So judging by this speech here, post Budget

Labour will take a different approach
to savings,
to exports
to foreign investment,
to monetary policy, and
to support for research and development, and innovation and skills.

How are these policies different – and what trade-offs are involved.  That is what we will discuss here.

At least from this speech, it appears that Labour’s policies are very close to Nationals – the parties have both moved towards each other.  However, there are two primary differences:

1. Labour wants more words in the Reserve Bank Act,
2. Labour wants more state involvement regarding savings, spillovers, and exports.

Furthermore, the primary reason for the first difference is because of how the Labour party believes it will impact on the second issue.

In the same way National stated that they want to rebalance the economy and increase savings, Labour differs in so far as it wants to do the same thing.

Wait, what?!?!

It sounds strange doesn’t it.  Both main parties seem to talk the same talk deep down – “New Zealand needs more savings, more exports, blah”.  However, implicitly neither party is targeting a sole focus on these issues, this is just how both parties have chosen to frame their policies.

Essentially, Labour wants marginally more state involvement in the allocation of savings and production/exports – but both parties agree that the country has found itself in a situation where there is something funny with the incentives to save/borrow/work.

So how are they different

Overall, if Labour released an alternative budget it would involve more government spending than the National budget – and as a result it would have to involve higher taxes.

My impression from the speech is that Labour believes there are areas with “positive externalities” in the economy – where the government can improve outcomes by investing.  Examples of this are R&D spending and tertiary education/skills training.

Now it is important to keep all this in mind when stripping back the rhetoric – Labour’s justification for higher government spending is based on mainly on efficiency in the post-Budget speech.  As a result, the only reason they really have a different budget to National is because they believe in larger spillovers from investment in skills and technology [on that note, link].

Savings, exports, and monetary policy

On these three issues it is really unclear exactly how Labour does differ.  There is a difference between stating “we wish we had more savings, we wish we made more stuff, we wish monetary policy would give us stuff” and actually having policies that could deal with the inherent trade-offs in society.

Furthermore, each of these issues isn’t really a target in itself – it is a means to an end.  The decision to save is a personal one based on the the value of future and current consumption and the rate of return on savings.  If we think that this rate of return is different from where it should be then the policy should really look at that market failure rather than savings per see right?

On exports, we are sending stuff overseas and we get paid for it – paid so that we can buy stuff.  Exporters face the market price for goods, we would again need a market failure before we could really justify intervention.  One example of this is “spillovers” once again.

On monetary policy, it is important to note that “all these other countries with multiple targets” effectively still just target inflation in the typical sense (things are a bit funkier when we have a supply shock, but central banks know this) – they just have to add fluff to their statements so politicians are happy.  The main risk from changing their statements is that it reduces transparency and accountability, and to be fair I can’t see any benefit … at all.

Their discussion on prudential policy is fair, but it isn’t clear how they want to do it.  They seemed to have broadened their outlook from this period.

As a result, I only see actual changes in policy through “spillover externality” targeting – so essentially Labour is aiming for a specific type of higher government spending than National.

Conclusion

To reiterate what I think is a major point of interest though:  Labour has a different view of the efficiency trade-offs in society than National.  This is an issue that could actually be tackled by research!!!  It is not an equity issue – the two main parties actually differ in their belief regarding allocation issues.  I think that is pretty interesting.

This difference leads Labour to believe we need a higher level of government spending (and thereby taxes) even if the inherent “welfare function” that the two main parties are looking at is the same.

First here are links to other round up post round the country as of now:  Offsetting Behaviour, The Standard, Red Alert, Kiwiblog (*,*,*,*), Dim Post, NZIER, Infometrics, Rates Blog (*,*,round up post!), NBR, Not PC (*), Public Address, Education Directions (*,*,*).

So far we’ve done a review of the ACT and Libertarian alternative budgets.  Now it is time for the actual Budget, and then if we see any other alternative budgets we will have a look of them too   When reading all these reviews, keep in mind that I am aiming to be critical – I am putting up trade-offs so I will NEVER say “that is a good policy”.  I am not trying to say I hate any of these groups by doing this, I am just trying to describe other ways to look at policies to give them context.  If you keep that in mind when looking, then hopefully it will be useful.

