Brian Fallow: Those babies that keep Cullen awake at night

This afternoon Finance Minister Michael Cullen will stand up in Parliament and with a straight face announce something like a $10 billion Budget surplus, acknowledge that the economy has slowed more than expected, but insist there is still no scope for income tax cuts.

Then the Leader of the Opposition, Don Brash, will lament the continuing haemorrhage of Kiwis to Australia, whose Government keeps lightening the tax burden, and impute a causal connection between those two things.

The two men are haunted by different nightmares.

Cullen's takes place in a retirement home. It is the prospect of the rock 'n' roll generation becoming the rocking-chair generation, an army of geriatric babyboomers burdening the dwindling ranks of their taxpaying children and grandchildren.

Brash's is set in an airport departure lounge. It is the giant sucking sound of the brain, or at least the skill, drain as people respond to the income gap which has opened up between New Zealand and its former peers across the Tasman and further afield.

Cullen will stress that this year's surplus has been swollen by particularly good investment performance on the part of the national and public sector superannuation funds and ACC, and by Meridian Energy's $600 million profit from its foray into Australia.

He will warn that it will be the last of the bumper fiscal surpluses for the foreseeable future, as the economic slowdown bites into corporate profits and job creation.

He will emphasise that capital spending, the retained earnings of state-owned enterprises, loans to students and contributions to the New Zealand Superannuation Fund all have to come out of the operating surplus. For the next few years, the Government will be running cash deficits and increasing its borrowing.

He will hail the fact that we have joined the select group of five OECD countries whose net government debt has fallen below zero (provided you count the assets of the NZ Superannuation Fund).

Cullen, along with his National predecessor, Sir William Birch, is entitled to claim credit for hauling it down.

It leaves the Government accounts in far better shape to cope with the fiscal impact of an ageing population than most developed countries.

They, on average, have net government debt of 46 per cent of GDP and will have to devote a chunk of their future taxes to servicing that debt even as they face higher health and pension costs.

But all this fiscal prudence comes at a cost, an opportunity cost, which is whatever taxpayers would have done with that money instead.

A paper this week by former National Party researcher Phil Rennie, now an analyst for the Centre for Independent Studies, a Sydney-based think tank, reminds us we are now paying about half as much again in tax as we were in 2000. Inflation explains less than half of that increase.

In 2003, the most recent year for which comparable figures are available, central and local government taxes in New Zealand were 34.9 per cent of GDP. If other countries are weighted for the size of their economies, the OECD average is 31 per cent.

We are less heavily taxed than the Europeans (just under 39 per cent) but more heavily than other Anglo economies (28.7 per cent) including Australia (31.6 per cent).

Since 2003, there have been income-tax cuts and threshold adjustments across the Tasman.

The upshot is that anyone earning less than $180,000 is likely to be paying less personal income tax in Australia than here from July this year, Rennie calculates. That includes Australia's Medicare levy and New Zealand's ACC earners levy.

Australia's income tax scale is more progressive than ours. It has a top rate of 45c in the dollar at a $150,000 threshold and the second highest rate of 40c starts at $75,000.

New Zealand's top rate of 39c kicks in at $60,000.

For Australians on more modest incomes, the tax take is significantly diluted by the fact that the first $6000 of income is not taxed.

And there is a broad band in the middle, between $25,000 and $75,000, taxed at 30c in the dollar. By contrast, someone on the average wage in New Zealand would face a marginal tax rate of 33c as well as missing out on the dilution effect of a tax-free zone at the bottom.

Overall, the gap between Australian and New Zealand income tax levels narrows as incomes rise but it is never much more than 3 percentage points.

All of this is for single taxpayers and ignores the complications arising from family tax credits like the Working for Families scheme.

And, of course, the Australians have a capital gains tax, state payroll taxes, stamp duty and other imposts we are free of.

Even so, their overall tax burden is lower relative to GDP.

More to the point, their GDP per capita is about 30 per cent higher.

That flows through into higher pretax incomes, which accounts for much more of the difference in take-home pay than differences in the income tax scales do.

So long as that income disparity exists within what is a common labour market, we can expect to be a net exporter of people to Australia.

Cullen contends, plausibly, that tax rates are not a major factor in people's decision to move to Australia, noting there have been big swings in the net migration flows while the relative tax position barely changed.

But tax policy still has a significant signalling effect.

It is a binary thing: a Government is either committed to cutting taxes or it is not. Ours is not. Australia's is. Theirs is the better look.

Cullen makes the obvious point that the money for tax cuts would have to come from somewhere.

To cut back on social spending would just create a different set of reasons for people to prefer Australia.

To cut taxes but not spending would take us down the slippery slope of ramping up debt-to-GDP levels.

Those babyboomers again.

Australia's higher GDP per head is not because they are smarter or harder working than we are. Nor can it just be put down to an island continent's worth of mineral wealth or that economies of scale are easier to achieve in a market of 20 million people than in one of four million.

It reflects higher productivity levels associated with much higher levels of physical capital - plant and equipment - per worker.

Hopefully the forthcoming business tax overhaul will increase incentives for businesses to invest and raise productivity. That is its avowed aim.

But it is also a challenge for businesses to muster the confidence to make those investments.

And if the benefits are to be fully captured by New Zealanders, we have to provide the capital. Households spending $1.14 for every $1 of income is not an encouraging start.

Cullen's seventh Budget will make the ritual rhetorical nod towards "economic transformation".

But will it mark an historic turning point in reversing these trends? Don't hold your breath.