KEY POINTS:
The prospect of generous tax cuts in the next few years appears to be fading because of a sharp dip in tax revenue.
Yesterday's sudden deterioration in the Government's accounts has given Finance Minister Michael Cullen a new challenge as he decides how big the personal tax cuts promised for May's election-year Budget will be, how they will be applied and when they will take effect.
Dr Cullen said the tax cuts would go ahead, but hinted that it might be difficult to promise large amounts in later years.
National, which is also promising tax cuts, is likely to face a similar problem if it wins this year's election.
The monthly Crown accounts yesterday revealed a surprise operating deficit of $394 million for the seven months to January 31 - the first deficit since June 1993.
That doesn't mean there is less money for politicians to spend, but there were other worrying signs in the accounts for Dr Cullen and National's number-crunchers.
Tax revenue was $700 million less than expected, and if it stays under forecasts, that will affect what can be spent.
The revenue drop was partly caused by a fall in GST takings as the economy weakened, but it is not clear yet if the decline will continue past January.
Dr Cullen has only one more month of figures to consider before he locks in the Budget and he admitted yesterday that the scenario was an awkward one.
"These are challenging times in that respect," he said.
"We'll be monitoring very closely the February tax revenue."
He said there would be tax cuts in the Budget, although their timing might be affected by what was coming through in the Government accounts.
Dr Cullen has been working on phased tax cuts which will come in over three years, and he appeared to suggest the later years of that plan could be affected.
"These figures today impact upon my thinking in the sense of do we need to be a little bit more careful about the phasing of the package so that we're not locked into a package which could prove difficult to sustain," he said.
Labour will not want to look miserly with the tax cuts it offers in election year, so it could opt to trim back on the cuts it plans for later years.
National yesterday said there was still room for cuts.
"It doesn't affect our plans," said finance spokesman Bill English.
"We've said we will have a credible programme of tax cuts, taking account of economic circumstances.
"Nothing today changes that view."
But adding to the pressures on politicians is concern about whether tax cuts will be inflationary and how they might affect interest rates, which are already hurting many homeowners.
Other spending options are tugging at the Government's purse strings - including Dr Cullen's consideration of a deal to buy back the rail and ferry operations of Toll New Zealand for several hundred million dollars.
Yesterday's Crown accounts slipped into deficit mainly because of weakness in international markets, which dented the portfolios of the New Zealand Superannuation Fund, Accident Compensation Corporation and Earthquake Commission.
A revaluation of ACC's claims liability produced another unexpected hit, worth $1 billion.
Dr Cullen, who has long said the big operating surpluses he has presided over in recent years were not available for spending, could be helped in political terms by the deteriorating accounts.
He has been quick to emphasise the virtues of his "prudent" management of the accounts, and he has been able to suggest that tax cuts National promised in its 2005 election campaign would have made the accounts even worse if they had been implemented.
National is trying to convince voters that Dr Cullen missed an opportunity to cut taxes when surpluses were high.
