Six years ago in opinion polls prior to the election, it was overwhelming. Voters would rather not have tax cuts, preferring instead to see higher government spending on health, education and benefits going to those in need. Helen Clark’s Labour government has delivered on that commitment and government spending has grown apace of rapidly growing GDP during her government’s six year term.
The major issue for the 2005 election has become tax cuts, how large they can be and who gets what. Correspondingly both major parties have stumped up with their bids to capture your vote. To assess the merits of each, rational voters I presume will compare the offerings from two perspectives. Firstly the personal hip-pocket impact – how much do I get? Secondly which package best promotes the well-being of New Zealanders overall.
On the first count voters need to look beyond the direct impact on their wallets and take account of second round effects from tax cut packages of the magnitude of those offered. These effects include what the package might do to the economy as a whole and them personally as a consequence.
On this score both offerings are expansionary – we’re looking at the budget surplus being reduced over the next 3 years from 7% of GDP to around 2.5% of GDP. Such a reduction is a significant reduction of government savings, in an economy already at the top of the borrowing league of the OECD club. Remember our economy is already at full capacity, we are out of labour and we have inflation at the top of the permitted range. Now if the private sector is set to undergo a significant slowdown or even contraction, then an expansion of government won’t impose a strain on those macroeconomic indicators of health. But if the private sector doesn’t acquiesce then adding government spending fuel to the fire of an economy already running hot, will have exciting results.
So what’s most likely? Over recent weeks the consensus view of world growth has lifted. The forces of globalisation and the impact of cheaper production from China and India are increasingly seen as keeping world inflation in check. Combined with continued excess capacity in the world’s largest economy, this portends ongoing global growth without it needing to be checked by aggressive central bank lifting of interest rates. For New Zealand the consequences of this development are clear – oil prices have lifted again as traders realise there is less of a case now for a slowdown in Chinese demand, and secondly the New Zealand dollar, reflecting the prospective fortunes of this commodity-trading economy, has started to rise again. The natural hedge we have against higher oil prices – the world prices of our own commodities – is working well. So for our exporting sector at least the prospects have improved – better prices, higher incomes enabling it to spend more.
It’s a little different for the domestic side of our economy. The elixir of recent growth in this sector has been high net immigration and falling interest rates. Both have reversed of late, spelling the economic slowdown that is consensus. But how does this look if the next government tosses large tax cuts about? Obviously it’s a balance – will the extent of government largesse provide the offset? A surplus reduction equivalent to 4.5% of GDP is not trivial and it would be reasonable to expect it to have a major impact. This taken together with the improved prospects for exports adds up to a very short, if any slowdown in New Zealand’s growth – once more.
But there’s a problem. Our economy is at full capacity now so there is very little leeway for the Reserve Bank to allow the economy to run hotter. If it faces excited spenders letting loose in anticipation of promised tax cuts it will have no choice (remember the pre-GST booms) but to raise interest rates sooner rather than after the event.
This risk is slightly higher with National’s package as announced but then National does have a card up its sleeve – it could declare on “opening the books” that things are worse than it thought when it didn’t have access to all the information, and it will have to phase its tax cuts in more slowly.
The second consideration for voters apart then from personal hip pocket impact, is whose tax package is better for New Zealand? To assess this each offering should be benchmarked against the best-practice tax regime there is. That regime would be one that provided a guaranteed minimum family income and thereafter has a flat income tax regime, a GST and a comprehensive (rather than Cullen’s proposed selective) capital gains tax. With such a wide tax base the average tax rate (income, GST and capital gains) can be very low. The single rate of income tax, GST and capital gains tax could all be 15%.
Under such a regime the income redistribution objective of egalitarian New Zealand would be met through the decision on what the guaranteed minimum family income should be, and under that regime expect many families to pay no tax or negative tax just as they do now. What this benchmark or best-practice regime promotes is simplicity, neutrality and lowest effective tax rates – all desirable of a tax regime. What it does not promote is what I’d call the tax policies of envy. That is a progressive income tax regime imposed for no other reason than that some people are deemed to earn too much and should be punished for it. Of course people on higher income would pay more tax but not at a higher rate. Under this best practice tax regime the poor are subsidised to the extent of the guaranteed minimum family income, thereafter take-home pay is determined by market forces. Progressive tax scales aren’t permitted to interfere with people’s determination to procure more income for themselves by working harder, longer or smarter.
So against this benchmark how do the tax offerings compare? Neither look great but National wins – its personal income tax regime isn’t as progressive as Labour’s although it does still impose very steep marginal tax rates (poverty traps) on middle income families exposed to abatement of their benefits. Labour unfortunately has some middle income families losing 60 cents in every additional dollar they earn, to tax.
For the voter seriously considering then the efficacy of the tax packages for New Zealand overall, the question they have to decide on is actually quite simple. People who earn more than you pay more tax. But do you think that they should pay proportionally more tax and if so why? If the answer is simply because you’re jealous and feel they should be punished, vote Labour. Don’t however delude yourself that we need a progressive income tax schedule to finance the welfare of those who earn less than you and qualify for income supplements or benefits. We don’t. National’s package is closer to one which retains progressivity only to the extent it’s needed to fund minimum family incomes.
Good luck.
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