With the election shaping up to hinge on the question of tax cuts versus spending, economics expert Brian Fallow crunches the numbers.

This story was first published on interest.co.nz

Tax cuts versus spending. The divergent fiscal priorities the two main parties will take to the electorate in September have been on display in the budget and the opposition reaction.

The government has opted to apply the benefits of a period of above-trend real growth, a recovery in inflation and exceptionally favourable terms of trade primarily to boosting households’ disposable incomes, chiefly through adjustments to income tax thresholds.

By April next year we will have had seven and a half years of bracket creep pushing an ever-growing share of household incomes into higher tax brackets. It is hard to quarrel with some unwinding of that passive or stealth tax increase.

The adjustments over-correct the lowest threshold for inflation but fall short of doing so for middle one. It would have had to rise from $48,000 to $53,500 not $52,000. The top threshold, above which sit the one in five taxpayers who contribute 62% of the income tax take, is left unchanged.

And while the budget’s increase in Working for Families tax credits will be helpful in the lower reaches of the income distribution, the abatement rate has also been raised. As a result a household with a sole breadwinner on the average wage and eligible for Working for Families would face an effective marginal tax rate which has risen to 55c in the dollar – or 67c if she is still paying off a student loan. Getting to keep only one in every three extra dollars earned is tough.

Labour’s response has been that all those years of fiscal drag have also been accompanied by a tight-fisted rein on government spending, the cumulative effects of which leave any number of public services seriously underfunded.

Why is the government dishing out $1,000 a year of tax cuts to those on higher incomes, they ask, when people are living in cars, and mental health is in crisis and (insert portfolio issue here)?

The government’s reply invariably takes the form: How can you talk of underfunding when we are spending (insert some nominal aggregate sum projected over the next four years)?

Comparing National and Labour spending records

But, especially at a time when the population is growing rapidly and inflation is no longer AWOL, it is real per capita measures of government spending that are more relevant.

So the time series measurement that tracks spending in real per capita terms, and the shifting shares of spending by the major classifications, which Toby Moore at Victoria University of Wellington and Derek Gill at the New Zealand Institute of Economic Research have compiled, is a valuable contribution to the fiscal debate.

Now that we have had a ninth budget from the current government it is possible to compare its record on this score with that of the previous Labour-led administration.

The difference is stark.

The government’s operating spend in the coming year will be just 0.6% higher in real per capita terms than in the fiscal year just ending. And it will be 3.5% lower than it was in fiscal 2009, the last year of Michael Cullen’s tenure as Finance Minister. That in turn was 24.5% higher than it had been in 2000, before his first Budget.

That point-to-point comparison and the difference between plus 24.5% and minus 3.5% is a bit unfair to National, however. The change of government coincided with the nastiest recession since the 1970s, which boosted welfare spending in Cullen’s last year and meant a correspondingly higher starting point for Bill English.

It also ignores the fact that the peak year for government spending in real per capita terms, and measured against the size of the economy, was the fiscal year 2011 when the Christchurch earthquakes hit an economy in the feeble early stages of recovery.

Looking instead at the average real per capita spending over the terms of the two governments, the VUW/NZIER data indicates a decline of 11.7% between Labour and National.

The declining trend in core Crown expenditure since the 2011 peak, both in real per capita terms and as a share of GDP, is even more stark when you consider that it has coincided with a relentless rise in the share of the budget taken up by New Zealand Superannuation.

In 2009 super accounted for 12% of the budget; in the coming year it will be 17%. In real per capita terms super will cost the taxpayer 35.5% more in fiscal 2018 than it did when National took office, against a comparatively gentle 7.5% increase over Labour’s nine years.

The effect is almost entirely demographic. The entitlement parameters have not changed over the 18 years we are looking at.

For the biggest ticket item, health, the opposite applies. Real per capita health spending next year will be 4.6% higher than in 2009, but that in turn was 26.7% higher than in 2000. At least the health spend has increased in real per capita terms under the present government and held its own as a share of the budget.

Spending on education, by contrast, will be 7.7% lower in real per capita terms in the coming year than it was in 2009. Welfare spending, which peaked in 2010 in real per capita terms as the recession flowed through to the labour market, will have fallen 22.5% by the coming year, the Budget forecasts.

The National government’s aversion to debt continues

The government’s interest bill in real per capita terms continues to fall, too, and in the coming year will be the lowest since 2010. In dollar terms finance costs peaked at $3.8 billion in 2015.

But even with 10-year bond yields trading well below 3% the National government’s aversion to debt prevails. Finance Minister Steven Joyce has emphasised that while the budget forecasts growing surpluses in the operating balance before gains and losses, a jump in capital spending on infrastructure is set to keep net cashflow roughly in balance and the ratio of net debt to growing nominal GDP continuing to decline.

Currently 23% of GDP (when the rich country average is 71%), National’s target is to drive it down to between 10% and 15% of GDP by the middle of the 2020s. Labour and the Greens have set a target of 20% in five years.

The Treasury’s projections, which include National’s planned tax cuts next year, have government revenue wobbling in a narrow range around 30% of GDP over the next 10 years, while spending continues to shrink from 28.8% of GDP now to 27.2% over the next five years. Labour and the Greens envisage a spending limit of 30% of GDP.

So there is some gap between the spending and debt trajectories of National on the one hand and Labour and the Greens on the other.

It will be interesting to see when Labour releases its alternative Budget whether the gap is enough to cover its preference for increased spending without cancelling National’s planned tax cuts, should New Zealanders vote for a change of government.

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