Tax cuts or benefit rises? The answer’s not simple

There are worse problems to have than the embarrassment of riches that is a $7.5 billion surplus. Since Treasury unveiled the largest surplus in a decade last week, there has been increased pressure on the Government to either return money to people in the form of a tax cut, or to increase spending. The economic reason for this is stimulus. Around the world, economic growth is slowing. New Zealand is doing better than most: ANZ predicts the economy will grow by 2.5 per cent next year and 2.9 per cent in 2021 – not bad, but not quite the giddy heights of 2016 and 2017, when growth nudged 4 per cent.

Now’s the time for the Government to stimulate the economy by putting money in people’s pockets, to get them spending before the economic music stops. Done right, and you get to dance a little longer, or avoid a painful comedown.

Treasury’s fiscal impulse indicator is negative, meaning the Government is still taking more money from the economy in taxes than it disburses in different forms of spending.

The Government has two levers for getting money into the economy. One is not to take money in the first place by reducing taxes; the other is to give it back to people to spend via benefits. Both have their advantages, and the Government has options to spend through both.

As far as not taking money goes, the Tax Working Group proposed a $5000 tax-free threshold, meaning we’d pay no tax on the first $5000 we earn. This sort of stimulus is quick and easy. It’s administratively cheap, requiring no real bureaucratic heft compared to working out complex changes to benefits. The only real cost is revenue forgone by the Government, which the working group estimated would be $1.8 billion each year if you give beneficiaries a cut as well.

It’s also fast: if the economy needs a bit of cash quickly, it’s best if the Government leaves itself out of the equation. It’s great politically too: the cut helps low-earners more, because they get to keep a greater percentage of their income, but it gives everyone a tax cut, no matter how much they earn.

This is the major drawback of the policy. If you’re spending $1.8 billion on making people better off, wouldn’t it be better to target it at the people who really need it? Say, the 1.2 million people who earn less than $30,000, rather than the 644,000 whose earnings fall above the top tax threshold of $70,000.

It could go even higher. In the UK (apart from Scotland), the equivalent of your first $25,000 is untaxed. In Australia it’s NZ$20,000.

Still worse, many people in the lower tax brackets are secondary income earners, working part-time to supplement their partners’ far larger salaries. A $10,000 income might look small, until you realise it’s to top up a partner’s $200,000.

This is why centre-Left governments tend to favour beefing up the transfers system, which uses things like benefits and Working for Families credits to target payments.

This takes into account things like household income, the number of children living with a parent, ensuring, for the most part, that transfer goes to those who need it most. It’s good for struggling families, who get an income boost, and good for the economy, because these people spend most of the extra income they’re given.

Before she became prime minister, Margaret Thatcher was an unlikely champion of transfers. Most primary earners were men; ‘‘family incomes’’ as they were known then gave women the autonomy over household finances.

But there are drawbacks too. Done poorly, benefits can encourage people to stay in relationships that aren’t working, or try to hide the fact they’re in a relationship.

And lying about your family can trigger enormous tax debts for beneficiaries – bills they will struggle to repay. Working for Families is a classic example. In 2014, people owed more than $400 million in mispaid tax credits (the amount owed has now fallen to $140m).

Tax-free thresholds create no such debts. Thatcher was a fan of these, too. She said they encouraged women to control their own lives, as they gave them more money of their own in an age when men controlled family finances.

A UBS report from last year found that things haven’t changed much from Thatcher’s day. Fiftysix per cent of married women leave investment and long-term financial planning decisions to their husbands and partners.

So while it may appear you get more targeted stimulus and better social effects through the transfer system, in reality the merits of firing up a tax credit increase aren’t quite so clear-cut.

If you’re spending $1.8 billion on making people better off, wouldn’t it be better to target it at the people who really need it?

STUFF Rochelle Brown is a working solo mum, who was interviewed before the last Budget. She said they lived week to week. The Government will need to decide whether a taxfree threshold or tax credits would help her most.