KEY POINTS:
Suppose the Government reckoned it could afford around $1.5 billion worth of tax cuts. What could it do with that sort of money?
The possible permutations are endless but here are three possibilities:
Keep tax rates the same but raise the income thresholds at which they kick in.
As wages and salaries rise - often at little more than the rate of inflation - more and more people are pushed into higher tax brackets. It is called fiscal drag or bracket creep.
It has meant that someone on the average wage is now in the 33c in the dollar tax bracket, which used to be the top of the scale, and the 39c rate, which only applied to 6 per cent of taxpayers when the Government introduced it in 2000, now catches 14 per cent.
If the threshold for the 33c rate was raised from $38,000 to $50,000, the revenue foregone would be about $1.5 billion.
If it also raised the threshold for the 39c rate from $60,000 to $90,000 that would cost another $600 million.
But the Treasury estimates that for every $1 it loses in income tax it gets 17.3c back in extra GST and from other parts of the tax system.
So the net cost in revenue would be about $1.7 billion. It would benefit nearly 900,000 peope.
Alternatively it could drop the top personal tax rate back to 30c, benefitting those in the top and middle income brackets.
Economists argue that it is the marginal tax rate - amount of tax people pay on the next dollar they earn - that makes the difference to how much incentive they have to go out and earn it.
And the top personal rate would then line up with the rate paid by companies (from April next year) and certain savings vehicles, eliminating the distortions and tax planning that arise from having differences among those rates.
Deloittes tax partner Thomas Pippos puts the cost of cutting tthe top rate to 30c at $1.7 billion.
At current rates someone earning $50,000 pays $11,400 in tax (ignoring any tax credits from Working for Families and other complications). An Australian on $50,000 pays $9600.
Lowering the 33c rate to 30c would only save the Kiwi taxpayer on $50,000 about $360 a year and do little to close the trans-Tasman gap.
Someone on $100,000 would be $4300 a year better off and in line with his Australian counterpart in terms of the total bite income tax takes from his salary.
Just over 1 million taxpayers would benefit. But the lion's share of the benefit would go to those on higher incomes and one of the tests for tax cuts Finance Minister Michael Cullen outlined this week is that they should not increase inequalities in income.
Another is that they take into account inflationary pressures.
So he might be attracted by a cut in GST instead of a change to the income tax scales.
People on lower incomes tend to spend a higher proportion of their take home pay. A reduction in the GST rate from 12.5 per cent to 11 per cent would cost about $1.5 billion. Every consumer would benefit.
The effects on inflation would be complex and not all downward. But in addition to any initial effect in lowering consumer prices it might at the margin reduce inflation expectations and wage demands - temporary relief but timely when the Reserve Bank expects inflation to be around 3 per cent over the next couple of years.
The risk would be that a GST cut would be pocketed by retailers and tradespeople and not reach consumers. And Dr Cullen might think that a measure that encouraged spending and consumption rather than saving and investment is the last thing the economy needs.
