Dr The Rt Hon Lockwood Smith - Speech

Speech to the NZ Institute of Chartered Accountants

nospam@example.com (admin) — Fri, 26 Oct 2007 13:21:33 +1300

Dr Hon Lock wood Smith MP
National Party Revenue Spokesman

26 October 2007

Speech to the NZ Institute of Chartered Accountants
Sky City Hotel, Auckland

There are not many things I would say the Labour Government does particularly well, but collecting taxes has to be one of them. Fiscal drag alone is now netting the Government an extra $1 billion in income taxes each year.

What's staggering is that despite core government spending having increased from $34 billion in 1999 to almost $54 billion in 2007, Dr Cullen has collected sufficient extra tax to still run a cash surplus.

That would all be fine and dandy if raising taxes imposed low or no economic cost. Unfortunately, that's not the case. Research indicates that tax thresholds and marginal tax rates do influence the hours some people choose to work. They certainly influence individuals' decisions about whether or not to stay on welfare rather than take a job involving more hours work.

Those are examples of the deadweight costs of taxation, and in addition to them are the costs of administration, enforcement, avoidance and compliance – not to mention the non-productive rent-seeking activities when some sectors of the economy try to persuade the Government to allow favourable tax treatment for certain activities.

It should, therefore, be of no surprise that a 1990/91 study by Diewert and Lawrence put the cost of raising an additional dollar of tax on labour income at 18 cents. The Treasury since then has used a cost figure of 20 cents on top of each dollar of extra tax collected.

The fact, then, that New Zealand has climbed the OECD league tables for overall tax burden from 21st worst in 1999 to 13th worst in the latest edition of the OECD's Revenue Statistics is not something that augers well for New Zealand's future.

The OECD had already been sounding warnings in its 2005 report on the New Zealand economy when it stated that "higher taxes have a negative impact on economic growth", and it's sobering that in a study of 98 countries published this year, Dr Alex Robson from the Australian National University found that "on average, countries which significantly cut taxes on upper incomes between 1980 and 2000 enjoyed average per capita growth rates of nearly three times those that did not".

It's reported that a KPMG study on corporate tax produces similar findings: lower rates are linked with higher than average economic growth.

Far from cutting taxes on upper incomes, the Government introduced tax increases on incomes above $60,000 a year and has stubbornly refused to counter the effects of fiscal drag and bracket creep. Because of this, a quarter of a million taxpayers are now paying the old top rate of 33c but are earning less than the average wage.

These policy actions are clearly influencing New Zealanders' broader economic decisions, such as how to organise their income for tax purposes and whether or not to work more hours; and may well be influencing the increasing exodus of New Zealand citizens to Australia.

It's possible the significant increase in taxation is part of a clear economic strategy. In that light, the Prime Minister's public comments on 28 July this year are of interest, when she said "it has taken a while to build up the kitty for Working for Families. It has taken time to build up the kitty for interest-free loans and the early childhood programme. So undoubtedly there will be areas we'll build on for next time, which will be new".

"Building up the kitty", I would suggest, is not a sound basis for increasing the Government's tax take when the costs to the economy of collecting that tax are considered, quite apart from a philosophical objection to collecting more tax than is required to a run a sound government.

Finance Minister Michael Cullen's reluctance to cut personal tax rates, and Labour's decision to break its promise made prior to the last election to raise personal tax thresholds, despite significant and persistent cash surpluses, have made personal tax rates a major political issue as we head towards the election next year.

Add to that the fact that the Government has decided to reduce the corporate tax rate to 30 cents, widening still further the gap between the corporate rate and the top personal rate, and the fact that both major Australian political parties are proposing major tax cut packages across the Tasman, and the whole issue of personal tax rates is brought into still sharper focus.

A study published by the New Zealand Institute of Economic Research in the past week shows that since Labour has been in office, between 2000 and 2006, New Zealanders' average gross hourly wage rose by 22.1%. Due to fiscal drag, the net income of someone working 40 hours on this wage increased by only 18.9%.

By contrast, Australians' average gross hourly wage rose by 34.3% and the net income of an Australian working 40 hours per week on this wage increased by 33.6%. They've got to keep more of their share of the gains from growth.

That means that, at the average wage, the rate of growth of net income in New Zealand was just over half of that in Australia. What's more, the study showed that the Government's flagship Working for Families policy did not change that overall story.

This is becoming hugely important as New Zealand bleeds our young citizens to Australia. Our net loss in the 12 months to September was 26,194, up 27% from the 20,598 of the year before. Research shows 79% of these New Zealanders we're losing are less than 40 years of age, and across all skill sets.

It is no longer good enough for Dr Cullen to dismiss tax exiles fleeing to Australia with such sarcasm as claiming they are "functionally innumerate" and "we're probably better off without them".

The Australian Liberal Party's proposals will make the contrast starker. The Howard Government proposes that low income earners should pay no tax on income up to $16,000 a year. If that were implemented, it would mean someone earning that amount in New Zealand would be paying almost $54 a week more in tax than someone on the same income in Australia. That's a huge difference.

The broad political consensus in Australia supporting ongoing reform of income tax is the first issue we have to face up to. Both major parties have signed up to major tax cuts and to a broader programme of reform. It's significant because of the relative ease with which New Zealanders can simply shift across the Tasman.

The second issue is that, because tax thresholds have not been adjusted in New Zealand for so long, the top personal tax rate kicks in at a level of income only 1.5 times the average wage – compared with 2.4 times the average wage across the whole of the OECD.

Teachers, police, nurses, executive assistants, librarians and mechanics are now on our top tax rate – the tax Dr Cullen imposed on the top 5% of rich New Zealanders – those Dr Cullen described at the time as people who can and indeed should make a greater contribution and "who could well afford to pay".

Ironically, at the threshold at which New Zealanders go on to the top personal tax rate, if they have one dependent child they are considered too poor to cope on their own, and can apply for Working for Families tax credits. That is an absurd situation.

It's also a very serious situation economically because the Government is collecting vast amounts of tax, with the high deadweight costs of collecting it, churning it through the bureaucracy, and paying some of what's left back to the very same families it's collected it from.

In fact, if a family has five dependent children, their net tax position at $60,000 of earned income is zero after Working for Families payments, yet they're considered to be wealthy enough to be in the top income tax bracket.

At the heart of the problem, however, is not the absurdity of paying benefits to workers in our top income tax bracket, it is the effective marginal tax rates that those families face.

In its briefing to the incoming Minister of Revenue in 2005, IRD pointed out that a single-earner family with three dependent children, under Labour's existing Family Assistance policies, faced effective marginal tax rates of 52.2% on incomes from approximately $28,000 to $38,000, 64.2% from $38,000 to $60,000 and 70.2% from $60,000 to approximately $70,000.

Labour's most recent changes to their Working for Families policy have changed those effective marginal tax rates, but for that same family with three dependent children, over the income range from $38,000 to $100,000, the effective marginal tax rate is above 50% for that entire income range and above 60% over the income range from $60,000 to $100,000 of earned income.

Add to that the problem of a single parent family with three dependent children trying to work their way off the Domestic Purposes Benefit. At $10,000 of earned income, that's roughly 13 hours a week at $15 an hour, the DPB payments are still very large. At $25,000 of earned income, roughly 33 hours work at $15 an hour, the parent would have almost completely worked their way off the DPB.

The problem is this: at $15 an hour the parent would have to work an extra 20 hours a week to increase their earnings from $10,000 to $25,000 a year. The effective tax on that extra $15,000 of earned income is about $13,300. That means, even though the parent is paid $15 an hour, their take-home pay, after tax, is effectively only about $1.60 an hour. Who would work for that?

