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Paper For New Labour Party Policy Committee

This package is presented for the Policy Council's approval. It is a co-ordinated set of policies that will be implemented in the 1984 to 1987 period. It is aimed at raising, permanently, the living standards of New Zealanders by:

• Encouraging and facilitating sustained non-inflationary growth.

• The creation of a substantial number of new job opportunities.

• Improving the position of the less-well-off groups in the community.

The package of policies can be viewed in three parts:

Economic Management

• This involves fiscal, monetary and prices and incomes policies. The aim here is to restore stability and confidence to our economy so creating an environment conducive to our longer-term goals.

• This contains policies on export assistance, exchange rates, employment, protection, taxation and assistance to industry.

Equity

• While this policy is included in the section on prices and incomes, it contains major new initiatives to target public resources more precisely at the groups that need assistance.

Fundamentally, this package follows from the proposition discussed in the background papers that as a result of Government policies we have achieved neither growth (we are inefficient), nor equity.

We believe we can do much better on both counts.

By introducing policies contained in the package which encourage more efficient use of our productive resources we can achieve sustained growth and create new jobs. At the same time, by targeting existing public resources we can improve the position of the lower to middle-income groups, i.e. achieve greater equity. And over time, a growing national economic cake will allow for more redistribution to these groups to ensure they share in the benefits of growth.

There will be conflicts between these two goals.

Policies to improve efficiency and growth prospects will in some cases raise the cost of living faced inter alia by lower to middle income families. Many families cannot afford any cost increase. But rather than give away the efficiency goal the loss suffered by lower-income families can be offset by additional income provided through the taxation and social welfare systems, i.e. assistance is given to those who need it, not to all families. Both efficiency and equity goals are met.

The tax exemption for life insurance and superannuation, which is forecast to cost $290 million in 1983/84, is both inefficient and inequitable.

From an equity perspective, the exemption benefits high-income earners more than low-income earners. The value of the exemption depends on a person's marginal tax rate. A $1000 life insurance payment reduces the tax bill of a person with a $40,000 income by $600. A person making the same payment with an annual income of $12,000 has his tax bill reduced by $315.

From an efficiency perspective this exemption places life insurance companies and superannuation funds in an advantageous position vis-à-vis other financial institutions. They offer substantially the same after-tax rates of return to savers. This means that companies like AMP take a large amount of the benefit of the exemption. In effect, their operations are subsidised vis-à-vis other institutions and as a result they can be less efficient. Overall, the effect of the exemption is to divert personal savings into less efficient financial institutions.

Eliminating this exemption and using the revenue to assist lower-income people will represent a redistribution of income from the better off to the lower-income groups. In addition it would improve the efficiency of the financial system

The following Policy Papers are attached:

Summary notes on Employment and Equity are also attached as is a chart illustrating the effect of the policies on the objectives.

The inter-relationships and effects of these policies on the key problems and objectives are shown on the attached charts. The policies have been designed so that they work together to deal with the problems our economy faces, and achieve the economic goals.

Finally, it should be noted that the timing and speed of implementation of these policies will be dependent on the state of the economy when Labour comes to power.

These papers have been discussed in the Caucus Economic Committee and a number of changes have been made as a result of these discussions.

It is recommended that the Policy Council approve the Economic Policy Package.

The policies described in steps one to three immediately following, are a co-ordinated set of policies which are aimed at restoring business, worker and consumer confidence.

Economic Management under Labour will not jump from problem to problem - fixing each temporarily but making all others worse. Rather it will deal with all the major issues -

at the same time and within a medium-term prospective. Policies will be dealing with each of these issues at all times - we cannot afford to neglect any of them.

We recognise that there are trade-offs but essentially Labour will use a particular policy instrument to deal with a particular target. Over the medium-term as economic efficiency improves, these policies will become more effective and the trade-off less dramatic.

Above all else Labour's Management policies must be credible, create and maintain business confidence. This will require stable and certain policy stances. If this is achieved this will be an important contribution to Labour's growth, employment and equity goals.

The overall framework for the Prices and Incomes Policy is as discussed in the paper presented by Ann Hercus.

• To formulate a wage fixing system that relates wage payments to the capacity of the national economy to pay.

• To encourage consultative processes so that negotiations are based on common perceptions of the problems and economic objectives.

• To share key economic information more widely.

• To ensure that the process of structural change is understood by all parties.

• Prices policy.

The key elements a Labour Government would be seeking in the first year of office are as follows:

• Understanding and agreement over the need for radical changes in the economy, to achieve higher employment and higher rates of sustained growth.

• Consultation with the Union movement over the policies designed to achieve these changes.

• Agreement to income and price restraint in the short and medium term as an important policy in assisting these changes.

In return to offer (after consultation and negotiation):

• A Family Assistance scheme (APPENDIX I) which would offer a considerable net boost to the living standards of low to middle family income earners.

• A prices policy to hold prices including:

  • price justification

  • monetary policy

  • protection policy

• Consultation over Industrial Relations Legislation.

