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Budget 2006 Home Page Half Year Economic & Fiscal Update 2006

Economic Outlook

… and the labour market recovers

As growth in the economy lifts, employment is also forecast to rise, increasing 1.3% and 1.5% in 2010 and 2011 respectively. After declining during the period of weak growth, labour force participation is forecast to rise while the unemployment rate falls back to 4.3%, our assessment of the long-run structural rate of unemployment.

Corporate Taxes

Corporate taxes have been a significant source of upside surprises in recent years. The future pattern of corporate taxes poses a risk to the fiscal outlook. This box discusses the drivers of the corporate tax forecasts.

The strong economic performance of recent years has contributed to strong growth in corporate profits. Profit growth has been relatively broad-based across most of the economy for the past several years. However, more recently the pattern of profit growth has altered, with the continued strength in the financial sector masking softer performance in other sectors. The growth in tax receipts from other sectors is lower than in the past, indicative of falling profits in other sectors of the economy, with many businesses facing rising costs and falling margins. Meanwhile, a strong housing market and high returns in financial markets have boosted profits in the finance sector. It is likely the strong performance of the financial sector is masking softer performance in other sectors.

With profits forecast to decline in 2007, the forecasts incorporate some build-up in tax losses. This mirrors the 1998 and 2002 tax years, the last two occasions when net taxable profits declined. This build-up in losses is based on a judgement that a period of falling growth in profits will be associated with some firms recording losses. Falling margins are likely to affect firms in some sectors, with exporters particularly at risk as their revenues are directly affected by movements in the exchange rate.

The accumulation of tax losses affects the growth in tax in subsequent years as firms utilise these losses. As a result, once profit growth increases in the year to March 2008, and the number of firms recording losses falls, growth in corporate tax revenue is suppressed by firms utilising the previous build-up in losses to effectively reduce their taxable income. This is forecast to result in a fall in corporate taxes of 13.3% in the 2006/07 year, a small increase of 0.9% in the 2007/08 year then a rebound to growth to 7.0% in the 2008/09 year, with profit growth forecast to rebound strongly.

Figure 1.16 – Growth of corporate tax
Figure 1.16 - Growth of corporate tax
Sources: Statistics New Zealand, The Treasury

The build-up of losses is an important judgement in the forecasts. If a larger number of firms record losses, then tax revenue will grow more slowly as these losses are utilised. A smaller accumulation of losses would be associated with faster growth in tax revenue from 2008/09. By the time forecasts are finalised for the 2007 Budget Update there will be more information available that will provide an indicator of the extent to which losses are building up.

The outlook for corporate taxes is a significant driver of the differences between the revenue forecasts underlying the Half Year Update and the tax revenue forecasts prepared by the Inland Revenue Department (IRD). The IRD forecasts do not include the forecast accumulation of tax losses, with corporate taxes expected to grow from 2008 concurrent with the expected lift in profit growth. As a result, IRD’s forecasts of corporate taxes are higher than the forecasts in the Half Year Update.

Fiscal Forecasts – Finalisation Dates and Key Assumptions

Finalisation Dates
Economic outlook (refer Chapter 1) 15 November
Tax revenue forecasts 21 November
Fiscal forecasts 8 December
Government decisions and circumstances 8 December
Actual asset revaluations 30 September
Foreign exchange rates 30 September
Specific fiscal risks (refer Chapter 4) 8 December
Contingent liabilities and commitments (refer Chapter 4) 31 October

Key Assumptions

The fiscal forecasts have been prepared in accordance with the Public Finance Act 1989. They are based on the Crown’s accounting policies and assumptions (refer page 108 of the GAAP tables). As with all assumptions, there is a degree of uncertainty surrounding them. This uncertainty increases as the forecast horizon extends. A summary of the key economic assumptions that are particularly relevant to the fiscal forecasts is provided below (on a June-year-end basis to align with the Crown’s balance date of 30 June):

June years 2006/07 2007/08 2008/09 2009/10 2010/11
Real GDP (P) (ann avg % chg) 1.5 2.0 2.6 3.2 3.1 3.0
Nominal GDP (E) ($m) 160,013 162,667 170,633 179,817 188,764 198,068
CPI (annual % change) 3.3 1.9 2.7 1.9 2.0 2.0
Govt 10-year bonds (qty avg %) 5.9 6.0 6.0 6.0 6.0 6.0
90-day bill rate (qty avg %) 6.8 7.5 5.9 6.0 6.1 6.0
Unemployment rate ((HLFS) basis ann avg %) 3.8 4.0 4.7 4.6 4.5 4.3
Full-time equivalent employment (ann avg % change) 1.8 0.9 0 0.9 1.4 1.5
Current account (% of GDP) -8.4 -9.3 -8.3 -6.5 -6.2 -6.3

Source: The Treasury

New Zealand Superannuation (NZS) Fund

The contribution to the NZS Fund for the year ending 30 June 2007 is $2.049 billion. The contribution to the NZS Fund is calculated over a 40-year rolling horizon to ensure that superannuation entitlements over the next 40 years can be met if the contribution rate were to be held constant at that level. The Government is making the required minimum annual contribution for 2006/07 as calculated by the formula set out in the NZS Act.

$ billion (June year end) 2005 2006 2007 2008 2009 2010 2011
Required contribution 2.107 2.337 2.049 2.133 2.326 2.459 2.576
Actual/Budgeted contribution 2.107 2.337 2.049 2.133 2.326 2.459 2.576

Source: The Treasury

The underlying assumptions in calculating the contributions for 2007 are the nominal GDP series to 2047, the NZS expense series to 2047 and the expected long-term, net after-tax annual return of the NZS Fund (6.1%) (6.1% Budget Update). The forecast rate of return is based on the Treasury’s assumptions for the rate of return on financial portfolios of Crown financial institutions. The Treasury website contains further information on the NZS Fund, as well as a copy of the NZS Fund model.

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