Election year tax policies - what's on offer

Michael Cullen

Tax is a short word but a long argument. It is a political calculation, a fiscal management calculation and an economic calculation. None of those calculations are simple.

Take the politics first.

To National, less tax is better than more. That is an instinct, a tradition and a belief. It is also self-interest: National (and Act) supporters tend to pay more of their income in income tax than other parties' supporters.

But National has a stronger instinct: to be in power. National out of power is like a dog without a bone. So it knows it must not repeat the 1990s political mistake of penny-pinching social services and pensions too much for voters' liking.

Don Brash's personal instinct is different. In 2003 he said government spending increases should be held to the rate of inflation, thereby cutting spending by five percentage points of GDP over a decade - and incidentally hitting health services particularly hard, because health spending is driven not just by inflation but also by expensive new techniques and by the ageing population.

Now Brash insists he won't cut services but will instead fire bureaucrats and get efficiencies. We've heard that before, in the early 1980s and the early 1990s. At some point "efficiencies" become real cuts.

And Brash and John Key are not talking peanuts: Key says he will move $1 billion from spending to tax cuts. Add in $600 million of cuts from petrol tax money now going on general services which Brash promises to dedicate to roads.

Then factor in promises on police and defence that would cost $200-$400 million. That's $2 billion all up - a lot to recoup from firing bureaucrats and killing hip-hop tours.

In fact, Key is promising ground-up reviews of spending to see what can be chopped out, not just chopped back.

Then ask whether Brash and Key will cut (out?) the Working for Families lolly scramble for middle-income families, which is only now reaching household budgets in earnest.

At that point National's tax plans begin to look vulnerable to Labour nitpicking and rocket attacks.

But less vulnerable than Labour thinks. Voters are more open to tax cut promises after six years of Labour spending. Moreover, Act has a bold (if also boldly inflationary) tax cut proposal and New Zealand First and United Future (from different angles) also favour lower taxes.

Labour is thus in a minority - offering stingy, sub-inflation adjustments in 2008 and based on this year, not 1999 or even 2000.

Cullen snorts that real tax cuts for middle-income earners would take big bucks, which would bust the Budget. He doesn't say that he has levied that same cost on taxpayers, partly through bracket creep - people moving into higher tax brackets as their wages have risen, so paying a higher proportion of their income in tax - partly from paid work done by the many people moving off unemployment and partly from the 39c he imposed in April 2000 on income over $60,000.

The personal income tax take has risen 30 per cent from 1999-2000 to this coming year (2005-06). Over the past six years prices have risen 15 per cent and average earnings 20 per cent.

To restore the $38,000 threshold at which the 33c tax rate cuts in to where it was in relation to average earnings six years ago would require it to be lifted to $45,742. Likewise, the $60,000 39c threshold would have to move to $72,224.

Cullen has cut tax for business - not on profits but in allowances for depreciation, relaxed rules for fringe benefit tax, research and development and the like, to make it easier and to encourage investment.

Otherwise, Cullen has been a traditional Labour treasurer, balancing his Budgets on the revenue side. The deep and defining divide between Cullen and Key is that Key would shift the Budget balancing focus to the spending side.

Cullen's rapacity has been in the name of restoring public services. Unfortunately, it has also gone on some undeserving schemes - not many in the totality of government activity but enough to let opposition parties dent the Government's reputation for competence and integrity.

One claim to competence has been "prudent" budgeting: big operating surpluses and low debt give a lot of room to offset the looming economic downturn.

Which in fact Cullen is already doing. The 2005 Budget is stimulatory - adding about 0.7 per cent to GDP in 2005-06, 1.5 per cent in 2006-07 and 1.2 per cent in 2007-08. But stimulatory Budgets are also inflationary - and even before this year's Budget, inflation was heading through the top of the 1-3 per cent band within which the Reserve Bank must hold it.

Hence the OECD's warning this week that spending risks higher interest rates. Take heed for your mortgage.

Cullen used the OECD report to claim National could not deliver big tax cuts without a tough interest rate response. Key parries this by promising to phase in the tax cuts over several terms - a trickle, not the pre-Christmas flood some of Brash's recent statements could be misheard as promising. The programme would not likely get much momentum before 2006-07.

Why can't Brash and Key just spend Cullen's huge $6.7 billion operating surplus as Act says it would? In part because most of it goes on the superannuation fund, student loans, capital expenditure (though some of that could be borrowed, Key says) and investments.

More important, the operating surplus is in part "cyclical", that is, driven by high employment and high profits at the top of the economic cycle, and is so temporary. Not all of the $6.7 billion is "structural", that is, sure to endure economic ups and downs. A slowdown that cuts jobs and profits would also cut the surplus. A recession would whiplash the surplus into a deficit.

Cullen and Clark have been almost paranoid in their determination to avoid a structural deterioration by overspending or undertaxing. So they have insisted increases in spending can be met for several years.

Act reckons that misses an important economic point. It claims, and Brash and Key agree, that cutting taxes would leave more for private investment, stimulate enterprise and so attract people to stay rather than emigrate - and so, in time, boost economic growth and incomes and the tax take, which would make back the original giveaway.

Act argues - with support from many economists - that low-tax countries grow faster than high-tax countries.

The bigger the Government, the less room there is for private enterprise, which generates most of the wealth.

Not always, retorts Cullen. Sweden has generally done well on higher taxes than this country's. Many of the low-tax countries with faster growth are coming off a lower wealth and productivity base than this country's, which gives more scope for fast growth. There is no iron law, he says.

Moreover, he says, tax cuts boost consumer spending, which pushes up inflation. Inflation is bad for investment and so bad for growth.

So how does a voter decide? Take the money and run?

Try to weigh the benefits to oneself from health and education and other government activities against the immediate gain from a tax cut?

Set personal gain and loss within the wider context of how well the economy will do on the presumption that the better the economy does the better the voter will do?

There is no simple tax calculation. Labour won the 1957 election with a 100 tax rebate cash bribe, only to claw it back again six months later in tobacco, alcohol and petrol taxes. It lost the next election.

But those were different times and that was old Labour.