In a paper published in June this year, the New Zealand Institute of Economic Research, in analysing New Zealand's current economic conundrum of significant inflationary pressures, despite lowish economic growth, pointed out that a number of Government policies, such as Working for Families and interest-free student loans, were boosting the demand side of the economy while, on the supply side, high effective marginal tax rates were reducing the incentive to work. From the examples I've just given, it's not hard to see why.

With recent data on the collapse of productivity growth in New Zealand since 2000, there is a desperate need to re-examine the regulatory burden as well as the burden of taxation.

In addition, the perverse incentives of the effective marginal tax rates so many working families face need urgent examination. As the NZIER concluded, "if you provide people with inefficient or perverse incentives, you will end up with inefficient and perverse outcomes".

Finally, with respect to our income tax problems, IRD gave further quite pointed advice in its Briefing Paper to the Incoming Minister of Revenue in 2005.

IRD said "there seems to be growing evidence of tax sheltering and income splitting, raising questions about the robustness of New Zealand's tax system. This appears to be at least in part a consequence of New Zealand's company and trustee tax rates being lower than the top marginal tax rate. By itself, any reduction in the company tax rate would add to the possibility of further tax sheltering".

And that advice was given prior to the widening of the corporate/personal tax gap to 9 cents.

So, it can be seen there are a number of significant problems facing New Zealand's current income tax system. If it was just an argument about the fairness of some people paying more or less tax, it wouldn't be so bad.

As I hope I've demonstrated, the issues run far deeper. Not only do they go to the heart of the collapse in New Zealand's productivity growth since 2000, but they also impact directly on New Zealand's ability to compete successfully in a globalising world.

And that challenge has to be central to any efforts to seriously fix the problems I've been outlining. People, capital, and firms are all increasingly mobile. Firms and people have increasing choices about where they locate and for how long. Investors have a myriad of opportunities. In an evermore global and competitive world we're going to see intense competition for workers, for businesses, and for investment.

Add to this the fact that our population is ageing. There will be relatively fewer of our people in the full-time workforce in the future. We'll become even more dependent on attracting skilled people from overseas, more dependent on those who wish to work part-time, and more dependent on those who are currently outside the labour market.

Tax policy, therefore, cannot just be about one-off tax cuts or threshold adjustments. It must be a phased programme to deal with the disincentives and distortions caused by illogical tax changes and high marginal tax rates. It must enable us to compete successfully for business, capital, and skills.

Taxation reform, because of the economic and demographic realities I've outlined, requires a longer-term strategic approach.

That strategy needs to consider the dynamic effects of taxation on the economy. Unless tax reform can help lift New Zealand to higher sustainable levels of non-inflationary growth, cutting taxes will be only a race to the bottom as other countries will be compelled to do the same to remain competitive.

In considering the dynamic impacts on the economy, several issues become important:

1.    We know that high effective marginal tax rates are a disincentive to greater work effort.   That some New Zealand families face effective marginal tax rates of 101.2%, according to IRD's briefing to the Income Minister in 2005, is plainly bad policy.
2.    We know that where tax rates change significantly, we get nodes of employment activity.   People work out the hours they need to work to avoid moving up to higher tax levels.
3.   Though it can be argued that maintaining the difference between corporate and the top personal rates provides incentives for retaining earnings rather than making distributions, over time it's likely that significant gaps between the corporate rate and personal rates will lead to increased effort to avoid higher personal rates. A key issue here is the impact on the overall credibility of the tax system. Large-scale legitimate avoidance behaviour by higher-income earners will undermine the goodwill of lower-income earners and expand the black economy
4.    Where tax breaks are offered, such as the proposed R&D Tax Credits, we know behaviour will be influenced. It can be argued that where the activity is desirable, such as with investment in R & D, that is a good thing. However, we know equally that if significant distortions away from investments of higher economic return are the result of the tax incentives, the wider economic impact can in fact be negative.

These issues will be given full consideration when National brings together its tax policy prior to the next election. We need to find an appropriate balance in the iron triangle of efficiency, or less distortions, equity or fairness, and simplicity.

The line I have often heard from your representatives appearing in front of the Finance and Expenditure Select Committee on the numerous tax bills that come before us is a very good starting point. Your representatives keep reminding us of the value of "broad base, low rate".

It's a sound starting point. The challenge for us politicians, however, is how we move from the current dog's breakfast that is our growing plethora of tax rates, tax credits, and tax rebates to something more cogent, towards a tax system that will serve New Zealand well in an increasingly competitive world.

The liberalisation of trade has often been challenging for politicians over the past 50 years, but it has happened in part and will continue to happen. Technology and the fact that electronic transactions have little respect for national borders have seen less political hand-wringing as financial markets have been liberalised.

One of the new challenges for politicians is the liberalisation of the flow of people. It, too, is inevitable as the need for skills and the value placed on them grows.

The reality of these developments means tax policy cannot be hostage to the prejudices and manipulations of politicians. Nations and their governments that don't understand that will be punished by an unforgiving world.

Setting the right standards

nospam@example.com (admin) — Fri, 27 Jul 2007 15:23:00 +1200

Setting the right standards
Speech to the New Zealand Association for Migration Investment
Sorrento Park, Auckland

My thanks for the opportunity to spend time with you today. It's much appreciated. Can I also congratulate your association on its work this past year.

Your input into the significant changes heralded by the Immigration Bill, the work of your Ethics Committee, and your work with Immigration New Zealand policy teams on family and skilled migrant category policy issues, mean we all gain the benefit of your wide practical experience in handling the diversity of potential immigrants seeking to come to New Zealand.

Today, I particularly want to focus on those same policy issues surrounding skilled migrants and the business/investor categories, as well as family policy.

But first, I want to make clear National's position on the Immigration Bill. I believe that's important because the bill establishes the framework within which policy operates.

While policy will always be political to a greater or lesser extent, it's highly desirable that the immigration framework for New Zealand has bipartisan support. A sound, stable framework is in everyone's best interests.

I couldn't summarise the key elements of the Immigration Bill better than Bernard Walsh has done in his Chairman's Report. And the National Party supports the simplified visa system, the single Appeals Tribunal, the streamlined, fact-based, deportation system, as well as the provision enabling the Minister of Immigration to delegate positive discretion in residence decision making to appropriate officials.

There will undoubtedly be discussion at the select committee over some of the biometric information requirements, the use of classified information and the appropriate balance between the rights of the government to use and protect classified information, where it's in the best interests of New Zealand, and the rights of an applicant for a visa or residence.

There will probably also be some debate about the changes to the "reasonable excuse" for employers who take on someone not legally entitled to be employed in New Zealand. Relying on a completed IR330 will no longer be considered a reasonable excuse. The department will, therefore, need to make sure relevant information is readily available to employers if that greater onus in compliance is to be enforced.

I think we all want to see the bill introduced and I certainly look forward to your association's submissions on it.

Your annual report contains a foreword by the current Minister of Immigration. In it, he states "immigration not only fills the skills shortage in our workplaces, it helps boost New Zealand's productivity and contributes to moving our economy to a high skills, high income, knowledge-based environment". He concludes that "immigration contributes significantly to the transformation of our economy".

It's interesting to compare that assertion with recently published work by Dr Greg Clydesdale, an industrial economist in the Department of Management and International Business at Massey University with expertise in economic development and growth.

No one could disagree with the ambition in the Minister's rhetoric, but what of the reality?

Dr Clydesdale has analysed data on outcomes for new immigrants arriving in both New Zealand and Canada under reasonably similar business/investor immigration policies.

