Lurking laws of Budgets and taxes
Colin James's Management Magazine column for May 2012
It's Budget month, Bill English's fourth. He's back to zero net new spending, this time because of weak revenue, not an earthquake. This is a big political gamble. And it illustrates a lurking law of taxation.
The gamble is that voters in 2014 will care more about a return to fiscal surplus than about service guarantees. That might be a risky call.
In the 2011 election campaign John Key irreparably damaged Phil Goff with his "show me the money" taunt in the second one-on-one debate, imputing fiscal irresponsibility. Labour was already far behind. That set it back even further.
But a zero-new-spending Budget (as in 2011 after the second Christchurch earthquake) will likely mean some services cuts this coming fiscal year. More with less is achievable for only so long in the short term and new methodologies that do enable it need longer to mature than National has allowed.
Likewise, if English sticks to his February Budget Policy Statement track for 2013-14 and 2014-15 of $800 million and $1.2 billion net new spending, that will barely keep pace with rising health and education demand and also maintain other services before the election, which will be no later than November 2014.
The priority targets announced in March might also cut into services not accorded top priority. Ministers want to parade the priority "results" in the election campaign. That will put agencies under intense pressure to deliver those results, potentially at cost to others.
Ministers might then find accumulated voter grudges about patchy services outweigh voter acclaim for fiscal probity.
English's best hope will be that the economy grows faster than the Treasury projects, growing revenues faster and giving him more leeway for new spending while still delivering his surplus.
That was a good part of the motivation for the tax switch in 2010 when English traded lower income tax rates for higher GST. Lower income tax is supposed in economic theory to make an economy go faster and deliver higher total revenues from the lower rate.
But the 2010 vote switch uncovered a lurking law of tax: that if a rate gets too high, escape hatches are demanded and appear.
When the top rate of income tax was 66 per cent in the early 1980s, the tax system was riddled with exemptions, concessions and loopholes.
When Michael Cullen took the top income tax rate back up from 33 per cent to 39 per cent in 2000, making it harder to save, he introduced PIEs (portfolio investment entities) under which savers could still pay 33 per cent on earnings from approved savings funds. PIEs are still with us.
When English upped the GST from 12.5 per cent to 15 per cent, the voices demanding GST be taken off fresh fruit and vegetables got more strident and persistent and the Labour party put it in its election platform. At 12.5 per cent Labour had resisted pressure for exemptions in favour of the "broad base, low rate" principle that has guided most tax policy since 1986.
English back in 2010 would not countenance broadening the base to include a land tax and/or income tax on capital gain or "green" taxes. By instead upping the GST rate, he triggered the exemption response -- incidentally widening the gap with Australia's 10 per cent.
Labour is likely to ditch the GST concession, having concluded that it is unlikely to get poor people to swap from bad food to good, which was one of its beliefs. Instead, Labour is likely to keep its capital gains tax and, if in coalition with the Greens, widen the range of green taxes beyond petrol and waste.
But Labour still wants to raise the top income tax rate. You can lay bets now on the response of the subsequent National-led government.
Budgets are not just about numbers. They are also about all-too-human behaviour. As all Finance Ministers eventually discover.