Bracket creep, or fiscal drag, brings on tax cuts

When is a tax cut not a cut? When it just reverses a rise.

As wages rise, they take some earners across thresholds into higher marginal income tax rates on their last dollars. Those people pay a higher proportion of their income in tax. It's called bracket creep or fiscal drag.

If their wage rises have outstripped the price rises of the things they buy, they might still feel better off. If not, they feel worse off.

That is why some argue for regular adjustments of tax rates by the amount wages and salaries rise. Bill English last adjusted rates in 2011.

In the 2015 Budget, he allowed for about $1.5 billion of income tax cuts in the pre-election 2017 Budget.

In a speech on May 12, he canned that in favour of more spending in this year's Budget on health and other social projects, "in recognition of the additional spending pressures'' from "higher-than-expected population growth'' and to take "opportunities to invest in better public services'', code for the new children's support services and other upfront "social investment'' initiatives to reduce long-term benefit and other costs.

More spending means less for cutting debt, which Mr English wants down to 20% of GDP net by 2020. So he is diverting $1.2 billion over five years from capital spending into debt reduction.

Four days later, John Key kept open a tax cut for 2018. He mused on $3 billion. But for now, he said, the public prefers more spending on health and education.

That is unsurprising: despite efficiencies, health funding, particularly of hospitals, has not compensated for technology-driven inflation and rises in demand from the migration-driven population increase and the population's ageing.

This could turn into a political embarrassment and, next year, an electoral problem.

Moreover, if there is "solid, sustained [economic] growth over the next few years'', as Mr English forecast on May 12, the case for stringency weakens.

A couple of days later at National's South Island regional conference, according to Richard Harman in Politik, he was forthright: ``We can't run the argument that there is no money.''

Why? Mr Harman said Mr English said the Budget would show "$6 billion surpluses'' in "two or three years'', by which Mr English later explained to me he meant 2020-21. The December fiscal update forecast a $4.9 billion surplus in 2019-20.

Surpluses are only part of the Budget story, similar to the "profit and loss'' part of a firm's balance sheet. Mr English wants eventually the equivalent of a full balance sheet. Thursday's Budget will move some way in "language and layout'' down that track.

But surpluses are relevant to spending rises and tax cuts. And bracket creep allows Messrs Key and English to present any post-2017-election tax plan dangled in the 2017 Budget as a cut even if it isn't.

Act New Zealand's David Seymour snorted that bracket creep since 2011 had already added $2.1 billion to earners' income tax bill. Mr Key's $3 billion in 2018 would be "more a tax reset than a tax cut''.

But don't bet the house on a "tax reset'', even in 2018.

Labour ruled it out at the weekend. But even National may face economic constraints.

While tourism and construction are offsetting the dairy doldrums, there are large external risks.

Mr English himself on May 12 instanced "ongoing low inflation, driven by low commodity prices'', "weakness in developing countries and recessions in Russia and Brazil'' plus "risks around China's rebalancing''.

He might have added: central banks in uncharted territory with negative interest rates; overpriced global sharemarkets; fragile European banks; some fragile countries; falling global trade and, some think, the beginning of a long flat economic period ("secular stagnation''); the Middle East mess and other geopolitical tensions, especially around China and Russia; and, distinctly possible, a loose cannon in the United States White House.

And China's "risks'' are big. One is debt, now 237% of GDP and rising, an alarming portion of it in default. "A tree cannot reach the sky,'' the government mouthpiece, People's Daily, quoted an "authoritative figure'' as saying. "Any mishandling will lead to systemic financial risks, negative economic growth and evaporate people's savings. That's deadly.''

To avoid "mishandling'' will require supra-human technocratic skill - by an autocratic party, under the most autocratic leader in 40 years, who increasingly uses repression as a governing tool. Don't bet on success.

Against that backdrop, not all analysts share Mr English's bullish view. Westpac's Michael Gordon was "sceptical'' on Friday of the economic outlook and likelihood of hitting the 2020 net debt target. Mr Gordon projected GDP growth at just 1.4% by 2019.

But, next year, National has an election to win. To do that, Mr English aims to starve opposition parties of oxygen by leaving little fiscal room and by recruiting not-for-profits to National's side in his "social investment'' programme.

Read Thursday's Budget in that light. Tax cuts can be small beer - in more ways than one.

Colin James is a leading social and political commentator.

ColinJames@synapsis.co.nz

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