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  Assessment and recommendations
  The New Zealand economy decelerated during 2005, after six years of strong economic growth of around 4% on average per year, and remained sluggish in 2006. But there is, as yet, little sign of spare capacity, and the labour market has so far been resilient. Nevertheless, a series of inter-related imbalances have accumulated in the economy and have started to unwind only very slowly. Strong household income growth and ongoing immigration flows have stimulated house sales and put upward pressure on real estate prices. Banks have met the resulting increases in demand for mortgage finance by borrowing offshore, a process that has been facilitated by ample global liquidity and low risk aversion. While the government has a high saving rate, the household saving rate is significantly negative and household debt has climbed sharply to around 160% of disposable income, a ratio that is higher than in most other OECD countries. The net result is a current account deficit that stood at 9% of GDP at the end of 2006. Despite headline inflation falling sharply with the drop in the oil price, the maintenance of fairly strong domestic demand has limited progress in curbing underlying price pressures.
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  Raising New Zealand's living standards
  This chapter discusses the main challenges facing New Zealand in meeting the goal of raising living standards. In the near term, the economy needs to shift onto a more sustainable growth path and the stabilisation task of the central bank would be made easier if the government were to pursue a more fiscally-neutral stance over 2007 and 2008. Labour utilisation has been impressive but economy-wide trend productivity growth remains modest. The country has accumulated large net foreign liabilities, the current account deficit is at very high levels, and household saving has fallen sharply. Higher household savings could boost future national incomes, while greater accumulation of financial assets would make it easier for individuals to smooth consumption over their lifetimes. The government is currently a significant net saver, but the Treasury’s long-term fiscal projections indicate that adjustments over time to spending and/or taxes will be required to ensure that public finances are sustainable. Against this background, public pensions and other retirement income policies, financial markets and the design of the tax system can each play a key role in helping the country maximise its national income and, thus, its consumption possibilities, over the longer run. As well, several remaining structural reforms still need to be seen through to successful implementation, and policies to tackle climate change effectively still need to be developed.
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  Public pensions and retirement savings
  New Zealand faces the challenge of an ageing population, as well as doubts about whether it can continue relying so heavily on foreigners’ savings in the future. New Zealand Superannuation, the public pensions scheme, is straightforward and well-designed, but the growing share of recipients will lead to rising costs, although the New Zealand Superannuation Fund will help smooth the rise, through partial pre-funding. Future outlays could be pared back by adjusting the indexation of benefit rates and/or by raising the age of eligibility, and an automatic adjustment mechanism to share the fiscal risk associated with life-expectancy increases could also be considered. Households have accumulated relatively few financial assets and relatively few working-age adults are covered by registered superannuation schemes. KiwiSaver, starting in July 2007, is designed to encourage participation in voluntary work-place savings schemes, by automatically enrolling new employees. Employer contributions have been made tax-exempt up to capped limits. This should promote retirement savings although the housing elements of KiwiSaver may be inconsistent with households diversifying their net wealth away from housing. And all registered superannuation schemes that have lock-in of savings comparable to KiwiSaver should be treated equally for tax purposes to avoid substitution effects.
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  Deepening financial markets
  New Zealand’s financial markets are relatively small by OECD standards, and dominated by the banking sector, although there are no obvious regulatory barriers impeding financial market development. The country has accessed international capital markets for many years to finance investment, although in recent years the banks have channelled a significant share of foreign capital inflows into mortgage lending. Domestic bond market liquidity has been hampered by the twin developments of shrinking public debt and the Approved Issuer Levy that discourages domestic corporate bond issues. Fostering the development of deeper bond financial markets would provide a wider range of options for managing risks as well as for raising capital. However, there is little evidence that NZ businesses are systematically constrained by lack of access to finance and the small corporate bond market may partly reflect the small share of large private-sector enterprises. Some improvements could be made to enhance the enviroment for savings instruments. The governance structure for collective investment schemes needs to be strengthened and a more rigorous approach to disclosure requirements for fees and expenses would enhance transparency and comparability. Efforts to improve financial literacy and plans to integrate financial education into the school curriculum are welcome.
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  Toward a more efficient taxation system
  After the radical reforms undertaken in the 1980s, the NZ tax system has long been regarded as one of most efficient within the OECD, and is based on a comprehensive income approach. Looking forward, the country will require a tax regime that helps the economy to continue raising living standards, supports savings and investment and copes with emerging pressures such as increasing geographic mobility of labour and capital. In this context, it will be important to have in place a clear long-term direction for the tax system to guide reforms. There are at least two broad options that are worth considering: adapting the system within a comprehensive income approach or adopting a dual income tax system. Future changes to the tax system need to be consistent with the approach ultimately adopted. In any case, a number of limitations of current tax bases will need to be tackled.
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