In New Zealand we are currently concerned about a downgrade from S&P. They want us to be running operating surpluses from 2014, and we aren’t quite sure how to do that in the face of a massive global recession. The suggestion I have is to increase GST rates from 2011.
Now, if we believed that Ricardian equivalence was holding in its entirety any solution with taxes would be silly – as higher taxes would merely lead to higher private borrowing. As S&P is truly concerned about our national debt position this wouldn’t help.
However, pure Ricardian equivalence does not hold – especially in the face of a highly uncertain and credit constrained economic environment like the one we have now.
If the government can commit to increasing GST rates from 2011 they can both:
- State that they are increasing taxes in a way to fill the budget hole – taking us back to operating surpluses in our forecasts and preventing a downgrade (which would have a similar cost except that all the money would be heading offshore),
- Reduce the relative price of spending now compared to the future – increasing “aggregate demand” now at the cost of demand in the future. Given that prices are sticky in the short-term, and the increase in GST rates enters firm and household expectations of future prices, we only really care about movements in “aggregate demand” in the short term – so this seems super.
The main concern would be that a lift in GST would increase long-run taxes. However, if the economy moves back to potential (output) and the tax take becomes too large we can just can personal income taxes – thereby flattening the tax base and reducing the tax on savings. Sounds good to me.