• Repeal of the Economic Stabilisation Act, and its replacement by more suitable Legislation.

Assistance by Government to individuals and families comes in various forms. Much of it is paid irrespective of income. For example:

Subsidy on Power         $200 million

Medical Benefits           $320 million

Housing (interest)         $100 million

Family Benefit              $290 million

Subsidy on Milk             $ 30 million

National Superannuation $300 million

Tax Concessions           $780 million

                               $2020 million

Major reforms are required to achieve more effective income redistribution via Government tax and expenditure policy.

Firstly, much Government assistance is badly targeted and gives benefits or subsidies that do not depend on need or income. For instance, electricity is underpriced relative to its economic cost, but because high-income earners tend to have more electrical appliances and consume more electricity, the benefits may actually be greater for high-income people than lower-income people. Many tax concessions are also unrelated to need or income.

As a result of the wage freeze, continued inflation, rising unemployment and tax changes which benefited the top 20 percent of income earners, the position of the lower and middle-income families has seriously deteriorated. As part of a medium-term economic programme, this situation must be redressed.

The chronically unbalanced nature of public finances means that major additional assistance that boosted the deficit could not be contemplated. Offsetting savings must therefore be achieved.

Given that the across-the-board-wage increases are non-selective, inflationary and reduce employment, this approach is not regarded as being the most effective mechanism for dealing with the needs of this group. A more selective and targeted approach is called for.

Because of the 'ad hoc' way in which the Social Welfare system has grown up and the effects of declining relative wages for the low paid, there is a growing tendency for those on benefits to be in a better financial position that those who are working. Examples can be given of this effect.

Those on benefits face large disincentives to work, because of the abatement system. This often prevents beneficiaries entering the work force on a part-time or temporary basis and hence helping themselves to be more independent. Other forms of assistance such as State house rental subsidies introduce sudden changes in incentives, often of more than 100 percent (i.e. $1 income earned - more than $1 of subsidy lost). Examples can be given of this effect.

Details of the Proposal

Benefit and Family Assistance Scheme

1. There will be one basic benefit that replaces DPB, Widows' benefit, Unemployment benefit and Superannuation. This will be set at the same level as National Superannuation. This will abate at, say, 40 cents in the dollar till it reaches a minimum net income level.

2. There will be a Family Assistance payment that is paid on the basis of family income and family size. This would abate at, say, 40 cents in the dollar for every one-dollar of income earned by a wage earner above the minimum net earned income.

3. The Family Assistance payment would be paid to the non-income earner, or where both parents work, to the lower income earner (with the option to have it paid to the other - with approval of the other spouse).

The policies in the following sections will boost the profitability of the internationally competitive exporting and import-competing industries. This will be done by increasing the prices they receive, gradually reducing the costs they have to pay and making them less reliant on ad hoc and arbitrary government assistance.

Better profitability and a more stable outlook will lead to investment, increased output and incomes and more jobs.

In addition, new growth industries will be encouraged by this package of measures:

The improved position of these potentially highly efficient industries will allow them to undertake more longer-term investment in critical areas such as research and development, market development, staff training. These endeavours will be supplemented by the public sector institutions - DSIR, Trade & Industry and the educational institutions.

Finally, the service and infrastructural industries also need to be internationally competitive in the services they provide.

The major reason for devaluation is to stimulate fundamental structural changes in the economy. Ultimately, these structural changes will enable both the Balance of Payments and the internal deficit to move into better equilibrium and allow the economy to grow more rapidly.

The objective of the package is to boost profitability of the export sector and the producers of goods and services that compete with imported goods in the medium term to get the Balance of Payments into equilibrium over the expected trade cycle.

New Zealand has had a substantially over-valued exchange rate for a number of years, as shown by our persistent external deficits. New Zealand producers have lost competitiveness due to high relative internal inflation and the unwillingness of the Government to use the exchange rate. The Government has reacted by introducing 'ad hoc' incentives such as SMPs and export incentives.

• (These subsidies also attempt to compensate for costs imposed by import protection)

  • An over-valued exchange rate, while making exports less competitive, also makes imports cheap, and this cuts away sales from the local import substitution industry - thereby lowering employment, wages, profits and investment.

  • Invisible earnings and payments are also adversely affected by an over-valued exchange rate (e.g. travel and insurance - an over-valued exchange rate makes overseas travel relatively attractive, compared with travelling internally. Similarly, expenditure on services such as insurance is made relatively cheaper overseas compared to within New Zealand.)

  • The over-valued exchange rate has to some extent, been offset by subsidies and import controls.

  * The precise cost of these subsidies is unknown, but is believed to be in the range of $2000 million. They take the form of Government provided services below market charges (power/timber), below market interest rates, export incentives and SMPs.

   

• Subsidies have major disadvantages:

  • They often do not fully compensate for over valuation and the cost disadvantages imposed by import protection.

  • They result in either higher taxation (i.e. transfers from taxpayers to farmers and manufacturers) or higher budget deficits, more borrowing and higher interest rates.

  • They are highly uneven in their effect between industries and hence cause major profit and investment distortions.

