Make expansionary fiscal policy work – give it to the technocrats

I have no doubt that my views here will be contentious – but they need to be put forward nonetheless.

I think that Treasury (or some mix of part of Treasury and IRD) should function at arms length in the same way as the Reserve Bank, and that they should set tax rates in the same way that the RBNZ sets interest rates.

Now, let me discuss why.

In a recent article on stabilisation policy I put forward that, as long as we can use monetary policy we should prefer it. Now I critiqued other assumptions that I made, but I did not attack this or explain it.

Fundamentally, my mistrust of fiscal policy is two fold:

  1. The “inside lag” associated with fiscal policy – namely it takes a long time to sort out what policy is appropriate.
  2. The “pork barrel politics” associated with fiscal policy expansions, where a politically expedient expansion is not the same as the best type of fiscal expansion.

Without these type of issues, fiscal policy has a role as a potentially “more timely” way to get a stimulus rolling.

Now, if we accept that a “fiscal stimulus” can increase demand in the economy, either by propping up demand for under-utilised resources or countering some sort of household level credit constraint then there could be a role – but that role will never be useful in the face of government bureaucracy.

One way to deal with this that has been suggested is more “automatic stabilisers” such that taxes and spending change when GDP growth falls to a certain level, or unemployment rises. However, given the subjective nature that is required to evaluate this data it seems difficult to set appropriate stabilisers.

As a result, I am suggesting the separation of Treasury, and tax setting, from the actual government, which determines spending.

But no tax with representation!

A common argument against this sort of thing is “no tax without representation“. Technocrats are not elected so why should they determine our tax burden. Well they aren’t really.

The government sets a level of spending, the technocrats merely figure out how and when we should raise the funds to meet this level of government spending. As a result, the elected official do determine the tax burden – however, the “cost” of this spending (the impact on taxes) is now MORE TRANSPARENT than it currently is.

As a result, not only can taxes by changed to provide stabilisation (or not changed when the government adjusts fiscal policy), but the tax burden the New Zealand public faces will be more directly shown to be a determinant of the level of government spending.

Imagine – political campaigns will no longer be about “tax cuts” themselves – but on the quality and quantity of spending.

But it doesn’t seem right that the Treasury can change the price of goods/labour

At the moment the RBNZ transfers funds between savers and borrowers in order to stabilise the economy. In a similar fashion the Treasury will be doing this for income earners and consumers. The main goal is that the impact of these redistributions cancel out over time – then we are left with a situation where (hopefully) no group is made worse off and the cost of uncertainty from the economic cycle is diminished.

Truly, if we are fine with our interest rate being set centrally by technocrats, I can’t see why we wouldn’t do the same with taxes – the government will maintain control of spending, which allows it to redistribute to its hearts content, which is really the primary purpose of the elected officials.

UpdateAccomplice in the Wood Chipper muses on the same issue.

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  • One problem is that governments that want to spend more or less than what they collect in tax, will find inefficient ways to do so.

    If they want to spend less, they can just return the difference in benefits, with transaction costs and perverse incentives compared to not collecting it in the first place.

    If they want to spend more, they can just borrow, thereby forcing Treasury to increase taxes so we can repay it. Or they could find inefficient ways to raise extra revenue, e.g. road tolls or vehicle license fees instead of a petrol tax.

  • Hi Nigel,

    “If they want to spend less, they can just return the difference in benefits, with transaction costs and perverse incentives compared to not collecting it in the first place.”

    Benefit spending is spending less 😛 I can’t really imagine a situation where the government would want to “spend less” – and so I assume that in this case Treasury would probably look at immediately cutting taxes.

    Their goal would be keeping the budget balanced in the “medium term”.

    Furthermore, I think the cost of “churn” is very over-rated in New Zealand – as computer systems become more efficient churn will become a complete non-issue.

    “If they want to spend more, they can just borrow, thereby forcing Treasury to increase taxes so we can repay it. Or they could find inefficient ways to raise extra revenue, e.g. road tolls or vehicle license fees instead of a petrol tax.”

    This is an important point agreed.

    There are two things here – first, they “overspend” and Treasury increases taxes.

    That is what we want to happen – and Treasury then tells the public, if the government wants to spend that extra we have to pay more. It is more transparent then current policy where the tax cost is often treated separately from policy. As a result, I see this as an advantage.

    The second thing, “other taxes” is an important issue to sort out.

    Ultimately, tax rates on other things should be set by Treasury as well so the government has no way to “raise” revenue – the government should pick a spending path and the way of raising that spending should be determined separately.

    The problem is though that a “petrol tax” is often termed an “externality tax” – the purpose of this tax is to actually achieve some policy with pre-determined value judgments, a subject which involves the “role of government” rather than technocrats.

    As a result, “externality taxes” do pose a potential difficulty – if in a policy targets agreement the government can state that externality taxes should be set to maximise “efficiency” then we have no problem, but it would be hard to get agreement surrounding that.

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  • DG

    It is one thing to have a central bank set an interest rate, its another to hand over the complexity of tax rate setting, with all its implications and interactions with the social welfare system, to a central authority….with one proviso…a variable GST within certain defined limits is something that could be handed to the RBNZ to be run on a tax neutral basis over the economic cycle.

  • “It is one thing to have a central bank set an interest rate, its another to hand over the complexity of tax rate setting, with all its implications and interactions with the social welfare system, to a central authority….with one proviso…a variable GST within certain defined limits is something that could be handed to the RBNZ to be run on a tax neutral basis over the economic cycle.”

    I think we are very much on the same page here – it is just the way the issue is framed.

    It seems that many people agree that a flat, single rate, tax could be set by a central authority – however, the other welfare considerations associated with other tax types have to be taken into account.

    This is an issue of design isn’t it – give a flat tax instrument to some independent body subject to a PTA. Use the PTA to set the other taxes relative to this central tax (as well as setting up the “medium term” in some more detail. And furthermore, the government can adjust benefit policy to try and “increase progressiveness” if that is its prerogative.

    However, having this central tax set centrally will still add transparency and make stimulatory fiscal policy a possibility.

  • I really like this idea. I would love to see elections where the main issue is spending rather than tax cuts.

    But I agree that the design will be difficult. Personally I would like to see us tax areas where there are externalities more, e.g pollution, water use, possibly replacing some income taxes. These sorts of structural issues would become more difficult if we hand over tax to a third party, as they are contentious and probably best decided on by elected representatives.

  • “Personally I would like to see us tax areas where there are externalities more, e.g pollution, water use, possibly replacing some income taxes. These sorts of structural issues would become more difficult if we hand over tax to a third party, as they are contentious and probably best decided on by elected representatives.”

    Very true – externality taxes are a huge sticking point.

    The best way I can think of them is that they should either be set in the PTA, or set “relative” to the general tax measure in the PTA – depending on how we view the “externality tax”.

    I would prefer that revenue is raised through externality taxes instead of other forms of tax myself – hell we are getting efficient price signals and some revenue 🙂