In Canada, a study in 2003 showed a large number of business migrants could not actually be located even though a Canada-wide search of credit records had been conducted.

The Canadian programme required a business immigrant to be involved in active business management, and the employment of at least one Canadian. Less than a quarter of the business migrants entering Canada could be shown to be meeting those conditions of the programme.

The income figures for the migrants located in fact suggested they were having a poor economic impact. What's more, tax files reviewed in the study confirmed the poor outcomes.

The Canadian Government had actually sought immigrants to achieve growth in technological innovation and manufacturing, yet only 6% of the immigrant businesses were established in manufacturing. The other 94% took over already-started businesses in the service sector.

Even immigrants who used sophisticated technologies in their homelands ended up buying convenience stores. It was found that although migrants may have come with high skill levels, the transfer of technology and human capital simply didn't occur to anywhere the extent expected.

Interestingly, Government reports were upbeat on the achievements of the policy, with statements similar to those by our own Minister of Immigration in your annual report.

So what of the New Zealand experience? What has been the success of immigrants chosen for their entrepreneurial qualities?

Analysis using the Labour Department's own data has shown interesting trends. The long-term business visa has been quite an important immigration path for New Zealand. Those successfully establishing a business can apply for permanent residence under the entrepreneur category.

Despite some thousands of new immigrants arriving in the country via the long-term business visa scheme between 1999 and 2002, the period of the particular analysis in New Zealand, only 56 applied for residence under the entrepreneur category.

Of those business applicants seeking residence, most were involved in cafes and restaurants, property and business services. There was little evidence of technology transfer. Hardly a recipe for economic transformation.

In a recent publication of Massey News, Dr Clydesdale claimed the Department of Labour figures showed only 2% of business immigrants introduced new technology here. He said many bought existing businesses such as restaurants, cafes and takeaways, with little new activity. He said there was no added value, just a change of ownership.

In a more comprehensive research paper, he said that in both New Zealand and Canada there appeared to be a strong reluctance to recognise the extent of policy failings. He went on to suggest that the missing element in policy may be a failure to better match the entrepreneur's skills and experience to the business environment to which they were migrating.

Citing comprehensive international research, Dr Clydesdale argued that the match or mismatch between market requirements, or the market environment, and the individual resources, skills, or experience of the migrant entrepreneur can have a significant impact on the success or otherwise of the outcome for the migrant.

While there are clear signs of some improved outcomes in recent years, the analysis should give policymakers food for thought. High-sounding rhetoric from politicians is one thing; calmer, more careful analysis of the realities should not be ignored.

Future thinking around business/investor immigration policy should clearly give appropriate weight to that issue of matching skills and experiences to the particular market conditions the prospective immigrant seeks to enter.

As one looks at the applications approved under the long-term business category, it's fairly clear that not just poor outcomes are limiting the economic potential of business migrants. The severe decline in the number of applications decided will hardly boost economic transformation.

From the 515 applications approved in the 2001/02 year there has been an 80% decline in numbers approved, with an average of only 106 in the past two years.

So, if the outcomes for our business/investor category migrants pre-2003 show they aren't exactly boosting New Zealand's productivity and transforming our economy, and the numbers post-2003 have dwindled alarmingly, what of the skills contribution of migrants coming in under the Skilled Migrant Category?

Again, Dr Clydesdale has used departmental data in some interesting analysis. He argues that the accepted breakdown of migrants – 60% coming in through the skilled/business stream, 30% through the family-sponsored stream, and 9% through the international/humanitarian stream, does not present a true picture the proportion of immigrants bringing in needed skills.

Department of Labour data, according to Dr Clydesdale, reveals that only 15% of the total number of immigrants currently arriving in New Zealand bring in needed skills. He points out that though 60% of the applicants may be in the skilled/business category, if the applicant has a partner and two children, for example, only one of the four immigrants arriving may be bringing in needed skills, yet the other three are not included in family sponsorship data.

I'm sure many will debate his figures. However, combined with his analysis of the outcomes for business/investor category migrants, and the recent trends in numbers, there is clearly a need to set aside the political rhetoric and do some careful policy work on how New Zealand can raise both the percentage of migrants bringing in needed skills, and the business successes of those coming in through the business/investor categories.

That shouldn't be beyond our wit. It's not that the current policies are all wrong. Just as better matching the skills and business experience of the investor migrant with the relevant market conditions could make a difference to successful outcomes, so tweaking the emphasis on skills could have a significant impact on the proportion of immigrants bringing into New Zealand the skills so desperately needed to meet shortages in our workplaces.

The key to achieving that latter outcome would be policy less based on 'government knows best' and more supportive of meeting employer recruitment needs.

To be fair, policy has already moved somewhat in that direction, with the Talented (Accredited Employers) Work Policy. The problem is that policy still retains a significant element of 'government knows best'. The potential accredited employer has to jump through hoops that can take several months of administrative time. The hassles include the provision of commercially sensitive financial information to Immigration New Zealand, which is then sought under the Official Information Act by trade unions.

Employers are finding Immigration NZ is putting significant pressure on them to have that confidential financial information released to the unions. For example, in a letter from Immigration New Zealand I tabled in Parliament yesterday, Immigration New Zealand stated – "INZ needs to clarify exactly how the release of the letter (the financial information) itself would be likely unreasonably to prejudice your commercial position. Specifically, INZ seeks your comments on the following:

· The exact nature of the prejudice to the commercial position if the letter (information) was disclosed.

· How likely would the disclosure of the letter (information) cause the predicted prejudice?

· Why would that prejudice be unreasonable?

I am stunned by the compromising position that Immigration NZ has placed applicants in. When confidential financial information is provided to a government department in the course of administering specific government policy, the law should protect that private information. The situation is totally unacceptable, and I call on the Minister to ensure that applicants under the Accredited Employer Scheme are not compromised in this way by the threat of release of their private financial information.

The unions are also making mischief in other ways. Some, such as the Northern Distribution Union, are openly telling applicants under the Accredited Employer Scheme that the union has a significant say in the ultimate tick-off for accredited employer status.

Recently, the Northern Distribution Union has boasted it is currently sitting on nine applications – that prospects for their tick-off for the applicant can be enhanced by arranging union meetings with employees, facilitating collective coverage, and encouraging the sign-up of employees to the union.

Further, it is unacceptable that administrative procedure for any government policy should enable a union delegate to tell an applicant for accredited employer status, during collective employment negotiations, that the union has the power to tick off or not tick off the employer's application.

In doing this, the Northern Distribution Union was undoubtedly overstepping the mark, but it is incumbent on the Government to ensure that the law surrounding important immigration policy such as this does not permit such Union intimidation. Crucially important policy to facilitate the acquisition of skills genuinely needed to make New Zealand a more successful place for all Kiwis should not be held hostage to such administrative and bureaucratic stupidity.

Prior to the next election, National will be detailing policies to ensure a higher proportion of immigrants do add to our skill base, and that employers are better supported in acquiring the skills they need. A measure of commonsense will drive those policies, rather than the philosophic compromises imposed by Labour.

Excessive union involvement in immigration policy is not helpful, and neither is confusing policies to meet the labour needs of vital seasonal industries in New Zealand.

Common sense suggests the seasonal work permit – that has for years provided much of the seasonal labour required for our vital horticulture industries, and enabled backpackers to work their way around New Zealand during the fruit-picking season, having a great holiday and leaving New Zealand singing the praises of our lovely place – should not be scrapped. That the Labour Government is scrapping it in September suggests they've really lost the plot.

Significant concern is growing right now around New Zealand's fruit-growing regions at this latest immigration policy adventure by the Labour Government. At least as an interim move, the Seasonal Work Permit should not be scrapped, and I call on the Immigration Minister to face up to that issue today, as well.

