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Budget 2008: An Admission of Failure

Budget 2008: An Admission of Failure

What should we hold a government accountable for?

The answer would seem obvious: whether it is achieving the goal which it has stated to be its “top priority’.

The current government has been unequivocal about its top priority goal: to get New Zealand back into the top half of the OECD income range. Prime minister Helen Clark reaffirmed that goal in parliament earlier this year.

Finance minister Michael Cullen has said that the government needs to achieve 4% plus annual growth in real GDP on a sustained basis to achieve it.

The goal is important and achievable. Economic growth – or more precisely growth in real per capita incomes – means the difference between hardship and a comfortable standard of living for many. Over the past 20 years Ireland and Australia have lifted themselves from below-average OECD income levels to well into the top half of the range.

Measured against this “top priority” goal, the budget is an admission of failure. Indeed, the goal is not even mentioned. It is not difficult to understand why. The economy’s average growth rate is falling, not rising.

Over the so-called forecast period (the next four years) annual growth in real GDP is expected to average only 2.5%. At that anaemic rate New Zealand will be lucky not to fall further down the OECD income ladder, and the income gap with Australia will almost certainly widen.

This depressing outlook should be no surprise. For years the Business Roundtable has been saying that the government does not have a credible strategy to achieve its goal. The clearest evidence of failure has been the slump in productivity growth relative to the 1990s. Labour productivity growth in the measured sector of the economy (essentially the business sector) has fallen from an average of 2.6% a year in 1992-2000 (after the reforms of the 1980s and early ‘90s began to pay dividends) to just 1.1% a year in 2000-2007, a lower rate than in the last economic cycle in the Muldoon years (1.4% in 1982-85).

As the budget rightly noted, “New Zealand needs to significantly lift productivity in order to build a high value, high wage economy to better compete globally.” Plainly this is not happening.

It is a prime role of the fourth estate – the media – to hold governments accountable for their commitments. Few journalists even mentioned the government’s growth objective in their commentaries. No doubt many had cynically discounted it years ago. But is this good enough? This is an issue that goes to the heart of people’s living standards. If the voting public does not have an informed understanding of the credibility gap between the government’s policies and its goals, it can commit fraud on the electorate.

Several other important issues were underplayed in budget commentary.

The first and related one is that the budget was all about redistribution, not economic efficiency and growth – about redividing the economic cake not making it larger. Indeed Michael Cullen openly admitted that he has taken redistribution as far as it could go. He made no claim that the budget was directed at achieving faster growth.

The lukewarm reception the budget received, after many taxpayers realised they would only benefit to the extent of a block of cheese a week from taxation and spending measures that completely wipe out future operating surpluses, will bring home to many people the limits of income redistribution. (For a good treatment of this issue, see Mark Harrison, The Outcomes of Income Transfers, Only a rising economic tide can lift all boats. There has been too much talk of reducing wage gaps with Australia by cutting taxes (and thus improving after-tax incomes). As Peter Conway of the Council of Trade Unions said after the budget, “The wage gap with Australia cannot be closed by tax cuts. It requires ongoing wage rises for New Zealand workers.” In turn, wage rises must be underpinned by productivity growth – they cannot be conjured out of thin air.

To restate this point: overall material living standards depend on gross incomes, not incomes after tax. Gross incomes are determined by what we produce. Tax merely divides the cake between what governments spend (which matters for living standards if the spending delivers value for money) and income available to be spend privately. The focus must be on the incentives needed to encourage productive activity, and excessive redistribution blunts incentives to work, save and invest.

Another aspect of redistribution is poorly understood. As the 2001 McLeod Tax Review pointed out, most redistribution occurs through government expenditure – on services such as health, education, welfare benefits and housing – not through the taxation system. This point will be brought home to those who notice that the difference in the weekly gains to people in different income categories from the personal tax cuts in the budget is not great. The current progressive income tax system (the PITS) owes its origins to Karl Marx, writing in his Communist Manifesto of 1848. The McLeod Review pointed out that in practice a flatter or more proportional tax system redistributes just about as much income as the PITS.

Progressive taxation ultimately rests on envy, not compassion for the poor.

(See Cathy Buchanan and Peter Hartley, Equity as a Social Goal, By cutting the bottom tax rate to 12.5%, Dr Cullen has widened the tax scale and made it more progressive, rather than moved towards a lower and flatter tax structure as recommended by the McLeod Review.

PricewaterhouseCoopers chairman John Shewan has made the point that “sharply progressive rates that result in a family with two children on $80,000 paying 14 times as much tax as the same family on $45,000 result understandably in perceptions of unfairness.” The top 15% of taxpayers (people on over $60,000) currently pay 55% of personal income tax; the bottom 47% pay less than 10%. This is a dangerous state of affairs in a world of highly mobile taxpayers, and it sets up worrying political dynamics with a large group of people having incentives to lobby for more government spending at others’ expense.


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