What Are the Tax Cuts About?

Is National pandering to greed or promoting principle?

Listener: 3 September, 2005.

Keywords: Regulation & Taxation;

Other articles on the 2005 Election Tax Debate

In 1957 the Labour Opposition, led by an elderly Walter Nash desperate to have a turn as Prime Minister, ran its election campaign on “Do You Want £100 or not?”, promising to remit up to £100 to each income taxpayer. It was accused of pandering to greed, without any principle. In fact, the National government was offering the same total tax cuts but more directed to the rich and self-employed, whereas Labour has targeted the poor and workers. The cuts were funded by the introduction of PAYE. Without them, taxpayers would have paid double income tax in the first year: PAYE plus the previous year’s income tax.

The electorate did not understand this. They thought the infamous, tax-raising Black Budget of 1958 was to pay for the election-promised tax cuts. It was actually designed to steady the economy in the face of falling export prices that Labour learnt about when it got into office – there were no Treasury pre-election forecasts in those days.

So is the National Opposition today pandering to greed with its proposed tax cuts? Certainly, its advertising is, but perhaps underneath there is a greater principle.

This time the government is not offering matching cuts. And National is promising to fund its tax cuts from the elimination of waste and significant additional borrowing. Will its policies cause an economic crisis?

You never can tell, but we can be confident that extra government borrowing will push up interest rates, although we don’t know by how much. Were I the Governor of the Reserve Bank, I would be very uncomfortable with National’s proposed fiscal stance. (I’m also a little uncomfortable with the Labour-led government’s fiscal stance, which seems to be right near the bottom of the range of fiscal prudence.) Higher interest rates will hit mortgage holders, and discourage investment in production. The exchange rate will rise as we borrow the money to fund the tax cuts from overseas investors. Exporters’ incomes will be hit by lower returns and higher investment costs, the effect of which will be to slow export expansion and stagnate the economy.

A strong prediction, but that is what happened under Labour in the 1980s. It was a fiscally undisciplined government, borrowing heavily to fund its tax cuts, despite also cutting public expenditure. The exchange rate went up, and the economy stagnated for six years. That is one of the reasons National had to cut public spending so dramatically in the early 90s.

So better to fund the tax cuts by cutting public expenditure. Can it be done by waste elimination as National promises? Oppositions always claim that there is public sector inefficiency, but in government they are unsuccessful at eliminating it, because the next Opposition also points to inefficiency, and promises to eliminate it. As ex-Treasury Secretary and Act-list candidate Graham Scott remarked, “It has to be done with a scalpel not an axe.” Total gains from waste elimination will not be great, and the attempts will often damage public sector efficiency.

That happened to health spending in the early 1990s. The National government believed that the health sector was very inefficient, so it cut spending, expecting its managerial revolution to generate more output with less resources. It did not. It just employed more managers and provided less health care. (Ironically, National is now campaigning that there are too many managers in the health sector. As with Labour in the 1990s, Opposition parties often forget that it is their cock-ups in government they are complaining about.)

To attain its public spending cuts targets, National will have to cut efficiently administered programmes that it judges not to be priorities and thinks would be better funded by the private sector (which often means “you”, the taxpayer). National is coy about which. But cutting those programmes would be a principled shift of policy, reflecting its belief that New Zealand would be a better place if there was more private spending and less public spending. Labour states that it believes in a different balance. This is the proper stuff of political philosophy.

Would that the election campaign were to focus on such issues of principle, rather than pandering to greed.