Economic Impacts

The tax changes will affect the New Zealand economy through the multitude of decisions made by firms and households. As a result, there is significant uncertainty associated with the impact of such policy changes. The economic forecasts and medium-term projections, which feature in the Economic and Fiscal Update and Fiscal Strategy Report respectively, assume that in aggregate the tax package will increase the level of real GDP by 0.9% over seven years. By the June 2014 quarter, the economic forecasts incorporate a level of real GDP that is 0.4% higher than in the absence of the tax package, and this grows to 0.9% by the 2016/17 projection year.

The impact on the real economy is mainly through the tax package's effect on the labour market. Private sector hours worked are assumed to increase by 0.8% and the rate of labour force participation by 0.5%.[3] No explicit allowance is made for altered incentives to study, undergo training, seek career advancement or to move to or stay in New Zealand. The number of people employed is expected to grow by 174,000 over the forecast period to 2.326 million. The tax package contributes around 10,000 of the rise. The timing of such impacts is influenced by the current cyclically-weak state of the economy and labour market.

In addition to the impact that a change in available labour has on the potential output of an economy, policy changes are likely to also influence the level and composition of capital via their influence on the incentives to invest. On average, firms will pay more tax as the reduction in the company tax rate does not fully offset the impact of higher taxable income owing to the changed depreciation and thin capitalisation rules. As a result, combined company and dividend tax revenue forecasts are slightly higher than they would have been in the absence of the package. The tax package is expected to change the allocation of investment, including a shift from the housing sector to the non-housing sector and the overall impact on market investment from these two channels is assumed to be largely offsetting.

Despite this, investment is expected to be higher in the long run as a result of the tax package owing to the increase in labour and consequently GDP. This arises because of the need to provide the additional workers with capital to use. As a result, firms will increase investment.

The tax package is also likely to influence the composition of real GDP. Consumption is predicted to be higher because income gains from lower taxes are greater in aggregate than the GST increase. Incomes also increase owing to higher labour force participation and more hours worked. Market investment is higher owing to a shift from residential investment. Exports are higher as more investment will be in the tradable sector.

The Budget forecasts assume that the tax package will see house prices around 2% lower than would otherwise have been the case. Recent weakness in the housing market may have reflected people anticipating changes in this Budget.

The Budget forecasts include a much higher CPI inflation track than in the Half Year Update forecasts. This is predominantly owing to the increase in GST, but also the incorporation of the increase in tobacco excise taxes. Inflation is expected to peak at 5.9% in March 2011. This compares with 3.1% in the absence of the tax changes and is the result of a direct GST impact of 2.0%, a tobacco excise impact of 0.5% and a 0.3% impact owing to stronger domestic demand flowing from the tax changes and a small rise in inflation expectations (although these remain well-anchored).