Savings incentives at the margin

Welcome to the Key-English tax world. The changes are the biggest since 1986 and bigger than analysts expected. But Bill English himself told the media they will change incentives “at the margin”.

This is the tension at the heart of the budget. Will New Zealanders give up their decade and a-half’s love affair with debt and houses and instead channel most of their tax savings into actual savings and actual productive investment?

Australia is ramping up companies’ subsidy of employees’ superannuation from an already whopping 9 per cent to 12 per cent, building up its already huge investment funds. Mr English has left KiwiSaver untouched and won’t add to the Cullen fund until 2018-19. It is a variety of “borrow and hope”: the tax package’s net cost in 2010-11 is $460 million, nine times new spending on research, science and technology.

But that is to see the tax package in static terms. Even in those terms the immediate tradeoff is positive for nearly everyone, even after the GST rise. Mr English says two-thirds of the cost of cutting income tax rates is in lowering the two bottom rates, covering 73 per cent of earners, and an average-wage earner with two children will pay net zero income tax after Working for Families.

But the budget’s longer-term economic and political impact is in its dynamic effect. If the cuts work as theory says they will, some portion will go into productive investment, higher productivity and so make people better off on higher real wages. They will like that.

That gives Phil Goff limited time to counter Mr English’s bulk cost argument with one of relative individual dollar gain by John’s Key “rich mates”. (Mr Key will meanwhile remind voters Mr Goff backed a 33 per cent top rate in 1986 and a 2.5 per cent rise in GST in 1989.) Four years from now this budget’s tax settings will be the norm and Labour might struggle to carry a case for cutting GST by slugging only the “rich”, who contrived the rorts, partly addressed in this budget, to escape the 39 per cent rate.

Meanwhile the budget boosts economic activity this year. Its new spending of $1.2 billion exceeds the much trumpeted $1.1 billion. The “fiscal impulse” equals 1.2 per cent of GDP — a fair chunk of the 3 per cent the Treasury projects for 2010-11 (and for the next three years).

That boost may help blunt the politics of the budget’s other tradeoff: the thousand small cuts in services as spending is “reprioritised”, which Mr Goff will exploit as they affect growing numbers. And, even though the fiscal position is enviable among developed countries and the vanilla economy got us through the last global shock, the economy and the government finances are vulnerable.

Longer term, the budget points to smaller government. Core spending is projected to fall from 35 per cent of GDP now to 28 per cent in the early 2020s. The last National leader to talk such numbers was Don Brash.