New Zealand Budget 2008: Tax cuts

Both Kiwiblog (more on budget) and the Standard (more) have already mentioned tax cuts – giving us two different views about their situability.

Instead of looking at this, I’m going to have a quick look at the Macro-economic concerns stemming from this tax policy. First lets ask Mr Market what he/she thinks:

Source NBNZ

That was a 70 basis point increase in our trade-weighted index of our dollar (update, as of 4.25pm the lift hit 100 basis points, if we keep going we might get back to where we were before the employment numbers came out 🙂 ) – compared to the 40 basis point fall from the poor retail numbers and the 50 basis point fall from a reduction in employment. Damn!

What does this mean. Well following Dr Cullen’s commitment to $4.6bn a year of tax cuts (once they are fully introduced – WFF benefits are being taken as tax cuts as they have the same stimulatory impact) will have a significant impact on consumer spending now – reducing the RBNZ’s ability to cut interest rates in the foreseeable future. This is contrary to his statement that:

in the current climate of low growth, with downside risks coming from international influences, and an easing labour market, I am reasonably well-satisfied that the package will not lead to further rises in interest rates

The fiscal stimulus from the October cuts alone is $1.6bn (three times what I was expecting) and the knowledge that taxes will be cut in the future will promote borrowing now – especially in the face of high food and fuel prices.

On the plus side, the tax side of this package will increase labour supply incentives – and should have some small impact on savings rates. However, overall this is a demand side expansion rather than a supply side expansion – with tax cuts having been focused at the areas of the economy that will spend rater then save it.

The economy is looking increasingly fragile as the result of severe aggregate supply shocks. The total result of this fiscal stimulus now will be to drive inflation over 5% by September (Note: This is wild conjecture on my part – it is a pretty wild forecast) – without avoiding a technical recession over the first half of this year. This situation seemed like a possibility before budget day – now it seems more likely. If only tax thresholds had been inflation adjusted to start with!

Update: Why are people complaining about the size of these tax adjustments – anything bigger would have been fiscally irresponsible, fiscal change is a gradual thing (especially in a high inflation environment). Surely no-one was expecting us to just copy the Australian tax system immediately – such a move would have been economically ridiculous and National wouldn’t have done it either (although they may have cut the taxes in different areas). Although to be fair not everyone is complaining.

  • goonix

    I think people are complaining as these changes should have been made a long time ago. People can see that restoring the tax situation from 9 years ago isn’t really a great break.

    Too little too late.

  • “I think people are complaining as these changes should have been made a long time ago”

    I completely agree that the tax thresholds should have been inflation adjusted – I’m not even sure these tax cuts adjust for the fiscal drag we’ve faced over the last nine years.

    However, if we adjusted tax all at once to do that the stimulatory impact would be too much too soon. I almost feel that this was a bit too much given that I believe our economy is slowing on the back of a couple of negative aggregate supply shocks rather than a collapse in demand.

    We’ll see – I’m still picking headline CPI inflation of 5%+ come September.

  • Kimble

    I think also that people are complaining about the tax cuts PLUS a massive spend up pushing NZ into cash deficit, as well as the apparant complete abandonment of prudent fiscal management as a principle.

  • goonix

    It’s possible. But a large proportion of that inflation is being driven by external factors outside of our control. I don’t see that as a reason to not give back what’s rightfully mine (and yours). 😛

  • goonix

    I mean to say that CPI of 5% is possible.

  • Hi Kimble,

    “I think also that people are complaining about the tax cuts PLUS a massive spend up pushing NZ into cash deficit”

    I agree with that concern as it does seem hypocritical. Colin Espiner did appear to be complaining about the size though – which I thought was entirely unrealistic.

    Heya Goonix,

    “But a large proportion of that inflation is being driven by external factors outside of our control”

    Last year it wasn’t – some of it might be now. The main thing is elevated headline inflation will keep inflation expectations up, which will lead to the good old wage-price spiral.

    Although people like to say that its petrol and food causing inflation, but those are relative price movements, not inflation – if you look at the numbers, underlying inflation is strong and it is all over the economy.

    “I don’t see that as a reason to not give back what’s rightfully mine (and yours)”

    Even if inflation was solely in the tradable sector, and so we could look past it, its not completely true that the tax we pay is “our money”. It could equally be construed as the firms money – which it has to pay to hire you. Remember the deadweight loss comes from a mix of lost producer and consumer surplus 😉

  • Kimble

    5%+ inflation, dear god. Its a poison pill budget.

  • goonix

    When I said yours and mine, I was including in that definition business and everyone creating wealth (i.e. not the government).

  • Kimble

    In before goonix, the employee does not extort wages from their employer.

  • Kimble

    damn

  • “5%+ inflation, dear god”

    I’m being a bit cheap picking 5%+ for September – as government subsidies in September 07 artificially lowered the price level, and so about 50 basis points of the increase is a result of that 🙂 .

    Furthermore, rent pressures, oil, and food prices will definitely take underlying inflation over 4% in June – so all I’m saying is that the fiscal stimulus needs to add about 50 basis points to inflation pressures to give us the magic 5% mark.

    “When I said yours and mine, I was including in that definition business and everyone creating wealth”

    I see I see. Could the government not claim that it improves the transaction of individuals and so take some credit for the creation of individual wealth 🙂

  • “In before goonix, the employee does not extort wages from their employer.”

    🙂

    The government does not extort either, if we assume that we are all part of a social contract which we would not want to voluntarily exit 😉

  • Kimble

    ‘social contract’?

    hippy

  • ” ’social contract’? – hippy”

    I believe collectivist liberal would be a more appropriate term 😛

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  • “5%+ inflation, dear god. Its a poison pill budget.”

    Just to be clear, 5% inflation in September (as well as 4% in June) would require a 1.6% lift in prices over June and a 1.5% lift in prices in September (on the earlier quarter). These numbers are very big, and would require significant tradable inflation – as non-tradable inflation is not entrenched at levels that high.

    At the moment, the possibility of 5% inflation seems pretty far out there – but it does seem to seriously be a possibility given the mix of factors (such as September being a relatively low base because of subsidies, the possibility of large falls in the exchange rate, and the entrenched nature of price growth in oil and food prices) and now the introduction of further demand side pressure with tax cuts.

  • The possiblity of large falls in the exchange rate is the main reason we will not see lower interest rates. Fuel price feed inflation world wide and higher global interest rates, including in the US will be the feature later on this year.

    Add in tax cuts and a stronger AUD/USD and the NZD/USD will again test 0.8000 plus!!

  • Ged

    Won’t those 70 extra basis points help to contain inflation, rather than increase it?

  • “Won’t those 70 extra basis points help to contain inflation, rather than increase it?”

    You are right that a rising exchange rate does lead to lower tradable inflation – but this effect is secondary to the impact of a huge demand stimulus on inflation.

    Think of it this way. The exchange rate only increased because the market now expects interest rates to stay higher for longer. The market only expects interest rates to stay higher for longer because this additional government spending will stoke already high inflationary pressures.

    As a result, the exchange rate effect will have some dampening impact (although to be fair it is still lower than it was pre-employment numbers), but the total impact of the tax cuts will be too lift inflationary pressures.

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