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The following OECD assessment and recommendations summarise Chapter 3 of the Economic Survey of New Zealand 2005 published on 4 July 2005.
Recent moves to address tax distortions affecting investment and financing should improve incentives to deepen capital
Although the country has seen a surge in capital formation as labour has become scarcer and the user cost of capital has fallen, tax rules have distorted investment decisions and affected the flow of financing towards firms in ways that can lead to a lower overall capital stock and a sub optimal mix of fixed assets. The 2005 Budget addressed two important problem areas. The first arose because capital gains on equity are generally untaxed, except for those earned by actively managed unit trusts. This reduced the flow of funds channelled through such instruments, which are often the most suitable source of funds for business expansion. The changes announced in the Budget should lead to better matching between savers’ preferences for risk and businesses’ financing needs. The second concerned the gap between depreciation allowances for tax purposes and economic depreciation rates: the formula that has been used amortised short lived assets (such as ICT) too slowly and long lived assets (such as buildings and structures) too rapidly. Budget changes to depreciation rates to more closely mirror true economic depreciation should lead both to a more efficient investment mix for firms and a more rapid diffusion through the economy of technological progress embodied in high tech capital. A third issue concerns the tax treatment of some foreign equity investors. A large share of the country’s investment is directly or indirectly financed from offshore, enabling companies to access funds at a lower cost than otherwise, but these flows may be inhibited by the current tax rules. This has led some observers to call for lower corporate tax rates, but given the imputation system, this would introduce other biases between dividend payouts and retained income. It would be better to tackle the problem via a more direct method applied only to foreign investors, but further work is needed to find an appropriate solution.
Congestion charging could help reduce road transport bottlenecks
Investment in upgrading the country’s road network has been a topic of extensive and drawn out debate, especially given congestion in the Auckland and, to a lesser extent, Wellington regions. A cautious approach is warranted because increased infrastructure does not automatically result in increased productivity. If the current mix of charges and taxes were more closely aligned with actual road use and included a congestion charge, it would provide some assurance that additional investments in roads were economically justified. Thus, a more rational set of road pricing arrangements should be established as soon as possible. The Land Transport Management Act (2003) formalises the framework for road infrastructure investment, allowing for public private partnerships and tolls on new roads. The overall thrust of this legislation – to introduce market type mechanisms and draw on private sector expertise – is welcome. But the rules may be unnecessarily strict to allow this to happen in practice. Relaxing these rules should encourage a greater variety of funding and pricing arrangements over time.
Labour markets need to remain flexible to enable firms to adjust quickly to changing economic circumstances
New Zealand has one of the most dynamic and flexible labour markets in the OECD. However, last year’s changes to the Employment Relations and Holidays Acts reduce labour market flexibility and add to labour costs, although it is too early to assess the extent of roll back, especially as some aspects may need to be clarified through the courts. For example, the recent judicial ruling obliging Auckland University to give further consideration to multi employer collective bargaining sets a precedent that may strengthen the scope for unions to press for such agreements. Furthermore, the full implications for job mobility may not become apparent until the economy has faced an economic shock requiring significant adjustment. In the meantime, the situation should be closely monitored, with the government ready to take corrective action if it looks like the legislation is starting to significantly undermine its broader growth objectives. In any case, the potentially damaging effects of increases in employment protection on the job prospects of marginal groups of workers could be mitigated by allowing an initial trial period during which the employer would be exempt from unjustified dismissal procedures. Employers might also be more willing to hire older workers if restrictions on fixed term contracts were eased.
Employment protection
2003
Source: OECD, Employment Outlook (2004)
Innovation policies could be streamlined and made more coherent
The government’s Growth and Innovation Framework highlights the importance attached to strengthening innovation, which plays a key role in expanding the output the country can produce with its available inputs. The overall strategy appears to be well designed, and the innovation rate among firms – as well as it can be measured – is around the EU level, although business R&D expenditures are well below the OECD average. Within the tax system, the depreciation allowances for capital equipment and economic depreciation in general also apply to fixed assets used for R&D, and the gap that existed for short-lived assets may have discouraged such activity at the margin. The more neutral approach announced in the Budget is welcome. The government has chosen to deliver public support for private innovation through a wide range of grants and subsidies: these could be streamlined, better co ordinated and carefully evaluated to improve policy coherence and minimise the risk of “programme clutter”. Innovation policies would also benefit from closer integration with education, immigration and labour market policies to improve the private sector’s capacity to absorb new knowledge. At the same time, closer collaboration between universities and private firms could expedite the diffusion and commercial application of publicly funded R&D and complement the already stronger commercial focus of the Crown Research Institutes.
R&D expenditure
As a percentage of GDP, 2002 or lastest year available (1)
1. 1998 for Austria; 2000 for Australia, Luxembourg and Switzerland; 2001 for Greece, Ireland, Italy, Mexico, Netherlands, New Zealand and Sweden.
Source: OECD Main Science and Technology Indicators, volume 2004/2.
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A printer-friendly Policy Brief (pdf format) can also be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.
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Non-subscribers can purchase the PDF e-book and/or printed book at our Online Bookshop.Government officials can go to OLISnet's Publication Locator.
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For further information please contact the New Zealand Desk at the OECD Economics Department at webmaster@oecd.org. The OECD Secretariat's report was prepared by Deborah Roseveare and Annabelle Mourougane under the supervision of Peter Jarrett.
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