Opinion: Tax cuts could slip into NZ's black hole of debt

By NZPA

Friday 26th August 2005

Voters were scrambling for their calculators this week to see how Labour and National's pre-election tax policies stacked up.

But the policies failed to immediately address a key issue for businesses - corporate tax, and economists warn they could carry a sting in the tail, triggering an interest rate reaction from the Reserve Bank.

Both parties made a play for the elusive swing voters - Mr and Mrs Middle New Zealand.

Labour is promising to extend its working for families tax breaks package to families earning up to $110,000 a year, depending on the number of children.

Not to be outdone, National came up with a potential knockout $4 billion policy that will deliver an extra $30 a week to those earning $50,000 a year, and $100 to those on $100,000.

While National's policy flattens the progressive tax scale, and Labour targets families, the policies are alike in that they are unashamedly biased towards the middle classes.

"People on high incomes don't get any more out of this than those on moderately high incomes," Infometrics economist Gareth Morgan said.

"They've been cut off from the fruits because they need that money to fund their middle income package."

So, as far as encouraging our best and brightest to work harder, smarter and longer for six figure salaries, the policies fall short.

And businesses are left out in the cold too, with National extending a limp promise to reduce the rate to 30% from 33% by 2008.

That is concerning, given that tax was raised as a top five issue in a recent Business New Zealand poll.

"We think that a company tax rate cut is important and is something that should be tackled immediately," Business NZ chief executive Phil O'Reilly said, although he added that National's offering is "better late than never".

The McLeod Report on tax issued two years ago recommended a 15% rate for new companies. And in Ireland the economy blossomed following a decision to cut its corporate tax rate to just 10% for manufacturing and export activities. That concept hasn't found much sympathy here.

Nevertheless, tax has emerged as a burning issue in this campaign.

In 1999, when Labour first came to power, it was based on promises for higher spending on health, education and welfare.

It introduced a 39% tax rate for income over $60,000.

When that tax rate first came into force, around 5% of tax payers were caught. Now "fiscal creep" has put a quarter of full-time workers into the top tax bracket.

With the second term Labour Government regularly posting billion dollar budget surpluses, the Middles have decided it's time to wrestle control of the cash box.

Morgan describes it as a situation of "electoral fatigue". After two terms, voters are looking for a change.

With the unemployment rate at record lows and wage rates on the rise, it's not like we need the money, but what the heck - with mortages up to our ears, why not take advantage of a little pre-election bribery to pad the wallet?

But analysts are cautioning voters to be careful what they wish for.

With inflation already hovering close to the top of the Reserve Bank's (RB) 1-3% target band, the cuts could lead to a rate hike.

Morgan says the RB's good doctor Alan Bollard will be "in fits" about both packages.

With the economy still in a fairly boisterous state, a sudden redistribution of tax money may leave the RB with no choice but to ramp up interest rates to keep spending in check.

"Sure, we get a tax cut on one hand, but if you are geared into your house, you are going to be spending it to pay higher interest on the other," Morgan said.

Bollard's finger is already on the trigger after official figures this week showed business costs rose sharply in the year to June, pushed up by steep fuel and power prices, and construction costs.

ANZ economist Cameron Bagrie says the high oil prices are soon going to be felt by consumers at more than just the petrol pump.

"It will be these second round effects that will have the RB worried."

New Zealand's trade imbalance with the outside world is also looking increasingly dire, with data out this week showing the trade deficit swelled to an uglier-than-expected $617 million in the July month, taking the annual tally to a $5.4 billion deficit.

National leader Don Brash - who in his former life as RB governor was a reknowned inflation hawk - better hope Bollard doesn't pull the same trick he did, hiking interest rates just 10 days out from the 1999 election.

Then, inflation was at 2.6% and Dr Brash raised rates in what he said was the "best contribution to steady, and as a consequence, prolonged, economic growth".

The six years of rampant economic growth that ensued could come back to bite him when the RB meets on September 15, two days before the election.

In pure accounting terms, New Zealand First leader Winston Peters' argument that the tax policies are fiscally risky is a red herring. Even National's $4 billion spend-up is affordable given the current health of the Government books.

A Pre-Election Fiscal and Economic Update showed that whoever wins the election will inherit $29 billion in operating surpluses between now and 2008/09.

Post-Rogernomics, various New Zealand governments have been a picture of fiscal health in terms of sensible levels of borrowing, savings and budgetary restraint.

Unfortunately, the broader economy isn't so flash.

In the year to March our net foreign debt - money borrowed overseas to fund households and businesses - climbed to $123 billion. That's around $31,000 for every man, woman and child.

Expressed as a ratio of debt versus gross domestic product it's a troubling 90%.

Borrowing isn't all bad - easy access to money is critical for building businesses. But when you weigh it up against our poor savings record - things begin to look a little shaky.

Perhaps the message to the Middles should be, think before you spend that tax cut on an imported DVD player or fill up the tank in your SUV - with high interest rates, wouldn't that money be better in the bank?

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