It's time for pragmatic common sense to drive immigration policy. It's time for pragmatic common sense to drive political prejudice out the immigration policy door. Bring on 2008.

Capital Gains Tax – Is This Needed In New Zealand?

nospam@example.com (admin) — Thu, 22 Mar 2007 15:23:00 +1200

To say that New Zealand house prices have risen spectacularly is not entirely unfair.

It’s certainly concerning the Reserve Bank which said in its latest Monetary Policy Statement this month that heightened medium term inflation pressures were underpinned by both expansionary government fiscal policy and buoyant housing and labour markets.

When it comes to housing affordability, it is sobering to reflect that the median house price was 3.75 times the average household disposable income six years ago, and is now 6.3 times that average income. With the median house price in Australia being 5.4 times the average household disposable income and only 2.7 times in the United States, it is fair to say that New Zealand housing is on the expensive side.

Affordability, however, is not the only issue. Equity withdrawal from housing has undoubtedly fuelled consumption in recent times, adding further to inflationary pressures.

So, I do not dispute there’s an issue. But I do dispute that a capital gains tax is the answer.

It’s really important we don’t have a knee-jerk reaction to this challenging issue. It’s also important we don’t start by focussing on a single possible solution – in this case a capital gains tax – rather than making sure we analyse the actual problem very carefully. To jump too quickly to possible solutions can lead to unintended consequences for both businesses and the economy at large. And, need I say it, National is more interested in reducing the tax burden on New Zealanders, not increasing it.

What’s more, a capital gains tax on housing cannot solve housing affordability and rising inflation when a major part of the problem is actually government spending. This is an aspect of inflationary pressure that the government can control, and I will return to it.

Put another way, imposing a tax that will increase government revenue in an effort to control the effects of government expenditure seems a little like chasing ones own tail and is likely to be equally fruitful.

So let’s go back to the basic problem. What’s been driving our housing boom?

Put simply, it is supply and demand. Net immigration means more housing is required.

Moreover, demand for housing has been driven by cheaper finance, and cheaper finance that’s available to more people. But the supply of housing has been slow to adjust to this increased demand.

When we look at global trends, the most important common factor driving housing demand internationally has been the wave of deregulation and product innovation taking place in the financial sectors of most countries. This has reduced interest margins on housing loans and lowered the interest rates paid by mortgage borrowers.

It has also expanded the range of mortgage providers and of mortgage products. Finance is now available to a much wider group of potential borrowers than was the case previously.

We’ve seen this in New Zealand. There are now more mortgage lenders offering a wider range of mortgage products, including 100% loans, revolving credit, interest only and fixed rate loans etc. The competition among lenders is so intense that a new form of business, the mortgage broker, has emerged.

In combination, these trends have boosted lending and stimulated the demand for housing.

It’s also fair to suggest that both the tax treatment of housing and our social attitudes towards housing as a savings vehicle have reinforced those trends.

Many experts are of the view that some features of our tax system do tend to favour housing over other forms of investment, but it’s not necessarily the absence of a full capital gains tax.

The ability to fully deduct rental income losses against other income may encourage some people to take on higher levels of debt in order to purchase investment property.

In fact, just last week an article by Westpac Bank suggested that the increase in the top personal tax rate made by Labour in 2000 has pushed house prices up by about one fifth. The tax increase made housing investment more attractive to higher income property investors.

It works like this. Most landlords make a loss on their rental properties, since rent doesn’t usually cover mortgage interest and expenses. As I’ve just mentioned, this loss can be used to reduce the landlord’s other taxable income.

The landlord receives a tax rebate on rental losses at his or her marginal tax rate. So, if that marginal tax rate increases from 33% to 39% the tax rebate available also increases. And this increased rebate will be available every year. Little wonder then, that many people are willing to invest increasing amounts on properties to secure that tax break.

It shouldn’t surprise, therefore, that recent analysis by Treasury suggests that about 19% of couples and 8% of individuals own some form of secondary residential property.

But other factors are at work as well. Let’s not forget that housing has been an effective savings vehicle for many people – in many cases it’s been their only way of saving.

It has been reported, for example, that only 5% of New Zealand pensioners are in financial hardship, compared with 20% in Britain.

A recent report on living standards by the Ministry of Social Development suggests the explanation may lie in high home ownership rates among older New Zealanders.

Home ownership is linked to good living standards for many older people here. And in saying that, I am not in any way suggesting a diversified portfolio of non-housing savings assets is not important.

So, for a range of reasons from net immigration pressures through an explosion in the diversity of borrowing arrangements, certain taxation incentives and a widespread belief that property is a reliable and secure form of investment, demand for housing has been increasing while supply has lagged.

Indeed, various legislative changes in the past 20 years such as changes to the Building Act, and increased compliance costs associated with such things as the Resource Management Act, and the OSH legislation, not to mention the Local Government Act, have slowed down and added to the costs of building in New Zealand. Even the supply of skilled builders has been a limiting factor.

This is reflected in a study for the Auckland City Council that found building a home in New Zealand’s two largest cities, Auckland and Wellington, is now 60% to 80% more expensive than constructing a similar home across the Tasman.

The report compared the cost of labour, building materials and contractors’ overheads in both countries per square metre. It showed that building costs in Auckland between July 1999 and July 2006 rose 65% for a small home and 60% for a large one.

And so, how would a new capital gains tax fit into this matrix of issues all putting pressure on house prices.

First, it must be made clear that New Zealand does have a capital gains tax on the profits from the sale of certain properties.

If a housing property is not lived in by the owner, and was acquired with the purpose or intention of resale, then any capital gain on that property is taxable under today’s law.

This so-called “intention test” is outlined in the Income Tax Act 2004.

While Section CB14 excludes residential property from the definition of income, provided the house or property was occupied mainly as a residence by the person, their family, or under certain trust arrangements, the exclusion explicitly does not apply to a person who has engaged in a regular pattern of acquiring and disposing, or erecting and disposing of dwelling houses.

The Inland Revenue Department has had a few sporadic attempts at enforcing that law.

For example, in 2004, IRD targeted property investment in Queenstown, Wanaka and some parts of Auckland. They gathered an extra $106.6 million in tax from those investigations, including $52.9 million from Auckland alone.

The Reserve Bank, IRD and Treasury all agree there continues to be widespread non-compliance with that existing law. In fact, in its March Monetary Policy Statement, the Reserve Bank went so far as to refer to a “greater emphasis on the enforcement of existing tax laws regarding capital gains made on investment properties”, and implied criticism that IRD is failing to enforce the law.

A quick glance at property sales statistics suggests these criticisms might be valid. Work by Treasury and the Reserve Bank last year showed that about 25% of residential property sales in 2005 were of properties that had been owned for less than 2 years. This was up from 10% in 2001. Such high turnover suggests a significant portion of residential property was acquired with the intention of resale.

The problem for IRD is that under existing law the buyer must have intended to buy and sell for profit when they purchased the property, for the tax rule to apply.

Perhaps it’s not surprising that in the March Monetary Policy Statement, the Reserve Bank hinted at the need for changes to the tax rules around investor housing. Under questioning at Parliament’s Finance and Expenditure Select Committee, however, the Governor stated that the bank did not have a view on a more comprehensive capital gains tax.

Last year the Reserve Bank and the Treasury looked at a range of options to cool the housing market and/or the market for residential mortgage credit – including better use of the existing capital gains rules.

First – and probably the most well known – was the mortgage interest levy. This was to be a levy imposed on all loans secured by residential property. It would be triggered whenever the housing market looked to be rising rapidly and when New Zealand interest rates were well above foreign rates.

