What chance tax cuts?

The focus is on 2008. That’s when the tax cuts come, if any. They are left over from Budget 2006 and won’t go away. So what are the odds?

First, there are tax cuts programmed for April 2008: the part-indexation of personal tax thresholds to inflation announced in the 2005 Budget: 2 per cent a year from 2005, the midpoint in the Reserve Bank’s target range, well below the likely actual averages.

But Michael Cullen threw these cuts into doubt in the context of the carbon tax scrapping and the business tax review.

Second, there is Cullen’s aversion to tax cuts. He measures New Zealand against the unweighted OECD country average and finds his tax take competitive — especially when quasi-taxes in other countries, such as compulsory superannuation contributions, are accounted for.

Third, there is the economic slowdown. The Treasury’s fiscal projections on Thursday were predicated on a bounce back from the slowdown to near 4 per cent in calendar 2007. That is well outside the consensus. The “Budget doesn’t add up,” said the Bank of New Zealand.

Though Working for Families — in part, tax cuts by the name of “relief” — will by then be pumping about 1.5 per cent of GDP into the economy, the Treasury is also projecting softer terms-of-trade, a small house price retreat, sluggish consumption growth and slow jobs growth over the next year or two.

If the Treasury turns out to be over-optimistic — and at some point its projections will be on that side of the ledger after being too conservative for six years — tax cuts will be difficult to accommodate within Cullen’s own strategic objective of a stable government debt-to-GDP ratio. He might even struggle to keep his spending commitments.

On the other hand, fourth, there is the Inland Revenue Department’s more bullish forecast of tax receipts. Cullen interpreted that as a “slight upside risk”, giving him more fiscal leeway by 2008 than the Treasury.

Moreover, fifth, Cullen has hinted that if the company tax rate is lowered, that has implications for personal rates.

Which leads to the sixth point: one of the scenarios to be canvassed in the company tax discussion paper due in late June or mid-July includes a 30 per cent company rate.

That doesn’t commit Cullen to anything. He said on Thursday the final package may be a mix-and-match of elements from various scenarios.

But, seventh, both New Zealand First and United Future want 30 per cent. Behind the scenes New Zealand First is quietly confident it will get that rate. In fact, counting those two parties in with National and ACT gives nearly a parliamentary majority.

Stir in a staged introduction of the package and it is highly possible that a company tax cut — and possibly also an accompanying personal cut — could be flagged for phase-in.

Now, eighth, simmer the mix over the Helen-Clark-very-much-wants-a-fourth-term element. Clark reckons the 2005 election decided in favour of spending over tax, albeit narrowly. That is true as between Labour and National but when you add in the small parties the picture blurs.

Clark will be supersensitive to voters as she nears 2008. If she reckons her 2005 hard line against tax cuts will cost her too much next time, she will move, replacing Cullen if necessary.

Critical in that calculation will be her fear that National might end up with more votes. It is highly likely that in 2008, as in 2005, her two (tax-cutting) support parties will initially negotiate with the leading major party. Lose to National and she’s a three-termer.

So there are pointers towards some sort of tax cut by a Clark government by 2008 — though, if so, probably modest.

What about National? Voters don’t like spending cuts, especially big one. Jim Bolger could tell Don Brash and John Key if they don’t believe that. National’s polling plunged to as low as 14 per cent after Ruth Richardson’s “Mother of all Budgets” in 1991.

This particularly applies to health spending, for which demand is insatiable and the supply of expensive new technology relentless. National claims huge savings can be made by sharpening management. But, as former super-dry Treasury Secretary, health funding chief and ACT candidate Graeme Scott said last year, such savings are limited and “if they (the National front bench) try to do this in a way that interferes deeply with the prerogatives of the DHB Boards and management there will trouble”.

And, after the 1999 desertion to Labour of middle class parents of tertiary students, rolling back the student loan charity would be suicide. The same goes for Working for Families, which can be undone only by dramatically raising thresholds, as promised in 2005. And so on.

So Cullen’s heavy spending regime will leave National with much less room for manoeuvre than in 2005. There will be lots of room for rhetoric about the Australian Elysium. But actually shifting votes on election day from Labour that didn’t move in 2005 will require hard numbers.

There is another option: deficit financing. This is the George Bush option. It is predicated on tax cuts stimulating economic growth and eventually making up for a (temporary?) big deficit. But that reckons without inflation and the Reserve Bank.

The Bank is in real trouble now. Inflation looks set to stay above 3 per cent for the best part of two years and still be pushing against 3 per cent going into the 2008 election. It will lean against loose budgeting.

In short, Cullen has pushed up against the fiscal limits. He claims to be conservative but has at most a small cushion against a house price retreat, a terms-of-trade fall or an international rebalancing that slows the American and Chinese economies — though, of course, he could claim extenuating circumstances and turn to debt.

So cross your fingers that it all goes to forecast, preferably the Treasury’s and still better the IRD’s. If not, it might be time for the tough to get going.