No tax cuts

Have been in the two hour PREFU (Pre-election Economic and Fiscal Update) at Treasury. These are required by law, after that period in the 1980s and 1990 when incoming Governments got a nasty surprise when they found out the Budget forecasts were so far out of date.

Key points made by Treasury are:

• Surplus for 2014/15 now projected to be $297 million, down from $372 million
• Core crown expenses forecast to be 30.3% in 2015, down from 35% in 2011. This is the critical figure – making sure spending doesn’t increase faster than the economy.
• Economic growth last year was 3.3% against 3.0% Budget forecast. For this year now forecast to be 3.8% against 4.0% Budget forecast.
• Unemployment forecast to be 4.5% by 2018
• Average annual wage forecast to increase by $6,600 to $62,000 by 2018.
• Household disposable incomes rose 7.1% last year and forecast to increase 4.0% a year in future
• Inflation forecast to peak at 2.5% in 2016
• Annual increases in house prices has declined from 10% to around 6% in the last year
• Total cost to taxpayers from the Canterbury earthquakes now forecast to be $15.8 billion
• Economy still growing strongly and above potential
• Fiscal restraint remains beneficial and important to stop inflation
• Trading partners still expected to have strong growth
• Terms of trade will ease up earlier than in Budget, but will remain above historic levels
• Should utilise upswing to strengthen Crown balance sheet
• Weakness in global dairy prices is more a short-term issue, not a structural issue, and not inconsistent with Treasury central forecast

It is a good reminder of how fragile our surplus is, and how we also need to start paying off debt. We are still forecast to have the best of all worlds – a growing surplus, higher after tax household incomes, inflation under control, more jobs, and less debt. I contrast that with the tens of billions being promised by certain parties that will mean higher taxes, more debt and probably no surplus.

The downside scenario, if export prices drop down, and stay low, along with weaker household demand, would be no return to surplus until 2018. That is unlikely, but possible. Again, don’t spend the surplus until we have it.

There are a hint of possible tax cuts. Treasury say “The operating allowance has been added to expenditure as a working assumption, but in practice would be available for a mixture of expenditure and revenue initiatives”.  However Bill English stated unequivocally that there will be no tax cuts announced before the election. He says there is not enough fiscal room at this stage, but does make it pretty clear they do plan some in the future, if re-elected.

I do hope there are tax cuts in the next parliamentary term. They will of course be modest. But as the Crown accounts reach surplus, the surplus should go on a mix of extra spending, tax cuts and debt repayment. It is fundamentally unbalanced to only increase expenditure. Tax cuts are the only guaranteed way to increase household incomes. It would be sensible to target the lowest and second lowest tax rates, or the thresholds they apply at.

Due to fiscal drag or bracket creep and the like, tax as a percentage of GDP will rise without tax cuts.  It is forecast to go from 26.6% to 28.4%. I’d like to see it eventually around the 25% mark.  We should fund extra spending from a growing economy, not by increasing the share we all pay in tax.

It is worth stressing that even by 2018, the surplus is only projected to be $3 billion a year. That can easily be wiped out in a downturn. We do not have the fiscal latitude to embark on huge amounts of new spending – now this year, not next year, not the year after. We can afford some modest spending and modest tax cuts within the $1.5 billion annual operating allowance. We can’t afford promises of $2 billion here, $3 billion there.