Tax cuts are a flexible piece of political ectoplasm. To those who peddle them, as Paul Krugman once noted, there is hardly an economic ill for which tax cuts are not claimed to be the best possible medicine. Your economy is running a healthy surplus? Tax cuts are needed, to hand the money back. The country is heading downhill into recession? Tax cuts will give the necessary stimulus.
You want to boost growth and productivity? Tax cuts will allegedly do so in future, even though they demonstrably failed to do so ( see New Zealand : 1988, 1996 ) in the past. Looking for longer term growth and for the right incentives for success ? Why, that’s the perfect reason for uncorking the tax cut bottle and taking a long hard swig, my friend!
In reality – which as Stephen Colbert once pointed out, has a well known liberal bias – there are a few ( admittedly fanciful) scenarios where personal tax cuts are not the first policy tool you should be reaching for. They’re not a great idea for instance, if you want to damp down inflation, and keep interest rates and the exchange rate from rising in tandem. They can also be a very bad idea if you want to stop the current account deficit from blowing out even further, via greater spending on imports.
Because most of the money handed back from tax cuts tends to be captured disproportionately by the already wealthy, they’re hardly the best policy if you’re really serious about tackling income inequality, and the related evils of crime and poverty. ( Tax cuts tend to make social divisions worse, not better.) Tax cuts are also not a great starting point if you ever want to expand and improve services in health, education or public transport.
Nor are tax cuts advisable if you should feel it desirable to face demographic reality, and the need to divert revenue towards caring for the elderly. Nor are tax cuts advisable if you want to encourage savings and productive investment. Nor are tax cuts a great idea if you’re trying to practice prudent fiscal management in the face of an international credit crunch and slumping global prices for our key commodities…No, for any government serious about those meeting those sort of challenges, a lot more policy than a tax cut sugar fix is needed.
Michael Cullen proved that yesterday. The numbers in yesterday’s fiscal update by Treasury were truly terrible : tax revenue is $3.1 billion less than predicted in the May Budget, unemployment will rise to a worst case outcome of 6.1% by March 2010, government debt is set to rise to nearly 25 % of GDP by 2013, and deficits are forecast for virtually the entire next decade etc etc. Quite simply, Cullen’s luck has run out. While it may have been politically unfeasible for Labour to deny tax cuts to voters this election, the state of the Treasury books also shows them to have been financially irresponsible.
None of which is stopping National from also doing its bit to play politics with the needs of the economy. Though the surpluses that once made tax reductions viable have now vanished, National remains intent on heading further and faster down the track of personal tax cuts and short term consumption led growth. National also seems to be pinning its hopes for longer term growth on tax cuts as well. ( See the presidency of George W. Bush for why this approach may not work out very well. )
In fact, National is putting forward a tax cut/debt development programme at the precise time that the cost of credit on global markets is headed south. It is living in denial. Even without the global meltdown and the credit crunch, the lakes of fiscal red ink will be causing overseas credit rating agencies to look once again at our massive current account deficit, currently running at 8.3 % of GDP. Those rating agencies may decide that one deficit is bad, but two deficits – external and fiscal – are intolerable. They may also find it scary that the frontrunner in our election campaign is promising an even bigger, even faster programme of personal tax cuts and consumption.
Provided one ignores Cullen’s tax cut programme this year, the one bright spot in the Treasury figures yesterday was that the Finance Minister has run a fairly prudent ship over the past nine years, and brought government debt down from a high of around 35% to a low of 17% of GDP. Even if government debt rises to the projected 24 % in five year’s time, this relatively low ratio ( by international standards ) should serve as a useful bulwark against the current global turbulence.
Unfortunately though, the main risk to the New Zealand economy from the credit crunch is located elsewhere, within our exceptionally high levels of private sector and household debt. Again, it is very hard to see how tax cuts will provide more than a temporary fix for those two addictions. It could even make them worse.
Tomorrow National will unveil its tax cuts package. The media fixation will be – how big is National’s tax cut package likely to be be, and will it still be phased in as promised? On September 30, Bill English flagged that Labour’s tax cut programme would be counted as part of National’s tax package, by saying
“National will build on the tax cuts due to kick in tomorrow. We will treat them as the first tranche in our tax-cut programme. “
Therefore, those expecting a $50 a week package from National should begin by subtracting the $12-28 sums already provided by the government’s October 1 cuts. At best, National will only be offering the remainder, tomorrow. Most of it – say, a further $20 a week seems likely – will be delivered next April, with National promising further tranches in 2010 and 2011. It doesn’t amount to much, given the hype.
No wonder that Mark Weldon down at the New Zealand stock exchange is feeling stressed. With stock markets plunging and the financial system in meltdown mode, the major parties seem eerily oblivious to the chaos raining down upon them. The zombie march of ideological policy ( Must …have.. tax…cuts ! ) continues, regardless. While from the Labour leadership, Cullen is offering no more than crossed fingers, a stiff upper lip and advice about how we don’t need to panic. Just yet.
Slamming on the brakes now, Key has advised, is not an option. The way out, he says, is to control the growth of Government spending, and to grow the economy. “That will require a fresh approach.” Presumably that fresh approach will not rely solely on the stimulus derived from tax cuts and less government regulation – a stale approach from the 1980s that the rest of the developed world no longer embraces with the same supply side zeal as when Ronald Reagan and Margaret Thatcher were promoting it. Surely, we have moved on.
The real questions for Key tomorrow are not about the size of the tax cuts – but about the growth policies that are meant to compensate for the loss of revenue. What are they? So far, Key has only suggested less regulation. Bill English for one, has never believed that the magic of tax cuts will release a flood of entrepreneurial enterprise, all on their own. This is no longer the Wild West 1980s. Domestically and internationally, there is a drive for more regulation of the economy, in order to protect the public from the greed merchants behind the current chaos. National, with its tax cuts and promises to strip the RMA of regulation, is living in the past.
The past, as Joe Biden says, is prologue. Or should be. In a Listener interview ( July 24, 1999) Bill English told me candidly that “ Tax reductions aren’t a magic bullet,” and never had been. Especially not in situations where Budget surpluses simply didn’t exist. Voters in any case, English went on, had other priorities than tax cuts.
“For all the people who want tax cuts, “ English said back then, “ there are all the people who want re-assurance that their publicly funded services are going to be improved. Not just maintained, but improved. “ Back in 1999, English had viewed the whole issue of tax cuts as being a secondary issue, and an approach that served as a ‘directional statement’ at best. How times ( don’t ) change.