Budget from the corner
Willis and Luxon will fight on through the tax cuts debate
I’m optimistic about the upcoming Budget — the first from our new Finance Minister Nicola Willis. Based on her pre-Budget speech on Thursday and other announcements so far (school lunches, Pharmac, social investment, etc) I’m expecting a considered and well-balanced approach on May 30.
Willis argues “it won’t be a big-spending Budget . . . but nor is it the time for an austerity Budget of the sort suggested by a few commentators seemingly enthusiastic to see the mistakes of history repeated”.
That presumably references attacks coming at the Government from those on the political right who believe this country urgently needs a 1991-style overhaul. Willis has pushed back and I’m glad. She appears to be treading a delicate Budget path through the middle of the treacherous political divide. That’s my kind of Budget . . . or it would be apart from what I think are ill-timed tax cuts.
I know I need to get over this issue as it’s clear that the Government is not for turning on it.
But I’m on record as being in the camp that thinks we can’t afford tax cuts right now. I’ve written that they effectively force the Government to address the difficult fiscal position with one hand tied behind its back.
The “borrowing for tax cuts” debate is an elephant in the room, threatening to trample other Budget coverage, so I’m going to address it again now and let it quietly stomp off to the corner.
National promised voters tax cuts and that’s what they are going to deliver.
I don’t even disagree that the tax brackets need adjusting. As Willis points out in her speech, “New Zealanders have not seen any changes to personal income rates and thresholds for 14 years, despite prices being 40 per cent higher now than they were in 2010.”
You could argue that if you keep waiting for the perfect time to adjust them they’ll never happen. It would bother me less if the Government just said that.
But the argument has been that because they have been offset against cost savings, they don’t involve more borrowing and won’t be inflationary.
This might be good accounting (I’m no expert) but it is not good economics.
It is such bad economics that the Government has achieved a rare unanimity of opposition from economists across the entire political spectrum.
I don’t doubt that on the Budget balance sheet, the revenue losses from the tax adjustments will be fully offset by other cuts and policy calls this Government is making.
But economists take a broader view. There is a more fundamental economic principle. There is an opportunity cost to delivering the tax adjustments.
The Government has been attacked by those on the right for foregoing the opportunity to pay down more debt and deal with the deficit faster than it otherwise might have.
The Left has attacked it for cutting spending more than it might otherwise have had to.
On balance, the deficit argument seems more compelling to me right now. Government spending has to come down. The longer we remain in deficit the greater the risk that we get caught by another external economic shock that we can’t afford.
Either way though, the Government would have more room to move if it delayed the bracket adjustments. It could have stuck to a more aggressive deficit reduction plan. Or it could have softened the blow of spending cuts in the areas that are most politically contentious.
I think it is weird that the Government can’t just acknowledge the opportunity cost. After supply and demand, it is one of the most basic ideas in economics.
Economists have also refused to accept the Government’s argument that these cuts won’t be inflationary.
The Government argues that offsetting the tax cuts in their accounts means they will be neither inflationary nor disinflationary. However, economists look at both sides of the ledger as having a “fiscal impulse” that is either inflationary or disinflationary.
Think of inflation as a fire that needs to be controlled.
We control inflation with the money supply. The Reserve Bank is the main firefighter and uses interest rates to restrict and expand the money supply, reducing or increasing fuel on the fire.
The Government also plays a role with fiscal policy. When it raises taxes or cuts spending, it reduces the fuel on the fire. When it spends more or cuts taxes, it adds fuel to the fire.
The Government is both adding and reducing the fuel on fire in this Budget. It argues the net result is less fuel than the last Government added.
But it is still adding fuel!
Okay, that’s it. I’m done. Willis and Luxon have backed themselves into a political corner and will fight on through. And I think they’ll be fine.
We’ll beat inflation later this year or early next. But we will get there. And the Government will get away with tax cuts at what is technically a bad time in the economic cycle.
The situation is not so dire that we’ll see a serious market reaction or get told off by international rating agencies — although that somewhat undercuts the catastrophising we’ve heard from the Government this year.
What’s important right now is: what next?
Beyond muddling through this economic cycle, New Zealand has much bigger challenges looming.
We have to fund retirement for a rapidly ageing population. We have to raise tax revenue from a rapidly retiring population. We need to fund infrastructure and we have to boost productivity. We have to deal with economically damaging social inequity.
These are the challenges I’m excited to hear Willis addressing on May 30.
Even if it is early days. I’m optimistic that we’ll get a Budget that puts building blocks in place for longer-term growth.
Willis appears to be treading a delicate Budget path through the middle of the treacherous political divide.