defence Force’s capability and $392.4 million for building and upgrading schools. Among other sectors to get a spending boost is $763.3 million tagged to boost New Zealand’s prison capacity with the muster at stretching point and $450 million for KiwiRail’s infrastructure and rolling stock. Joyce said the government plans to make more out of public-private partnerships, such as the Transmission Gully and Puhoi to Warkworth road projects, and said he plans to make an announcement on that in the coming weeks. Education will be the second biggest draw on the infrastructure spending with about 16 percent. About 13 percent of the future infrastructure spending hasn’t been allocated yet. The Treasury’s forecasts project $2.2 billion of capital spending when contributions to the New Zealand Superannuation Fund are resumed in 2021, down from a forecast $3.1 contribution forecast in the December half-year economic and fiscal update.

NZDMO lifts debt issuance by $1 billion over forecast period By Rebecca Howard The New Zealand Debt Management office lifted its issuance programme by $1 billion through June 2021 compared to prior forecasts in its half year economic and fiscal update and said it plans to launch a new April 20, 2029 bond before the end of the year. The 2017/18 programme is set at $7 billion, which is unchanged from the half year forecasts in December, the DMO said in a statement. The office will then raise $7 billion over the next three years and $6 billion in the year to June 2021. The $1 billion increase in issuance comes in the year to June 2020. Total issuance – including $8 billion in the current financial year – is $35 billion. Maturities and repurchases are $41.1 billion, similar to what it forecast in December. Its aim is to maintain New Zealand government bonds on issue at not less than 20 percent of gross domestic product over time. They currently stand at 28 percent but fall to 20.4 percent in the year to June 2021. The DMO said the new April 2029 bond would launched via syndication “subject to market conditions” and said that inflation-indexed bonds issuance is expected to be around $1 billion of the $7 billion it will issue in the 2017/18 year. It also said it plans to commence a repurchase programme of the March 15, 2019 nominal bond this year. It plans to repurchase up to $5 billion, depending on portfolio requirements and market conditions.