Ok, so let me roll with my personal opinions – hopefully supported by a sound economic framework

Also note that this is a first brush on what seem to be the main issues.  Over the next few days I plan to get down into more specific policies – and I will see if I can discuss some things through the weekend.

Was it a surprise?

Generally it wasn’t in my opinion.  The cut to the second tax bracket was bigger than expectations, not letting rental property owners claim losses to get WFF was harsher, and it was generally more “stimulatory” than expected.  Overall, it will act as a slight upward surprise for the RBNZ when setting monetary policy – so interest rates might be marginally higher.

It was definitely a shift in policy – although I would argue that the magnitude of the shift is being heavily exaggerated.

For example, everyone talking about the increased incentive to work forgets that we are paying for income tax cuts with consumption tax increases – implying that the buying power of said income is likely to drop.  There will be a shift, but it will come from the fact that GST doesn’t tax interest while income taxes do …

And the suggestion that this is going to completely change the equation regarding whether to move overseas – LOL.  It is such a marginal factor.  I can’t see why we are so concerned with individuals making choices about where to live – if we are worried they are taking skills we invested in the issue is to do with society paying too much for skill training rather than people have the freedom to move …

On marginal factors – what about the cut in the corporate tax rate.  What was the estimated benefit from it?  Or were we just trying to match Aussie .  It may be a good idea, but its not going to lead to a flood of investment – and whatever investment turns up on the basis of a slight cut in corporate taxes will only be a very marginally profitable investment opportunity right …

How would you rate it – like you have the other “alternative budgets”

By default this budget has the advantage of being based on an elected mandate – and as it stuck to election promises it is likely to support whatever social preferences are in some sense.  People can debate this, and they should, but this is not an issue for an economist.

As a little old economist, it is alway important to point out what the policy decision will do – and what these trade-offs are. In that sense, it will get rated just like the ACT and Libertarian budgets – with description and criticism.  Given that this budget has more detail, the post is going to be longer though

Just let me find some old TVHE blog posts to help inform this

The compensated lift in GST: In terms of a proportional tax on lifetime income, both GST and income tax do the trick.  The main issues are regarding the timing of tax payment in a persons life, the relative tax treatment of interest, the choice of where to produce/consume, and the idea that the tax may fall more heavily on exports/imports.

The first issue, timing, is a very difficult one and the welfare consequences are not clear.  Read some concerns here.  Also, when changing those that have saved are punished, those that have borrowed are rewarded.

The second issue is one of interest.  Income tax falls on interest, consumption tax does not.  Therefore income tax creates a wedge between interest rates received and paid – which is inefficient.  However, GST needs a higher base rate as it does not tax interest income.  Overall, through this channel a switch to GST will improve savings incentives.

The third issue is that GST does promote more “production” in the country directly.  It also promotes less “consumption”.  This is weird as production is the creation of goods to consume – which we get value from.  Fundamentally, the idea is that – by putting the tax burden on when you buy instead of when you earn – people can avoid tax by moving away when they are in low earning stages.  It will be interesting to see how significant this issue is – my feeling is not very at present levels.

The forth issue involves the idea that switching to GST is (relative to income tax) a subsidy to exports and a tax to importers.  I have said in the past I think it functions this way.  The eminently more intelligent Greg Mankiw has said this is not the case.  I agree with him that the real exchange rate is what matters.  My main point is that, by not taxing value added on exports and taxing some portion of value added on imports twice it seems to be that the real exchange rate would be different.  However, hearing him say otherwise definitely reduces my faith in my own logic

Investment (Housing):  Housing got a little more slammed than I expected in the Budget.  Namely this puppy “preventing property investors from using rental losses to inflate Working for Families eligibility and payments”.

Personally I don’t understand it.  If people can use other losses to induce payments why exclude a single asset type?  If it was only housing that allowed this – then I say fair game right.

New Zealand has “overinvested” in residential housing.  Prices are likely inflated.  Sure.  But we should look at the reasons why housing as an asset class has got preferential treatment – and then make sure all asset classes are treated the same, rather than throwing in hodge podge attacks.

Here is a question, why do we tax interest (the return on one type of asset) and not the rate of return on many other assets.  If we should be treating asset classes equally – that is where the focus of policy should be.  If we shouldn’t be treating assests equally, we should say why before we introduce/keep distortionary polices!!

