John Armstrong: Tax cut move lifts the stakes

Tax cuts in the good times; even bigger tax cuts in the not so good times. The minority National Government would seem to be indulging in the political equivalent of alchemy.

Exactly who and how many really stand to benefit big-time from the proposed reduction in tax rates - and how much spin-off there is for National in the process - are the big questions.

By any economic measure, the master plan released by John Key this week for galvanising New Zealand's productive sectors can be criticised for failing to be really bold.

That charge cannot be levelled at the personal tax cuts flagged in the Prime Minister's economic statement which was tabled in Parliament on Tuesday.

The apparent intention to slash income tax rates at the top end is no real surprise. It has been drowned out by the hullabaloo over the likely spike in GST. But it is still audacious stuff. It is also very risky stuff.

The exact rate changes will be unveiled in the Budget in late May. But if the Cabinet holds its nerve until then, the indications are that at the upper income end of the scale the cuts could be significantly larger than the three-stage programme of reductions promised by National in its 2008 election manifesto.

The second and third tranches of that programme were deferred indefinitely in last year's Budget following the recession-driven slump in the tax take.

At that time, Finance Minister Bill English dismissed any likelihood of tax cuts this side of next year's election unless there was a "miraculous" change in the Government accounts.

The accounts have since shown only minor improvement. That does not seem to have stopped a miracle from occurring, however. Thanks to some softening up of the public by the Government-established tax working group and a flip-flop on Key's and English's part, a rise in GST is now certain to happen. Combined with revenue-grabbing changes to tax rules in the housing rental market, National's love affair with tax cuts is back on.

If Key, who is comfortably positioned to win in 2011, can pull this one off, National should coast home. This is a huge gamble on his part, however.

The hike in GST from 12.5 to 15 per cent is not going to be popular at a time when many people feel materially worse off through the combination of stagnant wage levels and prices across-the-board seemingly being on a never-ending upward trajectory.

Key has promised any rise in GST will not happen unless the "vast bulk" of New Zealanders are better off through being compensated for the rise in GST by increases to benefits and national superannuation, adjustments to Working for Families entitlements and reductions in income tax.

The tax cut genie is now well and truly out of the bottle, however. Public expectations have been raised at the top end where National's core support resides. While those on lower incomes will be compensated, those on higher ones look like being rewarded.

Hints from the Beehive suggest the Government intends cutting the top 38 and 33 per cent rates to 30 per cent, alongside much smaller reductions in the 21 and 12.5 per cent rates on the bottom and other lower income bands.

This is more radical than the tax reduction programme put on hold last year. Under that scenario, the 38 per cent rate paid on income earned over $70,000 would have been eased by only a whisker to 37 per cent. Those earning $100,000 a year would have got just over $17 extra in the hand each week after April next year.

They now stand to gain an additional $77 a week. The impact of the extra GST still leaves them with $55 in the hand. Those on even higher incomes stand to get progressively more than that. These increases are in stark contrast to what those lower down the chain would get.

Someone on $70,000 would receive about $21 more in net terms. Someone on the average income of around $50,000 will get an extra $12 - about the same as they would have got under National's earlier plan. Those on $30,000 will get barely $3 more.

The question is whether National is putting too many eggs into too few baskets. Less than 10 per cent of taxpayers earn $70,000-plus, whereas those earning between $30,000 and $70,000 comprise 33 per cent of all potential taxpayers - and voters. They can be the critical difference between winning and losing an election.

Much will hinge on whether they are satisfied the tax cuts meet the Prime Minister's three criteria of fairness, equity and sustainability.

Key's concept of fairness, however, seems to apply only horizontally - ensuring those on similar incomes pay about the same amount of tax rather than avoiding it through write-offs in the rental market.

As for equity, Labour's Phil Goff probably cannot believe his luck. Key and English have gifted him and his finance spokesman David Cunliffe the opportunity to fiercely differentiate their party from National. It puts Labour on the side of the many who look like not gaining very much, while National is seen as aligning itself with the few who will gain a lot.

Labour is already defining the debate as tax cuts for the rich paid for by the poor.

There is grumbling in the Beehive that this is simplistic sloganeering. But the simple works in politics.

To make things even clearer, Labour will highlight that cutting just the 38 and 33 per cent rates would mean an extra $500 a week for the Prime Minister but less than a dollar for someone on the average wage of close to $49,000.

That won't happen. There will be some cut to lower rates - not least to ensure the Maori Party does not walk away from its support agreement with National.

Even minor cuts in rates at the bottom end of the income scale are hideously expensive, however.

National's room to move rates at the bottom end is limited therefore. Labour can therefore quietly unleash that most dangerous of beasts - the politics of envy.

Labour, of course, will be under pressure to say whether it would keep GST at 15 per cent or lower it should it win in 2011. Cunliffe refuses to say.

Labour will instead likely call for National to adjust tax thresholds upwards rather than bring rates down - an approach which would deliver more to those in the middle.

Those at the top would still get more than those in the middle, but less than National looks like handing them.

As for sustainability, the kind of cuts in rates being suggested may stick simply because it is politically difficult to raise rates once they have been lowered.

Key's big problem is equity. In that regard, National will be polling frantically to gauge the public mood as the debate heats up.

Nothing is yet cast in stone. Key for one will be surely intent on retaining flexibility for as long as possible as work on the Budget nears completion.