Brian Fallow: Call for big tax cuts ignores current account blowout

Tax cuts are coming, but they are likely to prove more modest than the bumper surplus the Government reported yesterday might suggest.

Whatever the economic case for continued fiscal prudence - and Michael Cullen was still pressing that case yesterday - no Government can expect to report an operating surplus of $11.5 billion, or 7.3 per cent of GDP, without expecting hard-pressed taxpayers to start licking their lips at the prospects of some relief.

But the affordability of tax cuts cannot be judged just by looking within the four corners of the Government's accounts, as he stressed repeatedly yesterday.

It has to be seen in the context of the truly parlous state of New Zealand's external accounts. We are running a current account deficit of $15 billion, nearly 10 per cent of GDP, and we are up to our collective chin in debt to the rest of the world.

Which means that no Finance Minister can afford to disregard the warnings of the credit-rating agencies that we can only expect to keep getting away with that because it is all private-sector borrowing and the Government's accounts are really, really good.

Against that background and at a time of still strong inflationary pressure, a significant fiscal easing on top of what is already committed, Cullen insists, would run the risk of higher interest rates, either as a result of a credit-rating downgrade or by compelling the Reserve Bank to tighten monetary policy.

The inflation argument will lose potency as the downturn drags on.

And no one really knows how much spillage in the fiscal position might trigger a downgrade.

But one reason for caution is that in recent years forecasting errors have resulted in a string of positive surprises. Unless there is some systematic upside bias, the law of averages suggests we are overdue for a string of negative surprises, with less revenue and higher expenses than Treasury had forecast.

The company tax take has yet to show the effects of the pressure profits are clearly already under. The tax base generally is being swollen by 4 per cent inflation but so - with a lag - will be the Government's expenses.

And there is a mounting bill for tax changes already announced or in the pipeline: tax breaks for employers' contributions to workplace savings; the portfolio investment regime; and the prospect of further concessions when the controlled foreign company rules are reviewed.

Bumper surplus? Now you see it ... now you don't.