Tax cuts without any pain? You’d have to be daft to have swallowed that.

Listener: 27 January, 2007.

Keywords: Macroeconomics & Money;

Nicky Hager’s The Hollow Men provides a fascinating insight into the realities of politics. A rich right-wing cabal got their man, Don Brash, into the leadership of the National Party. But the economic policies they stood for were unacceptable to the vast majority of the country, forcing the leadership to compromise in order to win enough votes. The adoption of policies that were anathema to its backers was described by Brash’s chief policy adviser, Peter Keenan, as “swallowing dead rats”. National turned to non-economic issues, most famously the first Orewa speech’s attack on race relations. The cabal became increasingly concerned that their policies were being ignored.

Perhaps they wanted a repeat of the 1984, 1987 and 1990 elections, in which the government was elected on a moderate policy but seized an excuse to implement an extremist Rogernomics/Ruthanasia one. It seems unlikely that could have happened. There was no obvious crisis in 2005, not even one that could have been exaggerated, as was the 1984 currency crisis and 1990’s Bank of New Zealand illiquidity. Would National’s coalition partners – Act, the Maori Party, New Zealand First and United Future – have bought into such a crisis scenario?

Possibly National could have manufactured a crisis around its promised tax cuts. They do not feature prominently in the book, but there are clues.

National election promises included reductions in the level of taxes that were unsustainable without deep spending cuts. Yet there were also promises to increase spending on education, health and transport. National spokesmen justified their lower taxes by citing a particular measure in the government accounts (OBERAC – the operating balance excluding revaluations and accounting changes) which they said implied considerable room for income tax cuts.

The OBERAC surplus did not indicate the possibility of major tax reductions. You would have to be stupid to believe it did, or to assume that Labour’s Minister of Finance, Michael Cullen, was as stupid as you. If there was any room for tax cuts, you can be absolutely sure Cullen would have given them. It is simple as that. There was no room.

Undoubtedly, Brash and Keenan, both professional economists, knew that too. Initially there had been plans to phase in smaller tax reductions targeted at the high incomes of the cabal. (Yes, there will be tax cuts in the future. Probably in 2009, if the economy continues to prosper. National’s cuts were to be earlier, and much larger.) But such cuts were of little interest to swing voters on middle incomes and would have emphasised that National was a pro-rich party. By the election National was promising large, unsustainable income taxes on middle incomes instead.

Brash talked about cutting wasteful government spending, stalwart rhetoric for politicians in opposition, that proves ineffective in government. Rob Muldoon’s government sought three percent waste reductions in 1982 and got about one percent. Brash probably intended to cut social welfare spending – the implication of the second Orewa speech – but the experience of the Ruthanasia cuts of 1991 tells us that such cuts would be about blood on the floor, not waste.

Privatisation would not have resolved the discrepancy. National had already swallowed that dead rat by playing it down. In any case, Brash and Keenan knew from economic theory and the experience of the 1980s that although privatisation might fund the government deficit, its macroeconomic impact is stagnation.

Yet National promised large tax cuts, without any indication of how they might be delivered. Those red-blue billboards showing “tax” versus “cuts” should have been accompanied by ones contrasting public “spending” with “cuts”. National might have lifted its share of the polls by as much as 10 percent – 12 parliamentary seats – with its “tax cuts without pain” message.

In office, the cuts would have posed a challenge. Perhaps that would have been the crisis: “We’ve promised the cuts: now we need real spending cuts to finance them.”

Tax and spending are about the balance of private and public activity in the economy, where there is a genuine philosophical disagreement between Labour and National. It was fraud, though, to pretend we could have the lower taxes without lower public spending. Had it attained government, the National caucus would have had to swallow a very large dead rat. So would the country.