Now before anyone calls vested interests, I have no house – so I am effectively “short-housing”.

Also, before anyone says housing isn’t a productive asset – it produces a service called “somewhere to live”.  So it is a productive asset

Investment (Corporate Tax):  And more investment news.  Corporate tax rates were cut.  Rightio.  I am a little strange for an economist it seems as I’m not very excited about corporate tax cuts per see – I just think that the tax system as a whole should more clearly represent what we are after.

The way I see it is here.  Corporate tax cuts will let marginal projects go ahead – but it isn’t going to lead to a massive “flow” of capital.  People that think we need the same rate as Australia are dreaming.

Conclusion

As you will note, all three of these policy initatives were focused at tilting consumption away from now and towards the future (through investment).  There was a distinct lack of other policies, which is fine.  Overall, this was the sort of direction that was signalled and expected.

The surprise has to be the lack of fiscal neutrality in the short term.  Something that will lead to a sharper reaction by the RBNZ – although off the top of my head I think that at this scale this is a very minor issue (especially given the medium term supply side impact of the tax cuts.

Now, I think the Budget was fairly well put together.  My post may have seemed very critical – but that is just because that is how I have to do these budget discussions.  There is NO budget that would have lead me to start going on about how great it is.  Given that it is in line with expectations, I have linked above to many posts where I have discussed the policy issues previously.  Feel free to read them if my criticisms seem to lack context in these posts.

The key point is that there are trade-offs, and its up to society to decide whether they think the government has gone too far one way, or not far enough.

I will write tonight, and other authors will pop things up today – I can’t do any sooner as I am out of the office.

It looks like it was a substantial change to tax rates – most of which were expected.  On the spending side things are how things usually are.

I am glad to see more people doing alternative budgets, but as always I have some concerns:

1. It is subject to the same criticisms as Sir Roger’s budget – namely the trade-off between equity and efficiency is not based on the revealed democratic process from the previous election … although having a transparent budget DOES mean that people know what they are voting for in the future.
2. The limiting scope of government in there budget is far too extreme – even if solely on efficiency grounds.  Why?  It ignores any scope for co-ordination issues and the such in government policy.  However, the size of this issue depends on relative value judgments – so I really just think they are saying that they have a value judgment that other co-ordination issues are irrelevant, which is fair enough I guess.
3. Also – it presumes optimal redistribution equals zero, which is highly unlikely given that luck and the such does exist.
4. It targets a tax rate of zero while still having government spending – based on a belief that voluntary provision of funds will be sufficient.  However, I disagree.  If we want any central government we have to have some type of “coercive taxation”.  Setting the tax rate to zero is effectively the same as asking for anarchism as it implies that this specific governmental institution will disappear into irrelevance.

Fundamentally, redistribution is a valid role of government – and the libertarian party bases its policy on the idea that it is not.  There is no theory – even among many of the most right wing economists – that justifies zero redistribution.  However, they are transparent about their value judgment here and they are consistent between budgets, so that is good of them.

So now we have an ACT and a Libertarian budget – the National (government), Labour, and Green ones will be still to come (if there are any others yell out to me).  Very exciting.

Update:  Link for Libs release here and excel sheet here.

GST hits poor people the hardest because nearly all of their money is spent on things that you pay GST on – food, petrol, electricity – so any increase is going to really hurt them

Interesting.  I was under the impression that low income households spent proportionally more of their income on “housing services” (read rents) which are exempt from GST …

Also if we believe that the poor have borrowed relatively more of their income in the past, then an unexpected decrease in a flat portion of income tax and an increase in the flat portion of GST will actually be a transfer too them from people who have saved.

It would be pretty easy to spin the idea that higher GST and broadly lower income taxes would help the poor … but I guess that wouldn’t roll with his politicking now would it

This is the first set of policies for the Budget, so it is the first post for our “Budget 2010” series.

Kiwiblog has a great rundown, I’ve only got a few points to add:

1. Yes it would increase efficiency and GDP.
2. Yes it would have “equity” costs.
3. Given that no party was elected on the basis of this sharp a change in “redistribution” between equity and efficiency it isn’t the budget I would recommend for actual policy at the current time.
4. I do applaud Roger Douglas for doing a realistic run through of what his budget would look like though – I respect transparency.

As more Budget or alternative budget details come through we will have a crack at looking at them.