In effect, it would do away with fixed rate mortgages. Apart from the technical difficulties involved in determining the right time to apply it, the mortgage levy also had disadvantages of impacting more heavily on first time and lower income borrowers, and on the many small businesses financed by housing loans. It was also widely seen to be the political equivalent of bird flu.

Another option considered included imposing a discretionary loan-to-value limit on lenders. Intense competition among lenders has led to banks and others offering mortgages of up to 100% of a property’s value. Similar lending practices in the UK meant that when their economy experienced a downturn, many homeowners who were unable to pay the interest had to hand over their keys to their banks.

A discretionary loan-to-value limit would set a cap on such lending. Again there were a number of technical difficulties in determining just what the limit would be and when to apply it — in fact, it seemed most likely that it would be applied late in any cycle — favouring those who “got in early” so to speak. And again it would impact more heavily on first time and lower income borrowers.

A third option was to require banks to hold more capital to cover their lending. If a bank wants to lend money then that loan has to be covered by a certain percentage of capital. The Reserve Bank could require banks to hold more capital to cover housing lending — it already has this ability. We asked Dr Bollard about this during the Finance and Expenditure Select Committee examination of the March Monetary Policy Statement.

We gained the impression that Reserve Bank officials are holding one-on-one discussions with the major banks about this right now, so the option remains live.

A fourth option was to ring-fence operating losses on residential properties. In effect, it would close off the ability to apply such losses to reduce a landlord’s taxable income. While ring-fencing of such losses is common overseas, these same countries also experience quite volatile housing cycles.

In their report, the Treasury and the Reserve Bank cautioned that ring-fencing could reduce the stock of rental property available to those on low incomes and could force rents up as landlords tried to avoid losses. In addition, the legislation to put this into effect would be complex to administer and may catch small businesses using the provisions for other legitimate purposes.

A fifth option was a more comprehensive capital gains tax on housing to overcome the problems in enforcing the existing law based on intent.

As I’ve mentioned, the Treasury and the Reserve Bank flirted with the idea of removing the current exemption for residential property altogether. In effect, anyone selling a house within, say, two years of purchasing it would see any profits or gains on that sale being counted as income — and taxed as such.

The problem, as one tax practitioner has noted, is that “it becomes easy to avoid, expensive to administer, easily exploitable, and still favours some taxpayers over others." And I’d add that countries with such taxes have still experienced housing booms.

Improving responsiveness of housing supply was the final option looked at. New Zealand is building about six new homes per 1000 people each year. This is below the rate of seven to nine needed simply to replace old homes and to respond to projected population growth. Australia builds about seven houses per 1000 people and some states in the US build 13.

The Reserve Bank and the Treasury also noted that land prices have risen twice as fast as house values, yet there was little research as to why.

One recent report, from the centre for housing research, suggested that zoning, infill/density regulation (such as plot sizes in fringe areas), infrastructure provision and planning regulation were contributing to increased prices. In my view this is fertile territory but an immediate impact is not possible and success would involve extensive work with local government.

Looking at all of these options, the main conclusion reached by the Reserve Bank and Treasury was “that there are no simple, or readily implemented, options that would provide large payoffs in the near-term. Moreover, it is important to stress that significant house price cycles have been a feature of many, perhaps most, developed market economies in the last decade or so.”

And let’s not forget a number of those developed market economies do have more comprehensive capital gains taxes than New Zealand. Yet, that has not prevented those significant house price cycles.

What’s more, we must recognise that the majority of New Zealand firms are small family businesses. Many of these are financed either directly or indirectly using housing mortgages.

A crackdown on those mortgages may, therefore, have the unintended consequence of damaging our business sector.

Having explored this wide range of issues with you today, I believe there are some simple things that the government can and should do to help take pressure off both house prices and inflation.

Improving housing supply would be a worthy long-term goal. In the short term, however, the Reserve Bank’s Monetary Policy Statement makes it very clear that government spending and the effects of certain government policies are significant contributors to current inflationary pressures.

The bank was quite blunt about this. Expansionary fiscal policy was as much, perhaps even more, to blame for increased inflation pressures the Bank was reacting to when it recently increased interest rates.

Before you dismiss this as simply what any party in opposition would say, consider this: according to The Reserve Bank , between 2005 and 2007 total core government spending increased by 17% while the economy had grown just 9% in that same period. That growth in government spending is almost twice the rate the economy is growing.

Add to that the fact that the Government’s recent Budget Policy Statement identifies an additional $7 billion of spending over the next two years, and a picture emerges of expenditure growth consistently exceeding GDP growth. And remember, next year is election year and those spending forecasts don’t even include any of the bids to try and win your votes.

I mentioned earlier that it has been estimated that housing equity withdrawal in 2006 amounted to 5.3% of disposable income for households. It’s believed much of that is going directly to fuelling the current consumer spending boom.

And so my final message is this. The Government needs to get its own house in order rather than trying to divert attention onto housing market disorder. Recent years have seen an unprecedented government spending binge that has possibly had the greatest impact of all.

The risk we face is of a rapid rather than a gradual unwinding of the current residential property situation. Other countries, such as Australia and the U.S. have seen a gradual unwinding, but they let existing mechanisms work. That’s what New Zealand should do without undermining the Reserve Bank’s official cash rate tool.

The chance of that gradual unwinding is less likely if the Labour Government continues its massive spending binge.

The longer that spending delays the correction, the greater its impact will be. That is the real issue that must be addressed.

Address to Society Of Trust And Estate Practitioners, Northern Club, Auckland

nospam@example.com (admin) — Wed, 04 Oct 2006 15:24:00 +1300

When one reflects on the efforts of the Clark/Cullen Labour-led Government of recent years, significant tax reform is not top of mind, that is if collecting record amounts of revenue is not considered reform.

Despite rising nominal wage and salary levels over the past seven years, income tax thresholds have remained unadjusted. And, despite the average company tax rate in the OECD coming down from 37% to 27% since 1990, our corporate tax rate remains unchanged. Little wonder that core crown revenue has grown 61% from $34.9 billion in 1999/2000 to $56.2 billion in 2006/07.

In the past year, Labour's confidence and supply agreement with United Future has pushed tax reform issues to the fore. We've had the business tax review discussion document released in July this year after seven months of deliberation by officials.

It was hyped by ministers to be big and bold. What we got instead was an odd, purposeless sort of report. We still have no idea how much money the Government is prepared to spend on business tax reform. The few scantily costed options presented were embarrassingly under-described.

What Dr Cullen now tells us, however, is that the Government favours a combination of lowering the company tax rate and offering targeted tax credits, particularly to exporters. The thinking that went into the review document remains a mystery because Revenue Minister Peter Dunne has refused to release the background papers to it under the Official Information Act.

There can be no argument that there is an urgent need to reduce our corporate rate to at least no higher than Australia's. As for the concept of targeted tax credits, particularly tax credits for exporters, the evidence is much less clear.

The argument that some goods and services deserve preferential tax treatment over others is one that requires careful scrutiny. One of the strengths of New Zealand's taxation system is that it is relatively clean and simple.

Our GST is much admired among value-added taxes for that very reason. Deviation from a low rate, broad-based and non-distortionary system should be treated with care if we're not to start, once again, on the slippery slope towards the ad hocery of our past, such as boat taxes. In fact, in 1981 the tax information bulletin contained over 90 different tax concessions.

Accordingly, there is much worth reflecting on in the company tax area as we await Dr Cullen's reluctant moves, which may or may not be in final form when we see the legislation.

One area where the Labour Government has told us what it plans to do, or what it thinks it plans to do, is in the area of the taxation of some international investments.

