National's tax policy will fire up election campaign

When National finally unveils its proposed tax cuts, the election campaign noise will get several decibels louder.

Supporters of cuts say there's plenty of room in the Government's accounts, even without chopping core services.

They point to a $7.5 billion surplus, "wasteful" and ever-increasing spending, and a lack of borrowing for things that could legitimately be funded by borrowing - such as roads.

Labour will fight back by bringing the fear-factor into the argument.

Finance Minister Michael Cullen is adamant that tax cuts will damage basic services such as pensions, health and education.

Last week he went on the offensive over National's spending promises in areas such as law and order, defence and prisons, claiming they would cost about $5.5 billion a year - a figure that didn't even include the cost of tax cuts.

He argued it would be impossible to deliver significant tax cuts without compromising spending on health, education, superannuation and law and order - and without provoking the Reserve Bank to raise interest rates.

Dr Cullen said no tax cuts were offered in the Budget - apart from a small increase in income tax thresholds in 2008 - because Labour's priority was to continue investment in social services.

Labour's flagship Working for Families tax credit and income assistance package would, at maturity, deliver an annual increase of around $100 a week to families earning between $25,000 and $45,000.

Labour insists this targeted form of tax cut is a much cheaper way of helping the people who need it rather than across-the-board tax cuts, which are not only expensive but give most of the money to richer people.

"Only by targeting is it possible to deliver those sorts of gains to people on low to middle incomes," said Dr Cullen. "You simply cannot do it through changes to the tax scale."

A tax cut delivering anything significant to ordinary workers and business people would be extremely expensive. He pointed out that each cent knocked off the 39c rate would cost $115 million; off the 33c rate, $95 million; off the 21c rate, $325 million; and off the 15c rate, $215 million.

Australia recently had tax cuts estimated to cost A$21.7 billion in lost revenue over four years. For that, taxpayers earning up to A$58,000 ($64,500) got A$6 ($6.70) a week more while those on A$125,000 ($139,000) or more got an extra A$87 ($97).

Dr Cullen said a favourite mantra of tax cut advocates was that the big surplus meant cuts were affordable. But he said the cost was ongoing, not one-off, so could not be financed from a single year's surplus no matter how strong it was.

He also cited a slowing economy and the impact it would have on the Government's accounts, forecast to go from surplus to average deficits of $1.9 billion over the next three years.

Tax cut advocates also ignored the fiscal impact of the ageing population, Dr Cullen said.

The large baby boomer generation was now at the peak of its earning power, but as baby boomers started retiring the ratios between tax revenue and Government spending would reverse.

So it made sense to pay off debt now, build up infrastructure and put money aside to smooth superannuation costs through the burgeoning New Zealand Superannuation Fund.

The OECD made similar points in a recent report, saying New Zealand would not be immune to the spending pressures of an ageing population and difficulties in constraining healthcare costs.

"Against this backdrop, it would be regrettable if spending or tax initiatives were implemented that significantly weakened the long-term fiscal outlook," the report said.

Dr Cullen said another popular misconception was that New Zealand was a highly taxed country.

He pointed out it actually ranked 12th lowest in the 30-member OECD on total tax revenue as a proportion of gross domestic product (GDP), showing there were many countries that were far more taxing than New Zealand.

Unions side with Labour on tax cuts, and have become increasingly vocal in recent months as they have seen National's message gain traction with voters.

The Public Service Association, representing public servants, recently released a report by Peter Harris, an economist and former adviser in Dr Cullen's office, debunking the "myth" of an exploding public sector.

The report said that by any sensible comparison there had been no spending blowout, pointing out that in 1999 the relative size of the state was above the OECD average - and by 2004 it was significantly below.

Council of Trade Unions president Ross Wilson said the unions' experience in the 1990s was that tax cuts meant chopping spending in "quite crucial areas".

As an example of what would come, National released the first phase of its tax plan a fortnight ago - tax deductions for preschool childcare costs, estimated to cost $160 million a year.

But another programme - Labour's $52 million plan for 20 free hours of childcare a week for all 3 and 4-year-olds, starting in 2007 - would be for the axe to help pay for it.

"That illustrates that for every tax cut, there's a price to pay in a funded Government programme," Mr Wilson said.

Economist Brian Easton said tax cuts would be inflationary and result in higher interest rates, but only if the Government failed to offset the tax cuts with spending cuts and borrowed instead.

He added that there appeared to be little waste in the public sector and it was difficult to get at in any case, meaning National would have to cut core Government spending.

"But that might be what New Zealanders want," he said, "and that's what we should be voting on."