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Pre-Election Economic and Fiscal Update 2008

Economic and Tax Outlook (continued)

Domestic Imbalances Lead to Protracted Downturn

Domestic demand is expected to start to recover in the final quarter of 2008 with a modest pick-up in consumption as a result of the first instalment of the tax cuts on 1 October. In the following year, a number of the negative influences will continue to affect the economy, making the downturn protracted and the recovery only gradual. Eventually these negative influences will diminish and growth in domestic demand will begin to recover.

Tax cuts will boost household disposable incomes …

Figure 1.6 - Private consumption
Figure 1.6 - Private consumption.
Source:  Statistics New Zealand, The Treasury

The October tax cuts will boost the disposable income of the average tax-payer by $16 per week. In aggregate, we assume that a large proportion of this fiscal stimulus will be spent, given the pressures currently faced by households. Most of the impact will be felt in the December quarter, but with a small amount anticipated in the September quarter. Although prices for food and fuel are expected to ease slightly as a result of weaker world growth, their rapid rise represents a shock to household budgets which will be relieved only slowly, constraining growth in consumption for some time. As a result, growth in private consumption will be lower than previously forecast (Figure 1.6).

… but firms are still under pressure …

Higher global commodity prices, especially for oil, are also adversely affecting firms' costs. Price pressures for a range of inputs are expected to dissipate only slowly and may be offset by the expected fall in the exchange rate which will also make imported capital items more expensive. These factors will mean that firms' margins remain under pressure and that profitability is low, constraining market investment. There are some supportive factors for business investment in the near term with the reduction in the company tax rate on 1 April 2008 increasing after-tax profitability and lowering the threshold for projects; in addition, ongoing dairy conversions and capacity constraints in some parts of the economy will also support investment expenditure. After a period of weak quarterly growth throughout 2009, market investment is forecast to pick up from 2010.

… leading to lower corporate tax revenue

With margins under pressure and profitability low, underlying corporate income tax is forecast to decline by 3% in the 2009 June year. Factoring in the company tax rate cut brings the total drop in corporate tax revenue to around 9% (close to 15% on receipts). In a period of low profitability, there are likely to be a significant number of firms making losses. Tax losses can be offset against profits when a firm returns to profitability and so have a small, but noticeable, lagged effect on corporate taxes. Thus growth in corporate tax is expected to be negligible in 2010, as tax losses offset profits, but is then forecast to exceed 5% per annum from 2011 onwards once those losses work their way out of the tax system.

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