Shrinking the grey list to just Australia and introducing a capital gains tax on foreign shareholdings in the other grey list countries, for investors holding less than 10% of shares in a company, has proved to be more controversial than I suspect the Government imagined.

The Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill elicited 2,226 submissions, with 148 wanting to be heard by the Finance and Expenditure Select Committee.

The Government believes the legislation is necessary to facilitate its KiwiSaver scheme. To encourage wage and salary earners, who aren't necessarily investment savvy, to save, it was believed necessary to not only give the $1,000 lolly, but also make managed funds more attractive.

Look-through provisions are proposed to enable investors in managed funds to be taxed at their personal marginal rate and not necessarily at the corporate rate. It was also thought necessary to put managed funds on a similar footing to individual investors and not tax them on capital gains in New Zealand and Australia. To achieve this nirvana, managed funds would need to become portfolio investment entities, or PIES.

The cost to revenue is thought to be about $165 million. True to form, Dr Cullen, always allergic to allowing individuals more say over their own spending, sought to recover at least part of that lost revenue through raising more tax on both the individual offshore investments of Kiwi savers and investments by passive funds.

And so was born the idea to impose a capital gains tax on 85% of share gains in former grey list countries, other than Australia, and of course other than GPG investors in the U.K. The lack of logic deserved the deluge of submissions that followed – 99.9% against such an irrational tax.

In response, the Government has now suggested, by way of a letter to the select committee, that the proposed capital gains tax should be replaced by a fair dividend rate tax. That stunning misnomer I'll come back to, because this latest tax proposal is neither a tax just on dividends, nor is it fair.

First, there are one or two points to deal with in respect of the establishment of PIES.

It's simple to say that we should tax the returns on an individual's investment in a managed fund at their own marginal rate, but giving effect to it is anything other than simple, especially when it is the PIE paying the tax and not the individual.

The Government wants it that way so that income from KiwiSaver savings does not count in abating benefit levels or Working for Families tax credits.

Attribution of income to the individual's level will involve complex calculations. Evidence to the select committee suggests that in order for a modern superannuation scheme with investment choice and 100,000 members, to become PIE-compliant, it may involve up to 15 billion extra data points of information that would have to be kept by that super scheme.

That is a huge compliance problem, and it has been suggested that some employer super schemes won't become PIE-compliant because they can't pass on the costs. For schemes that do become compliant, the increase in their charges to cover those compliance costs may negate the potential tax savings for the investor.

The legislation proposes that in order to determine the appropriate tax rate for the individual investor, gross income is added to the super contribution and the attributed investment income, and if that is less than $48,000 then the 19.5% tax rate applies.

If, instead, the Government were to accept that the determination involved simply adding the super contribution to gross income and looking at a figure less than, say, $45,000, in other words, removing the attributed investment income from the equation, the compliance cost problem of the extra data handling could be reduced by about 50%.

PIES also face problems over the payment of tax for investors who have pulled out, because remember it is the PIE paying the tax on behalf of the investor. The PIE has to do it on the basis of averages and there is a disconnect between the period when income is earned and the period when the tax is paid.

What's more, some funds, such as listed property trusts, and even life insurance-based products, don't qualify under the currently proposed PIE regime. Because listed vehicles don't know who their shareholders may be on any one day, they have major problems with the proposed attribution of income rules.

So, even the proposed portfolio investment entity regime that is in principle supported by many has some significant implementation issues.

But it is the shrinking of the grey list and the proposal to tax unrealised, accrued capital gains on offshore share investments that has caused such angst. I suspect the Government was somewhat ignorant of the extent to which ordinary, sensible New Zealanders have invested wisely in diversified portfolios.

That angst and the deluge of submissions have now seen the Government directionless and wallowing in uncertainty. One person appearing before the Finance and Expenditure Select Committee suggested we were seeing "legislation through media statement".

That's because on 19 September, Dr Cullen and Peter Dunne wrote to the Finance and Expenditure Committee, issuing a press statement at the same time, suggesting that the Government had changed its mind and now accepted that there was a problem with "the complexity of the offshore tax proposals currently in the bill and the taxation of capital gains".

The ministers told the committee that "the Government's preferred option is a fair dividend rate method" which "would also not target capital gains, but rather something approximating a reasonable dividend yield".

And so the Government is now proposing to tax all dividends and capital gains up to a cap of 5% of the opening value of the person's shares that year. There would still be a $50,000 threshold and no tax would be levied in a year where overall losses were made.

The ministers claim the new system would be simpler than their earlier proposal to tax accrued unrealised gains.

Submissions to the select committee in the last week, by and large, agree the approach would be simpler, but have thrown up a series of serious problems.

First, managed funds will be treated differently from individuals. The 5% fair dividend rate will be applied to managed funds regardless of actual returns. Also, because in the past decade funds have lost money on average three years in 10, funds will be paying tax when individual investors are not. They will also always pay more tax because the $50,000 threshold won't apply to them.

Secondly, the 5% "fair dividend rate" is above the average worldwide dividend yield. It therefore contains an element of capital gains tax. The weighted average dividend yield in world markets is currently around about 2.2%. The select committee has been advised that managed funds are, therefore, likely to shift to Australia, hollowing out yet another industry in New Zealand. The select committee has been told some private investment trusts are already moving to Australia, with others threatening to go.

Thirdly, there are problems with private companies that are not typically revalued each year. The proposal would deem them to gain at 5% or face the cost of annual revaluations.

Fourthly, the $50,000 threshold for individual investors will have a massive distorting effect. Wives, children and even pets are likely to become shareholders as people avoid the massive effective marginal tax rates that will apply on foreign shareholdings just above the $50,000 threshold. $50,000 and none is taxed, $50,001 and the lot is taxed.

Fifthly, the committee has been advised that international recruitment of highly skilled people, university academics as well as professional and businesspeople, will become a big problem. More than one investor has told the committee that should the proposed legislation become reality, they will leave New Zealand. A number of recent immigrants, even New Zealanders recently returned home, have told the committee they wouldn't have come had they known about this new tax.

For multinationals with employees involved in employee stock ownership plans, or ESOPS, the proposals are seriously problematic. Such investors' funds are often locked in for five years, and they can't even sell shares to fund the proposed tax. Even for ordinary New Zealanders, if the dividend paid in any year doesn't meet the cost of the tax, shares may have to be sold, and savings eroded, in order to pay the tax.

Sixthly, the committee has been warned of the problem of currency shifts. If the gain in New Zealand dollar terms on a foreign investment is purely because the New Zealand dollar has fallen, is it fair and reasonable to tax someone on that gain purely through a currency shift?

Finally, the committee has received repeated advice that the proposal will distort investment decisions even more in favour of New Zealand property, particularly residential property.

Already 75% of household balance sheet equity in New Zealand is in the housing market. It has inflated by 75% over the past three years. Such investment in the UK is just about half that level. The proposals, we've been told, will simply add to the incentives to bring money back to New Zealand and invest in an already overheated housing market.

So, what are possible solutions to the Government's mess?

Most advice to the select committee has been to expand the grey list and establish a red or black list to prevent tax rorting through tax havens. Because of the revenue implications, I suspect Dr Cullen is unlikely to listen to that advice, even though the revenue gained with the new proposals, over the cost of collecting it, is not a pretty sum.

Submitters have also focused on the advice of tax expert, John Shewan. His proposals echo the inflation-adjusted risk-free rate of return concepts in the earlier, Government-commissioned, McLeod Tax Review of 2001, so studiously ignored by Dr Cullen.