NZ economic growth seen peaking at 3.8% in 2019 By Rebecca Howard New Zealand’s economic growth is tipped to peak in 2019, boosted by ongoing population growth, investment, and a new family incomes package announced in Finance Minister Steven Joyce’s maiden budget. Growth, however, then tapers off as net migration subsides, construction growth eases and rising interest rates begin to bite. While the economy expanded less than expected this year as exports, residential investment and business investment grew at a slower pace than anticipated, “growth is forecast to accelerate to a peak of 3.8 percent in 2019 as investment growth gains momentum and private consumption is supported by fiscal stimulus associated with the family incomes package,” Treasury said. The $2 billion family incomes package – which will come into play in April 2018 - is expected to benefit about 1.3 million families in New Zealand by, on average, $26 per week. Treasury expects households to spend the majority of the boost to their incomes. Overall it is “estimated to have a modest positive long-run impact on GDP,” it said. The Treasury also expects residential investment growth to pick up again “after a temporary pause in 2017” as rapid population growth and low interest rates fuel demand for housing, although it will ease from 2019 onwards as supply increases to meet demand, it said. House prices lift 7.8 percent in the year to June 2018 after increasing 5.1 percent in the current year, according to Treasury forecasts. It also expects business investment to pick up, further supporting economic growth. It is expecting real GDP growth of 3.1 percent in the year to June versus a prior forecast of 3.6 percent. It now expects the economy to grow 3.5 percent in the year to June 2018 and 3.8 percent in the following year versus a prior forecast of 3.5 percent and 2.9 percent. Growth now eases to 2.9 percent in the year to June 2020 and 2.4 percent in the year to June 2021. Prior forecasts were for 2.4 percent and 2.3 percent growth respectively. Population growth continues to support the economy in the short-term. According to Treasury, net migration has continued to outpace its expectations, with annual net migration rising to 71,900 in the year to March 2017. While net migration is now expected to remain higher for longer, Treasury is tipping it to peak at 72,500 in mid-2017 before beginning to ease. Overall, it expects net migration to add 212,000 people over the next four-and-a-half years, around 67,000 more people than it previously forecast. The high inflow of people mans that unemployment is forecast to remain flat at around 5 percent over the year ahead, as rapid labour force growth is balanced by robust employment growth. However, it will ease to 4.3 percent in 2020, the forecasts show. It notes that employment growth is stronger than it forecast in the half year economic and fiscal update but the labour force is also forecast to increase at a faster rate “meaning spare capacity in the economy is not used up as quickly as previously anticipated.” The result is a higher unemployment rate and weaker wage growth over the period. Tepid wage growth has largely kept inflation under wraps. While Treasury noted that inflation surpassed 2 percent in early 2017 this was largely driven by temporary price movements. However, it is forecast at 2.1 percent in the year to June 2019, as spare capacity is absorbed and capacity pressures build, in part due to stimulus from family incomes package, it said. This will lead to a gradual lift in interest rates. It forecasts the 90-day bank bill – widely viewed as a proxy for the official cash rate – to remain at 2 percent in the year to June 2018 before gradually raising to 3.9 percent by the year to June 2021. While the end point is similar to its December forecast, it now sees rates at 2.7 in the year to June 2019 and 3.4 percent in the year to June 2020 versus a prior forecast of 2.3 percent and 3.2 percent. Earlier this month, the central bank left interest rates on hold at a record low 1.75 percent and continued to forecast that they will remain unchanged until mid-2019. Treasury also said the country’s terms of trade remains higher than it expected in the December forecasts given a recovery in export prices and a slide in import prices. However, it expects it to now remain flat, tipping import prices to remain “relatively muted,” largely due to a gradual increase in oil prices, and for export prices to “increase gradually” over the forecast period. The high terms of trade is one factor underpinning the New Zealand dollar. While it has fallen to around 76.1 on a trade-weighed-index basis, Treasury said it expects it to remain around current levels as the economy has continued to expand at a solid pace, interest rates are high compared to other advanced economies and the terms of trade remain high compared to historic averages. The forecasts show it reaching 76.9 in 2019 before easing to 74.7 in 2021. Its December forecast had it reaching 72.6 in the year to 2021. Treasury underscored that “the economic outlook is subject to a range of risks and uncertainties, with global risks skewed to the downside while domestic risks are more balanced.” It pointed to potential disruption in global trade, uncertainty around US fiscal policy, financial stability in China, as well as the Australian economy. Domestically it signalled that uncertainty around net migration add to uncertainty around the economic outlook as does household consumption, saving and the housing market.

Govt forecast surpluses narrow on family package, capital spending The government now expects a wider surplus in the year to June than it previously forecast but then tipped narrower surpluses over the forecast period in its latest budget as a new family incomes package and infrastructure spending bites into core crown revenue. Finance Minister Steven Joyce announced the family incomes package in the 2017 budget. The package - which will come into effect April 1, 2018 – is expected to benefit around 1.3 million families in New Zealand by, on average, $26 per week. It is also expected to reduce core crown tax revenue by $6.3 billion over the forecast period, although there are some “clawback” effects through higher goods and services tax. Treasury is forecasting those effects will total $1. 5 billion across the forecast period. As a result, Treasury forecasts the surplus will be $1.6 billion in the year to June 2017 versus a prior forecast of $473 million it made in December, as tax receipts have been higher than expected. However, in the following year the surplus is $2.86 billion versus a prior forecast of $3.34 billion. In the year to June 2019 the surplus is forecast to hit $4.05 billion versus a prior forecast of $5.4 billion. It’s around $700 million lower in the year to June 2020 and $1.2 billion lower in the year to June 2021. The impact of the family incomes package also means that net debt forecasts are higher than they were in December, Treasury said. Net core crown debt is forecast to reach $64.2 billion in the year to June 2020 versus a prior forecast of $62.1 billion. In the following year it reaches $62.8 billion versus a prior forecast of $59.6 billion. Regarding core crown residual cash, it is now forecast to be a deficit of $1.6 billion in the year to June 2019 versus a prior forecast for a $1.4 billion surplus. It is tipped to be a $1.7 billion surplus in the year to 2021, well down from the $3 billion surplus it forecast in December. In the year to June 2021 Treasury is expecting a $1.4 billion surplus versus a previously forecast $2.6 billion surplus. www.businessdesk.co.nz