Economics: Tax Cuts and Growth

Act leader and former Labour Finance Minister Richard Prebble predictably promoted tax cuts when he commented on the pre-Christmas Economic and Fiscal Update and its fiscal projections. “New Zealand can afford tax cut for every worker and cut in the company tax rate to below Australia’s rate right now,” he insisted.

The Treasury predicted $3.5 billion surplus this financial year, compared with Budget night expectation of just $2.3 billion, and projected pattern of rising surpluses reaching $5.2 billion by 2005/06. Prebble’s interpretation of this is that we are being over-taxed by $3.5 billion. “The Government can claim no kudos from surplus – it simply means we’re all paying too much tax,” he said.

Former Reserve Bank governor Don Brash, now National’s finance spokesman, curiously did not mention tax cuts in the press statement he issued on the EFU. The revenue numbers reflected what we already knew, he said – New Zealand had enjoyed buoyant economy over the past two years, thanks to good export prices, relatively low exchange rate, good times down on the farm, strong immigration and – he claimed – the beneficial effects of the reforms of the late ’80s and early ’90s.

Labour’s encumbent Finance Minister Michael Cullen shouldn’t kid himself that we’re well on the path to the much-vaunted target of four percent sustainable growth, Brash cautioned, while expressing disappointment that government spending will continue to grow at roughly the same speed as the economy, remaining steady at fairly high 40 percent of GDP.

Just few weeks previously, Brash told 2002 tax conference in Christchurch that increasing the country’s sustainable growth rate demanded reductions in the rates of tax most relevant to those who will invest and produce for the future. “The Government could cut the company tax rate and the top personal tax rate to 30 percent and still have budget surplus,” he said.

But we can forget about tax cuts for companies and those on the top tax rate if Dr Cullen remains Finance Minister, and there’s no sign of him being dislodged any time soon. He’s already ruled out the bigger-than-expected surplus being used for more government spending and he rejected company tax cuts. If the tax burden is relieved for anybody, it will be for low to middle-income families, he said. More important in this Government’s fiscal priorities is the reduction of debt.

In the United States, meantime, the champions of tax cuts were riding high.

President George W Bush freed himself from his obsession with Iraq just long enough to fire Treasury Secretary Paul H O’Neill and White House economist Lawrence B Lindsey. O’Neill’s replacement is CSX Corporation chief executive John W Snow, who sounded just like Cullen during the 2000 campaign when he told BusinessWeek magazine that the top priority for President Bush would be to “secure the surplus… and use significant part of it to pay down the debt”. But this won’t happen. Economists now reckon the short-term deficit will rise as high as US$250 billion.

Bush is putting his faith in the stimulation from aggressive tax cuts, hoping this will boost growth to 3.5-4 percent, which would trim the deficit to fairly small share of gross domestic product.

Supply-side economists, however, were sending conflicting messages to the Bush administration and Congress, about the types of tax cuts that would best do the trick for the still-sluggish economy.

Club for Growth president Steve Moore was favouring cuts in capital gains and payroll taxes, which fund the pay-as-you-go Social Security and Medicare systems; economists at the Heritage Foundation and Citizens for Sound Economy were urging the elimination of double taxation on dividends and making the Bush marginal rate cuts permanent.

Moore called for an “emergency anti-recession plan” – cut in “anti-growth taxes” that impede job creation and retard economic growth. These tax cuts would increase incentives for businesses to hire workers to work, investors to invest and families to save, he argued. This would primarily benefit working-class American families.

Heritage’s Dan Mitchell and CSE’s Wayne Brough, however, claimed tinkering with the payroll tax wouldn’t help the economy and might hurt the chances of social security reform.

This squabbling was grist for the mill of the administration’s political opponents, who accused it of having no general theory of what makes the economy grow or of what specifically government can do to encourage growth.

The same criticism should be avoided here. It is tempting to clamour for tax cuts, but there must be more to stimulating growth than lopping taxes. If that’s all there is to it, as Democratic commentators in the US scoffed, then who needs an economic team?

Bob Edlin is Management’s regular economics writer.

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