It is suggested that a simple low rate of tax should apply to foreign investments for small shareholders across the board. In other words, a deemed rate of return tax should be considered. That deemed rate of return would be set objectively and based on something such as the MSCI (world sharemarket index).

Current evidence would suggest that rate should be somewhere near or below 3%. If it were to apply to both funds and individuals, regardless of whether or not losses were made, and because it would be based on average dividend returns most recently applying to international equities, it would eliminate the perception of a capital gains tax.

What's more, because the rate might be applied across the board and be set at an objective level, it has been argued that the threshold for individual investors of $50,000 would no longer be necessary, and both the Australian and GPG exemptions could go. In other words, it could render possible the removal of most of the differences between the treatment of individuals and funds, and reduce the distortionary impacts that have caused such concern.

The impact of this legislation on investment in New Zealand and by New Zealanders could be quite profound. The difference between a 5% fair dividend rate and a 3% deemed rate of return is, in fact, very significant.

The Government must go back to its basic policy process. It must decide whether its policy intent is to tax in a broad-based, simple way, dividend returns, or to tax both dividend returns and capital gains.

The ministers, in their letter to the select committee, say they don't want to target capital gains. Yet one of the examples they enclosed with their letter had a fictitious "Mary" holding offshore shares to the market value of $100,000 at the start of the year, paying tax on an unrealised capital gain of $2,000.

Once the Government has decided what its policy intention actually is, it should then re-write the legislation and invite further submissions. Anything less than that would reflect a level of governmental irresponsibility breathtaking, even by the Clark Government standards.

If the Government pushes ahead with its new, misnamed, fair dividend rate tax, it will put at risk our capital markets, not just financial capital but, perhaps even more important, our human capital.

In a globalised world why would highly skilled people come to live where their global savings will be taxed on unrealised returns? We already compete with Australia for those skills and, judging by the net annual exodus of more than 20,000, we're not competing too successfully. If this poorly thought out legislation is implemented badly, that steady stream across the Tasman could be swollen by a storm of discontent.

Remember, our tax system relies on voluntary compliance. If it is seen to be unfair, it will be avoided one way or another.

The Power of Trade

nospam@example.com (admin) — Mon, 03 May 2004 15:25:00 +1200

If you consider all of the actions that lie within the power of politicians, the one that I believe could enhance the wellbeing of the world’s people the most is trade liberalisation. I know that’s a bold statement, but it is one I make with confidence.

In parts of the world, freedom, personal and property security through the rule of law, and the elimination of corruption, would of course have a profound impact. Education, too, is vital, as is basic infrastructure.

But trade liberalisation is the single individual initiative that would deliver the greatest improvement in living standards to the people of the world. And the gains would be across the board – in free countries and those still struggling without democracy; in larger countries and smaller countries; and in countries rich and poor.

In fact, one study has suggested that if all trade barriers could be abolished right now, global income would be boosted by as much as US$2.8 trillion.

But it’s not about the money per se. That growth in global income would lift 320 million people out of poverty by 2015 – that’s in just 11 years time.

While that’s an estimate from an academic study, and can therefore be the subject of debate, I doubt it is out by US$2.8 trillion. The history of the world is the real case study and that undeniably demonstrates the extraordinarily positive effect of liberalising trade.

I want to take you back a bit over 80 years. After the First World War, the world faced serious economic difficulties. With the wisdom of hindsight, the way the situation was handled wasn’t great. Governments may have had the best of motives. They sought to protect their industries and workers by putting in place protective barriers to reduce competition from trade. The result was the great depression, which itself played no small part in the lead up to the Second World War.

After that war, governments of 23 nations, determined not to make the same mistake again, agreed to establish the General Agreement on Tariffs and Trade at the historic Bretton-Woods conferences. What became known as the GATT was established soon after in 1947.

Since then, the theatre that often surrounded eight sets of trade negotiations rightly raised cynicism in some. But, in fact, the cumulative effect of that trade liberalisation was overwhelmingly positive. Average tariff rates were reduced from 40% to just 4%, and global trade has grown more than sixteen-fold.

Again, though, it’s not the money. It’s the people. Over the five decades since the GATT was established in 1947, according to a United Nations human development report, more people have been raised out of poverty than during the previous five centuries of human existence. And while war is still with us, the world has not suffered the calamity of the two major world wars of last century.

It raises the question then: if trade liberalisation is so good in eliminating poverty and preserving the peace, why is the Doha round at the World Trade Organisation almost stalled? And why did the WTO ministerial at Cancun fail?

I blame politicians, my own profession. Too often the trade ministers at the WTO, often on orders from their governments, abandon their historic mission. They abandon what they know to be right in favour of political expediency. The political power of protected interests too often wins the day.

If you doubt that, look at the recent United States steel decision. Raising tariffs on imported steel in the past couple of years has cost the United States tens of thousands of jobs. For every American employed in producing steel, there are at least 30 employed in using it. Protecting one job in producing steel cost the US, through higher input costs, many more jobs in steel-using industries.

The political reality, though, is that those producing steel are concentrated in key states that have a significant impact on the outcome of us elections. Those whose jobs depend on the use of lower-cost steel are spread much more thinly across the country.

Of course, one of the most economically absurd protectionist policies is the common agricultural policy of the European Union. We’re told that European families are happy to pay the extra $1500 a year they do in artificially high food prices. But I can’t believe they’re happy to see the millions of young people unemployed that is, in part, a legacy of the common agricultural policy.

Believe it or not, across the OECD, that is the 30 countries of the developed world, almost one billion US dollars a day goes into subsidising farmers one way or another and protecting them from the competition of international trade. That subsidy would be enough to pay for each of the OECD’s 41 million dairy cows to fly first class around the world one and a half times. And that cost is incurred each and every year.

Those massive subsidies in Europe mean that vast levels of investment are going into activities, which purport to be farming, but from which there is no market return. The subsidies are so high that they are often equivalent to the world product prices.

Were those billions to be invested in growth areas of the economy, it’s been estimated that economic growth in Europe could be improved by 1% a year. That in turn could raise employment across Europe by millions.

You’d think that might sway politicians. But no, the voting power of farmers in France and Germany, and their skills at direct action, mean that rational development is, again, held hostage to the headlines of the day.

It may be that some European politicians are prepared to accept higher unemployment amongst their young people to keep their farming lobbies sweet. But their trade-offs do not affect their own people alone.

The people who are hurt most by protectionism are the poorer people of the world. If the quotas and tariffs imposed by developed countries, including New Zealand, on textiles and clothing imports were eliminated, developing countries could earn an additional US$8 billion a year. And if North America, Europe and Japan were to eliminate import barriers for products from sub-Saharan Africa, that region’s exports could earn an additional US$2.5 billion each and every year.

In the poor West African nation of Mali, 3 million people, that is a third of their population, depend on producing cotton for their survival, and I mean survival. But 25,000 cotton farmers in the United States are paid almost US$4 billion a year in subsidies. Some might say but “ah, the US gives Mali $38 million a year in aid”! The problem is those massive US cotton subsidies cost Mali $43 million in lost trade.

What’s obscene is that those agricultural subsidies in the developed world are two thirds of Africa’s total GDP. Abolishing those subsidies would return three times all the official development assistance for developing countries put together. United Nations Secretary-General, K ofi Annan, wanted US$10 billion to fight Aids. That is just 12 days of the developed world’s subsidies to farmers.

The protectionist policies of so many in the developed world are a stain on the morality of the world.

But it’s not all bad. The Uruguay round of trade negotiations completed in 1994 achieved much lower tariff levels that have saved, to take New Zealand as an example, NZ$3.1 billion in tariffs so far. So far our economy has gained more than NZ$9 billion, and more than 17,000 jobs, from the liberalisation achieved through the Uruguay round.

