Treat the Kids: Why Michael Cullen Should Blow a Bit Of the Budget Surplus.

Listener 17 May, 2003.

Keywords: Macroeconomics & Money; Social Policy;

One of the political oddities is how American conservatives are keen to blow the US budget surplus, creating an enormous deficit which will substantially adding to the US government’s debt. Under Ronald Reagan the justification was the merits of tax cuts, and the belief the deficit would force the US Congress to cut spending. It didn’t. Under George W. Bush the justification is the merit of tax cuts and need to support a sluggish economy, even though the cuts are poorly designed for macroeconomic stimulus. The commonality is the cutting of the burden of taxation on the rich, in effect switching the burden to future generations.

That does not entirely explain the poor design. Perhaps it is recognising the excessive debt burden in the private sector, the purpose of the tax cuts is to shift some of that private debt onto the government books. Ironically, in the future the American Right will pour scorn on the government sector, even though today it uses it to bail out its friends.

No doubt the bizarre economic logic of the American Right towards government deficits will reach New Zealand, although the good news is that both Minister of Finance Michael Cullen and National Spokesperson Don Brash agree the current need is to run a fiscal surplus – that is to take in more revenue (mainly from taxes) than outlay on government spending and debt servicing. (Cullen has said he would run a deficit in a severe recession. Brash agrees, but they may disagree on the degree of severity required.)

The case for the surplus is that private sector savings in New Zealand are poor, and the public sector is offsetting the shortage. If it did not, the deficiency would have to be made up from foreign savers, and their greater capital inflow would drive the exchange rate up higher, making it harder for the export sector to compete overseas. Ultimately the sustainable growth of the economy would slow down.

At the moment the budget surplus is running higher than forecast, mainly because the economy has bene surprisingly strong, and tax revenue is up. What should the government do with the windfall? A cautious view is the New Zealand economy’s growth rate will fall off this year, although still remaining positive. Moreover there is a strong downside risk that the world economy will tip into recession. The logic is much the same as for your family receiving a windfall. Put it aside for a rainy day.

But doesnt the household use a little of the windfall for a treat? Could the government not do so too? However, were the government to splash out on a new expenditure program or tax cut, and the economy were to turn sour, then it would have to reverse the policy – one of the politically hardest things to do. The problem can be got around by bringing forward some planned new expenditures. Current budget practices include setting aside funds in future year for new policies (which may be added to by rationalisation of existing policies). The total amount comes to about $800m a year, much of which will be spent on education and health. Bringing some of the more urgent policies forward a few months earlier gives us a one-off treat. Since the policy was going to be implemented anyway, there is no problem of political reversal. The parallel is the family purchasing a new car a few months early out of its windfall.

What are the urgent policies which might justifiable be brought forward? Top of my list are family assistance and infrastructure. There is no question that families with children are under a lot of financial pressure. (This group makes up over 80 percent of all the poor.) Rising prosperity, as has occurred in the last few years, does not automatically benefit children. The government has to share the nation-wide prosperity with them. It is committed to a family assistance package in the year beginning July 2004. Why not introduce it in, say, January 2004? (It would also provide some relief to many poorer wage earners who have had little rise in their pay packets over the last four year.)

The other priority has to be infrastructure. It was easy to cut back on new electricity, roads, telecommunications, and water over the last decade, but the cost has been growing congestion and shortages. Again the government plans to address the infrastructure deficit in the future. Again it could bring forward some of its planned investments now.

The government may have to use some of the windfall to prop up those privatised businesses which were run into the ground by their owners – like Air New Zealand, but there are others. Even so it would be prudent to keep some for the rainy day that will soon be surely upon us.