Tax cuts

I had a chat with Radio Live this afternoon on whether the government can afford tax cuts. I like to make a few notes for myself for these things ahead of time; here they are for you.

Over the medium to longer term, the government should aim for balanced books – or to run modest surpluses to get net debt down, providing headroom in case of future emergency need. Part of preparedness for future uncertainty is having fiscal room to take on debt in case of disasters like earthquakes.

Treasury projections have surpluses increasing through 2021. Those projections already incorporate core Crown expenditures increasing from about $74 billion currently to about $88 billion in 2021: core tax revenue increases more quickly than that, from about $76b to about $97b. So the expected path is for more government revenue and more government spending. Treasury also notes that its expected surpluses are structural rather than cyclical: this isn’t just a temporary thing that will wash out. On average over the medium to longer term, we see surpluses. By 2021, that surplus is projected to be $8.5b.

Part of the reason for surpluses is fiscal drag. Inflation is very low, but still present. And as incomes rise, more people jump into higher tax brackets. It’s a small overall part of the expected surpluses, but it still will give the government about $1.4 billion more revenue in total in the period to 2021 (about $300 million per year).

A balanced policy response to the situation we face would include:

1. A third of the projected surpluses being devoted to tax cuts (so about $2.8b by 2021).
• First, undo the effects of fiscal drag. We really should just index the tax thresholds to inflation so that this didn’t happen any more. But governments like the automatic tax increases that come with inflation because it lets them announce tax cuts regularly (or spending increases). 
• Remaining tax cuts should be focused, in my view, on rates reductions on lower-income earners, at least in part because that helps bring down effective marginal tax rates that can be very high for poorer cohorts when income taxes get added onto clawbacks of various income-contingent benefits like Working for Families. 
• Treasury notes that a percentage point drop in the each of the personal tax rates would cost about $1.3 billion currently. Dropping each by two points, and cutting the 33% rate only to 32%, would cost about $2.3b. So there’s room to move on tax cuts, even if only a third of future surpluses went to tax cuts. And these could be scheduled to phase in as expected surpluses grew.
2. A third of the projected surpluses being devoted to spending increases:
   • This should be targeted at infrastructure improvements to deal with the housing crisis. Recall that Treasury projections already bake in some spending increases, including superannuation spending and non-NZS welfare spending.
   • One mechanism that we at the Initiative have liked is rebating to Councils at least some of the GST associated with new housing construction in their areas for a period over the next few years in order to encourage councils to consent and permit a lot more activity a lot more quickly. Councils could use that funding to roll out infrastructure more quickly, or to otherwise grease the wheels that need greasing to let new development happen. We need a lot more housing, quickly, to get through the current crisis.
   • The Productivity Commission is likely this week to recommend substantial redesign of the urban planning framework, but those changes would take a long time to implement.
3. A third of the projected surpluses being devoted to paying down government debt:
   • Government debt is already on track to reduce as a fraction of GDP;
   • Very low Crown debt means that if a large earthquake hits Wellington, or somewhere else, it is easier for government to sell bonds to fund reconstruction. If the government goes into a crisis with higher debt, it is more expensive to raise the funds needed for rebuilding. Pushing debt down more quickly is a prudent part of preparedness.

Government should resist calls to simply increase spending in response to surpluses. The government has been pushing hard, over the past few years, to encourage a greater focus on the value that government delivers for its expenditure as the measure of its success rather than just what it spends. If it identifies areas where spending delivers strong value for money, by all means increase spending in those areas. But that has to come with a commitment to pare back spending in areas where spending doesn’t really achieve much. Blunt calls to increase overall expenditure miss that the government still has a lot of work to do in identifying areas where spending should be reduced because it is ineffective.