Week in politics: Tax cuts tricky balancing act

Has Michael Cullen successfully spiked National's plans to offer bigger tax cuts than those he unveiled in Thursday's budget? The Minister of Finance had no doubts he has left National with no room to move when he spoke in the debate on the taxation Bill, which was rushed through Parliament after the budget to lock his tax cuts into law.

Referring to National's yet-to-be-unveiled cuts, he gleefully described how he had stolen National's "fox".

Not only had he destroyed it. He had eviscerated it. And then he threw it back over the fence into National's backyard.

Parliament was left none the wiser as to the source of what sounded like some literary allusion. But everyone got the point.

Mr Cullen's reluctance to cut taxes before the public demand for such cuts became insatiable has been one of the glaring political mistakes of Labour's nine-year term in office.

It meant Labour could never get tax cuts to work in its favour.

Having finally accepted he had no choice, Mr Cullen is now trying to neutralise that disadvantage ahead of the election.

Mr Cullen's pre-budget ploy was to admit that, yes, while he had bowed to the inevitable, National's promised cuts would still be larger than his.

Then, on budget day, he confounded his critics with cuts which are far more extensive than had been expected from him.

Mr Cullen clearly examined every option - such as bringing forward the inflation indexing of Working for Families payments - to boost the amounts of money which will flow back into cash-strapped households from October.

No-one should have been too surprised Mr Cullen's package was more extensive than expected. Labour's dire electoral circumstances demanded it.

The financial markets were shocked, however. Interest rates in the bond markets rose sharply, despite the Government's bond programme being of similar size to previous years.

The markets viewed the budget as a highly political document, which did not match the pre-budget caution displayed by the Finance Minister.

Neither did it sit happily with Mr Cullen's reputation for orthodox fiscal management.

In going for bigger cuts, Mr Cullen has cut loose and is now willing to stomach a cash deficit of about $3.5 billion for the next four years.

It is a tricky balancing act, however. It required pushing the limits on fiscal prudence without provoking the Reserve Bank - worried about tax cuts stoking inflation - to either hike interest rates or delay a rate reduction.

However, rather than putting pressure on National, Mr Cullen yesterday found he was the one being accused of jeopardising reductions in interest rates.

He consequently spent part of the day trying to sweet-talk market commentators and economists via interviews with financial media.

It would be disastrous for Labour if Mr Cullen's tax cuts are negated by a mortgage interest rate rise.

Obviously, the flip-side is that taxpayers with bank deposits would enjoy the double benefit of tax cuts and higher interest rates.

However, Labour is targeting its package at electorally crucial middle-income households with mortgages. That still leaves National having to be equally careful on the inflation front.

And National also accepts that the fiscal impact of Mr Cullen's tax cuts along with his free spending proclivities combined with a slowing economy's negative impact on tax revenue will make it difficult for National to write an alternative budget which includes larger tax cuts without cutting Government spending in sensitive areas.

While Mr Cullen has always been something of spender - Labour's spending is not far off being double the level it was when it returned to the Treasury benches in 1999 - he has now pared back future spending to constrain National's ability to switch that money into tax cuts.

Core government spending is forecast to rise by another $4.5 billion next year - an increase of close to 8%. But much of that was already committed to past budget initiatives.

Mr Cullen has now also cut back the amount set aside in future budgets for new initiatives.

In the meantime, he has spent money on things National would find politically difficult to axe or require continued investment to function properly - most notably the rail and Cook Strait ferry services.

National might well find Government programmes that can be axed, delayed or cut. But any savings might not add up to be enough to fund what will be expensive tax cuts.

And it may instead have to be deployed into maintaining money- hungry social services.

While there are obvious items which could be axed by National, such as the $600-million plus set aside to expand the global reach of the Ministry of Foreign Affairs, many of these projects are the price of the support from minor parties, like New Zealand First, United Future and the Greens.

Unless National can govern on its own, it will have to reserve some cash to court partners to form a government.

National, of course, is perfectly entitled to set its own spending priorities.

But Labour is confident that National cannot reprioritise without something major having to give in health, education or other social services - and the public will not like it.

National, however, believes the public mood is changing as the economy goes into a steep downturn.

It thinks people are now willing to contemplate a hard look at Government spending, particularly when it involves the Wellington bureaucracy.

Fed up with Labour, voters are less suspicious of National changing spending priorities because there is a growing desire not just for a change of management, but also changes in policy direction.

To that end, National also plans to set different spending priorities to differentiate itself more from Labour and dispel the "me-too" stigma gained from matching Labour on difficult policy matters.

National has also given itself some room to move by saying it will fund capital and infrastructure through debt, whereas Mr Cullen has done so out of tax revenue.

Mr Cullen will consequently accuse National of borrowing to fund tax cuts - an argument which, according to Labour's research, has some resonance for older voters who remember New Zealand's debt problem of the 1970s and 1980s.

National, however, is not too worried about that.

It considers arguments about debt-to-GDP ratios to be of little interest to the bulk of voters consumed by the difficulty in meeting their own household budgets.

Above all, National believes that Mr Cullen's delight in seemingly leaving the cupboard bare for National has simply backfired on him by destroying his credibility.

Voters do not like Mr Cullen, but they respected him for his fiscal rectitude.

Now the weapons he used against National - that its tax cuts are a reckless gamble with the country's future - can be used against him.

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