And the WTO dispute settlement system has seen us win cases against Canada on dairy, and the US on lamb, worth a combined NZ$90 million a year. Just last week it was reported the WTO is about to rule that the subsidies paid to US cotton farmers contravene the WTO rules on subsidies and countervailing measures as well as the agreement on agriculture.

These gains are just the start of what’s possible. The New Zealand Institute of Economic research has shown that if all our exports went to Japan, we’d pay an average tariff of 50% compared with the US and EU, which would pay less than 2% if all their exports went to Japan.

If all our exports were to go to the US, we’d pay an average tariff of 24%, while Japan and the EU would pay less than 4% tariffs on their products. And, likewise, if all our products went to the EU we’d pay an average tariff of 45% while Japan and the US would pay less than 6%.

We stand to gain hugely from the Doha development round that just this week is balanced on a knife-edge in Gneva. An outstanding New Zealander, Tim Grosser, is chairing the agriculture committee that, as i speak, is trying to find a way forward to deal with market access problems.

There is some hope of consensus emerging on the phasing out of export subsidies. Likewise, there is hope that domestic support of agriculture will be decoupled from production. But how best to deal with tariffs and quotas continues to defy all efforts to find a way forward.

I know some will challenge me on my focus on the economic gains from trade liberalisation. They will cite, as being of greater importance, the increasing tensions between extremist parts of the Islamic world and the West, the growing tentacles of terrorism, not to mention the ongoing situation in Iraq and the Middle East.

But let me again take you back, this time just 57 years. About the time of the Bretton Woods conferences that led to the formation of the GATT, US Secretary of State, Cordell Hull, is quoted as saying, “if goods don’t pass our borders then armies surely will”.

Europe was living proof of it. War had blighted almost every generation, reaching a catastrophic crescendo with the trenches of the somme and passchendale and shortly after the worldwide horrors of the Second World War.

The European leaders who recognised that things had to change were of world historical importance. They initiated international cooperation in the coal, iron and steel industries, developments that were to become the forerunner of the European economic community, now the European union. Within its borders, it has been spectacularly successful, accelerating living standards after the destruction of the Second World War and making a repeat of that unthinkable.

Put bluntly, people are usually pretty reluctant to shoot their customers. In other words, if trade flows smoothly and freely, and both sides enjoy a healthy commercial relationship, political conflict is less likely.

What’s more, smoothly flowing trade helps people all over the world become better off. Better-off people are usually more contented and less likely to get into major conflict. The economic gains from trade can reduce the inequality between nations that can spark resentment and conflict.

And so there is a powerful link between trade and security.

Addressing today’s global tension the growing evil of terrorism, and ongoing conflict in the middle east, obviously requires more than trade liberalisation. But how much more effective could those diplomatic efforts be if the economic powerhouses of the US, the EU and Japan were prepared to offer the rest of the world more open access to their markets, and if the extraordinary benefits of trade and economic integration could be demonstrated to those who currently feel shut out of the global economy, and trapped in poverty?

That’s why the US is trying to reach out in its bilateral trade work with strategically key economies, including some in the Middle East, with a free trade agreement recently completed with Jordan. That’s also why it’s so important for countries like Saudi Arabia to gain accession to the World Trade Organisation.

Having had the privilege of standing on Chanuk Bair at Gallipoli, standing under the Menim Gate at Ypres and in the village of Messines, i have felt a tiny part of the terrible cost of global conflict. Having stood beside the vast, gaping hole that was once the World Trade Centre, and thought of those innocent people jumping from 90th story windows in utter terror, i say again that the barricades of conflict must come down.

The politicians of the developed world have within their grasp the ultimate means of achieving that. They can put an end to the protectionist barriers to trade that keep parts of the developing world in the kind of poverty that can be the breeding ground for terrorism.

New Zealand can play a role in this, and does. For years now we’ve been consistent advocates of trade liberalisation. We’ve undertaken unilateral tariff reduction in our own market, that has benefited us foremost, but which has demonstrated to others the opportunities that are within their grasp.

Here, in New Zealand, we’ve shown that freeing up our markets did lead to some adjustment costs. But we’ve shown that the gains from doing so exceed those costs.

Protecting jobs is hugely expensive. It’s been said that the cost of protecting our car assembly industry was such, that it would have made more economic sense to pay every worker in that industry the same salary as our Prime Minister, and send them on holiday forever, rather than protect that industry.

In the US, it has been estimated that across 21 industries in 1994, the cost of every job protected by tariffs was US$170,000. Across 47 industries in Japan at the end of the ‘80s, the equivalent figure was US$600,000 per job.

Right now, the US remains the key player in advancing global trade liberalisation, even though its internal politics can make that difficult for its trade negotiators. On our own, New Zealand is too small to make much impact. We should be working closely with the US, but we’re not.

Last year when US trade ambassador, Robert Zoellick, held a breakfast for ‘friends of free trade,”’ New Zealand was not invited. Twenty years ago, whoever would have thought that our Anzac partner, and CER partner, Australia, would refuse to have us alongside them as they negotiated a free trade agreement with America?

While in polite circles it’s suggested the Australians didn’t want our significant dairy industry to burden their progress, in reality they didn’t want the political baggage of our damaged relationship with the US to stand in the way of their agreement. .

The track record of the Labour Government of Helen Clark on concluding free trade agreements isn’t that great. Sure, they finally signed the Singapore deal, but National had negotiated the guts of that. Since then the Hong Kong negotiation has stalled, progress is very slow on the three-way deal with Chile and Singapore, and with the US we haven’t even reached the starting line.

Helen Clark is partly responsible for that.

Jim Sutton has built on National’s work to progress work on free trade agreements with China and ASEAN, and they are potentially huge deals for New Zealand.

We must hope that the Prime Minister sticks to her foreign affairs brief, and doesn’t make the same sort of off-the-cuff comments about those countries that so harmed our chances of making any progress with the United States.

A trade agreement with China would be overwhelmingly in New Zealand’s interests. We must hope that the predictions of Dr George Friedman, chairman of the respected international consultancy, Stratfor, in New Zealand recently – do not come true: that the Chinese economy may be in for “meltdown”, to use his words, in the not too-distant future. They are seeing the kind of capital outflow that preceded Japan’s protracted economic malaise.

But we must also put the China development in perspective. Every analysis shows that by the middle of this century, the US will be economically an even more dominant player in the world than it is today. Its population growth will, relatively speaking, exceed China’s and its age profile will stay much younger than that of Europe.

It is, therefore, even more in New Zealand’s interests that the political difference between New Zealand and the US is sorted out.

It must be done in a way that can find broad acceptance in New Zealand; ideally, across political party lines. It is not in this country’s interests to have foreign policy flip- flopping on changes of government. We should seek, wherever possible, to manage foreign policy across party lines.

I am not in the habit of scoring a political point each day over every little slip-up that Phil Goff and Jim Sutton make. But I most strongly criticise Helen Clark and her Labour Party for the radical direction she is taking New Zealand’s foreign policy, that sees us turning our back on our traditional allies, and which is not in our interests.

The collapse of Soviet communism and the end of the Cold War, and the rise of ethnographic conflicts and terrorism make this century very different from the last. Just as Helen Clark and the Labour Party have shown their inability to competently manage treaty of Waitangi issues domestically in this new century, neither do they have the capacity or competence to turn around the gradual but ongoing decline in our relationship with the countries most important to us -- Australia and the United States.

It’s just another reason why this country needs a Brash-led National Government. All of us need to fight towards that goal, in everything we do, through this winter and beyond, towards the change of government next year.