The fiscal neutrality or otherwise of the 2010 tax changes is important because it goes to the heart of the economic competence of National. They claimed the cut to income tax for upper income earners plus the cut to the company tax rate was balanced by the increase in GST and other tax changes. That is, they were broadly fiscally neutral.
If the tax changes were not fiscally neutral, then it undermines National’s credibility and it undermines their whole argument that we have to cut government services because there isn’t enough money. And it also means that the Government is having to borrow to pay for upper income tax cuts.
So I questioned John Key in the House yesterday over this repeated claim that the 2010 tax cut package was fiscally neutral.
The exchange ended with the two of us waving around different pieces of paper: I had a series of numbers from Treasury. John Key had a memo from his Finance Minister.
Let me present my evidence in three steps:
1. Treasury have consistently reported that the 2010 tax cut package – the package that cut taxes for those on high incomes, lowered company taxes, and raised GST to 15% – is not fiscally neutral in the short-to-medium term.
When announced, Treasury estimated that the static four-year cost of the 2010 tax cut package would be $1.1 billion. (See the original table on page 8 of the Minster’s Executive Summary in Budget 2010.) You will see that the projected cost in just the first financial year was expected to be about half a billion.
2. Just nine months after the tax cuts had taken effect, Treasury had significantly revised their initial estimate of the fiscal impact of the tax cuts. Within nine months, the net cost of the 2010 tax package was close to $1 billion, or double the initial estimate. (You can see the original table here on page 8.) The gross cost of the tax cuts was $2.7 billion but this was offset by a $1.6 billion increase in GST.
3. Yesterday, the Financial Statements of the Government of New Zealand for the Eight Months Ended 29 February 2012 were released showing tax revenues had collapsed even further due to the weak economy. Treasury reports a further $369 million shortfall in GST revenue, a $200 million shortfall in income tax, and a $193 million shortfall in corporate tax. This indicates that the cost of National’s 2010 centrepiece tax cut package has crashed the Government’s budget even further.
This is not a smart way to manage the Government’s finances. What household would slash their income sources when times are difficult, thus throwing themselves deeply into debt?
Here’s what’s happened to Government revenues (as a percentage of GDP) over the last few years.
And here, likewise, is what’s happened to Government debt.
It is true that the difficult economic conditions have put downward pressure on the tax take. But that is not the issue. The issue is, given the economic conditions, are the Government’s books in a better or worse position as a result of the 2010 tax changes? The answer is very clear: The deficit is much worse because of the 2010 tax changes. They were not fiscally neutral and the Government is having to borrow to fund the tax cuts to upper income earners.
In many ways, the Government’s dire financial position was of their own making.
(1) Note that they try to reduce the projected cost in the line in the table “adjustment for macroeconomic effects” by claiming that tax cuts cause GDP growth which increases the tax take (think Reagan’s J curve), but given what actually happened to the tax take, we can safely ignore their Reganomics.