ECONOMICS : Waiting for advice on tax cuts

The newly elected Clark government unambiguously set out its fiscal-policy objectives in the Budget Policy Statement (BPS) of 2000. Over the next four years, it declared, it planned to build budget surpluses. Stronger operating surpluses would allow it to start pre-funding the future fiscal costs associated with population ageing. “While the extent of pre-funding has yet to be determined, the government will need to build structural fiscal surpluses to undertake this saving,” the BPS said.
So when could it be said the government had succeeded in building structural fiscal surpluses? Good question.
In its Fiscal Strategy Report in Budget 2005, Finance Minister Michael Cullen said his government had been cautious not to spend what may have been cyclical increases in operating surpluses. “This has enabled us to make faster progress on our debt and NZS Fund objectives over the past four years,” he said. “However, the persistence of these surpluses and their composition have made us more confident that structural factors have been at work.”
Indeed. The economy had grown 4.8 percent in real terms over 2004, employment growth had been strong, and unemployment rates had fallen to record low levels. The Government could talk of big improvement in its operating balance adjusted for revaluation movements and accounting policy changes (OBERAC). “After adjusting for the economic cycle, the majority of the increase in the OBERAC remains pointing to structural improvement in the fiscal position,” the Government said.
Even earlier – in 2004 – Treasury advisers told Michael Cullen the government’s healthy fiscal position presented it “with scope to cut taxes, increase expenditure, and build up financial assets”. But Prime Minister Helen Clark waited until the Labour Party conference early in November this year before announcing personal tax cuts could be afforded now because Treasury had advised Cullen in recent weeks the budget surpluses were structural, not cyclical. It was the first time Labour had received that sort of advice, she contended. Yeah, right. And it was delivered with remarkable serendipity as the political parties jockeyed for support as election-year loomed.
Significantly, Clark resisted National Party demands to publish the advice. By then, she had gone out on political limb, claiming she had not been able to agree to cuts until now because of inadequate fiscal forecasts from Treasury. “I’d have liked to have done it earlier and I think all our Cabinet and Caucus would have, but we’ve never had advice which made that possible,” she told TV One’s Agenda programme.
But the Treasury now was forecasting budget surpluses to be long-term and “structural” rather than just “one off”, and Cabinet and Caucus were assured they could safely deliver tax cuts.
True, the Treasury has consistently underestimated government revenues and surpluses. The New Zealand Herald’s Brian Fallow calculated that over the past three fiscal years it had underestimated operating surpluses by an average of $2.2 billion year. The cash surpluses (the sum left from the operating surplus after funding capital items like contributions to the Cullen Fund, student loans and spending on roads, school buildings and so on) had been higher than forecast by more than $3 billion year. Essentially, Fallow explained, this is because nominal gross domestic product – real growth plus inflation, rough proxy for the tax base – has grown more than expected.
But if the Government now insists it had to wait for the appropriate Treasury advice before acting on personal taxes, what are we to make of the advice given to the incoming Clark Government in Treasury briefing papers in 2005? The papers said the Government should cut personal and company taxes as soon as the next Budget. The rate of growth in government spending should be reduced, too, to give more scope for tax cuts and other measures to promote growth. Cullen discarded the advice as the usual three-yearly “ideological burp” from Treasury. He also said he rejected the advice because “I’m elected, they are not.”
Taking Treasury’s advice isn’t necessarily economically smart, however. Cullen himself recognised this before the 1999 election, when he wrote in The Southland Times about “National’s dilemma”. Cutting taxes when the current account deficit was already above six percent of GDP would be “to commit economic sabotage”, he argued. Either the Reserve Bank would become alarmed at the potential for inflation and tighten monetary conditions, pushing up the dollar and interest rates, “to the extreme disadvantage of the export sector as occurred after the 1996 tax cut”, or foreign investors would become nervous at the prospect of further blow-out in the deficit and would pull their money out of New Zealand, precipitating depreciation in the currency. The current account deficit is now above eight percent of GDP.

Bob Edlin is regular contributor to Management.

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