Be careful what you wish for

Unless there is a huge political earthquake in New Zealand, the coming General Election is going to give us a government led by Labour or by National. Both parties have promised tax cuts. In deciding who to support, voters need to be aware of the consequences of those tax cuts, and to consider the likely response of the next government (depending on its make up) to those consequences.

People are certainly feeling the pinch from higher fuel and food prices, and from higher interest rates – the hope of some kind of relief must be appealing. But tax cuts won’t offer much relief, even in the short-term, and the likely longer-term consequences may give many pause to think (if they pause to think).

According to financial commentator Bernard Hickey, Labour’s tax cuts require expenditure cuts of $1 billion, (and that’s assuming -optimistically – that economic growth and tax revenue will pan out as Treasury forecast):

“Buried in the budget is a line about unspecified spending cuts totalling NZ$1 billion over the next four years that Labour will have to find to help pay for the tax cuts. Dr Cullen flat out refused to answer my question in the lockup about what type of spending cuts they would be.”

Meanwhile, National is promising even larger tax cuts, and is promising to pay for them with cuts in spending. Larger tax cuts means they will need to make larger expenditure cuts:

“National leader John Key is hinting his party will bring in tax cuts sooner than Labour’s second round in 2010 – and that they will be bigger. ….Asked how he would pay for them, he said: “We are confident there is waste in the system that can be cut, that we can structure things in a different way. It’s about priorities.”

Indeed – it’s about priorities. How much and what kind of government spending are you prepared to see cut in order to pay for tax cuts? These tax cuts will, I predict, lead to spending cuts in areas most voters don’t want to see cut – education, health, and social services.

And for what benefit? Interest rate rises and rises in the cost of fuel and food have already wiped out any disposable income gain from tax cuts for most households. Sometimes, economic circumstances change, and we become poorer. We face such a situation at the moment. Money is more expensive to borrow, because of the international credit crunch. Oil is rising in cost because global demand is growing faster than supply. Demand changes, weather events, policy changes, commodity speculation, and the price of oil are pushing up food prices. There is no escaping those economic changes.

Speaking to the New Zealand Herald recently, Westpac Chief Economist Brendon O’Donovan said: “Households have got a correction to go through whether interest rates are lower or not.”

Finally, consider this – quite plausible – scenario: say oil prices rise faster than Treasury is projecting, with the effect inflation rises and the economy slows further than predicted – result: the government faces pressure to make even deeper expenditure cuts, while at the same time interest rates rise even further to try and hold back those inflation pressures. Not a pretty scenario.

Are tax cuts worth the risk?

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