  • They often represent the political power held by various lobby groups.

   

• Import controls may lessen, in the short run, the effect of an over-valued exchange rate, but, in the medium term they also have major disadvantages -

  • They push costs for other industries and hence reduce their competitiveness.

  • They cause distortions in investment patterns.

• For devaluation to be successful, it is vital that it is accompanied by a set of policies that ensure the potential inflation (resulting from the rise in import and export prices) is minimised. If these policies are not implemented then devaluation could be counter-productive.

• This package contains these key measures which will help control inflation.

  • A prices and incomes policy.

  • An appropriate monetary policy compatible with the inflation objective.

  • Measures to progressively reduce the internal deficit.

  • Lower and more even rates of protection.

The aim will be, in the medium term, to use the exchange rate in a more flexible manner than has been the case under the present Government, to assist in achieving better external balance.

Export incentives and subsidies will largely be removed. The prices of Government services and products currently under-priced in relation to the market place will be increased.

The objective of the Policy is to:

• As discussed in Step Number One 'ad hoc' incentives have a number of major disadvantages. A devaluation will make exporting substantially more profitable, provided the accompanying anti-inflationary measures can be made to work.

Dependent on the size of the devaluation, this will allow the following subsidies, in large part, to be removed.

The removal of subsidies will have to be achieved on a case by case basis. Different sectors will benefit to a different degree from devaluation. The objective will be to leave efficient exporters in a more profitable position than previously.

Export incentives, SMPs, and other agricultural subsidies would be removed most rapidly. Other policies such as increasing electricity prices would be achieved on a more gradual basis.

The full charging for agricultural infrastructure support services, such as meat inspection advisory services would encourage more efficient use of these services.

Full charging for stumpage would eliminate subsidisation of large forest companies, and remove the bias against smaller forest companies.

Contractual obligations may limit this occurring in the short term, and would be achieved over time.

Increased electricity prices would encourage more efficient use of electricity.

Again, this would be achieved over time.

There may be exceptions to the general aim of removal of subsidies for the following reasons:

Labour's approach is to introduce policies that encourage resources to move into high-productivity internationally competitive uses.

These policies will apply not only to the manufacturing sector but also to the infrastructural and service sectors for example, finance, transport and communications.

Even though high levels of protection have been maintained since 1958 our import licensing and tariff system has not prevented since the mid-1970s:

Most economists would argue that there are much better policy instruments to improve employment and external prospects. They do not have undesirable side effects of import licensing which are outlined below.

In addition, studies have clearly shown that import licensing has encouraged substantial foreign investment in New Zealand as overseas companies have set up plants here to get market access. In many cases such plants, in addition to being overseas owned, were heavily dependent on imports and foreign technology.

The imposition of lowish tariffs on imported raw materials is an important component of the overall strategy that is aimed at encouraging the processing of local raw materials rather than imported ones. In addition, this action will offset any revenue lost through the reduction in high tariff rates and will reduce the deficit over time; e.g. 5% tariff will raise $200 million in revenue if applied to items currently imported duty free.

These funds will be administered by the Departments of Trade & Industry, and Labour.

• The first $100,000 worth of gifts received would be exempt from tax, the next $100,000 to attract tax of 10 cents in the dollar, the next $100,000 - 20 cents in the dollar until 50 cents is reached.

• It would encourage the spread of wealth, since tax can be avoided by spreading an inheritance amongst a larger number of people.

• Under the current system a person who has received a million-dollar estate, loses the same amount in death duties as a person who has never received anything.

• Under a cumulative gift tax, the person who has received no gifts would get his first $100,000 free, while a person who has already received half a million in gifts would lose half of any further inheritance in tax.

The protection policy will have a negative effect on investment and employment levels in inefficient highly protected industries in the short term. However, the long run output and employment will, in aggregate terms, increase.

The effect of devaluation may be somewhat negative in the short run, but will be positive in the medium and long run. Increased employment will be generated in the competitive export and import substitution sectors.

The Government Assistance to Industry fund will assist more rapid establishment of new industries, markets, products and processes and hence increase the rate of growth and employment creation.

The taxation changes will shift the bias against employment by progressively shifting the burden of taxation on to consumption and away from production and incomes, and ensuring that employment is not discouraged vis-à-vis capital.

The taxation changes will also progressively reduce the attractions of capital gains and towards investment in income and employment generating investments.

Sustained employment growth based on efficient high productivity industry is the major aim of the package.

The Prices and Incomes Policy has several functions in relation to employment.

• To encourage an understanding of the need for structural changes in the economy necessary to produce sustained employment growth

• To negotiate a wage fixing system that takes account of the capacity of the economy to pay and which is complementary to the Government policies promoting structural changes.

• The removal of arbitrary and varying disincentives which currently prevent beneficiaries and the unemployed entering the workforce on a part-time or full-time basis.

The Fiscal and Monetary policies are designed to improve the performance of the economy in the medium to long run, resulting in a higher rate of growth and higher levels of employment.

Improved certainty and a more stable investment climate will encourage investment and job creation.