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Post Pre-EFU The Tax Cut Competition Heats Up

Post Pre-EFU The Tax Cut Competition Heats Up

Election Fiscal Update Shows Little Room For Tax Cuts - But Labour Offers Some Anyway
By Alastair Thompson

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Click here for streaming video

Finance Minister Michael Cullen this morning unveiled the economic projections which will form the playing field for the economic debate of the election campaign, an economic playing field with little apparent room for immediate tax cuts as promised by the ACT and National Party.

However as soon as the Pre-EFU briefing was over Dr Cullen nevertheless announced a $1.3 billion tax cut policy for middle income New Zealand families.

The Pre-Election Economic & Fiscal Update (Pre-EFU) is required under the Fiscal Responsibility Act and can be read in full on the Treasury website (CLICK HERE).

In form the Pre-EFU is essentially the same as the economic and fiscal updates published by Treasury before (PREFU) and during (BFU) the budget each year. All fiscal updates are by law required to forecast three years into the future, which in the case of the Pre-EFU is the term of the next Government.

In his statement accompanying the release of the Treasury forecasts Dr Cullen focused on the changes in the NZ Government's financial fortunes from 1999 to Treasury's projected figures for the state of the economy and Government spending in 2006.

Specifically he points to.
- Unemployment falling from 7% to 3.9%;
- Vote Health expenditure rising by 63.4%
- Vote Education expenditure rising by 51.2%
- The "social dividend" in the Working For Families package of last year;
- A reduced debt to GDP ratio from 32.8% to 23.3%
- Accumulated financial assets in the NZ Super Fund of $6.6 billion

Where the Pre-EFU gets down and dirty is when it comes to consideration of the inflationary outlook. And it is here that most of the attention on today's Fiscal Update is likely to focus.

According to Treasury inflation is likely to stay within a smidgen of the upper level of tolerance in the Reserve Bank's riding instructions for the next three years. And where the BFU (Budget Fiscal Update) had a tiny amount of room for maneuver, 0.25% for the Reserve Bank, the Pre-EFU out today has none. "Annual consumer price inflation is predicted to peak at 3.1% in the September 2005 Qtr and remain near 3% for much of the next two years.

According to Treasury the reason for the strong inflationary outcome comes from several different sources, a falling dollar, falling commodity prices and rising energy costs.

Should the dollar remain higher than expected this inflationary pressure may be reduced but according to Treasury this is not expected to happen as commodity prices are expected to decline in accordance with the usual economic cycle.

In the final analysis this leaves little if any room for fiscal stimulus in the form of new spending or tax cuts over the coming 18 months, somewhat dampening the ability of National to buy an election victory with a tax cut.

This is because if a tax-cut were to take place immediately it would run the risk of pushing up interest rates as the Reserve Bank moved to prevent the tax cut taking inflation out of the 0-3% target band.

In effect all that any new Government gave in tax relief would be sucked back out of the economy via higher mortgage rates.

In his press conference (Click here for streaming video) Dr Cullen commented extensively on the inflation issue and pointed closely to where the tax debate is likely to go once National unveils its plans this coming Monday.

A slide comparing the cost of Labour's Family Tax Relief with National's spending promises to date.
Click for big version

"They have already announced tax cuts of $3.2 billion over three years, corporate tax cut, the carbon charge and tax rebates on childcare and student loan repayments. That is twice as much as the improved fiscal position in the Pre-EFU. Our advice is that this will lead to increased pressure on inflation," Dr Cullen said.

Dr Cullen said the precise inflationary impact of any possible tax cut proposal was impossible to project as it was unclear what spending cuts there would be to accompany it.

In addition Treasury had not provided any actual numbers on what impact any tax cut might have as to do so would involve straying too close to election territory.

However even Dr Cullen acknowledged that as a result of the better than expected outcomes in the Pre-EFU that there was some additional room for spending or tax cuts over the coming four years.

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At their post pre-EFU policy announcement (Click for full audio 45 mins .MP3) PM Helen Clark and Finance Minister Michael Cullen enjoy a quip from the Finance Minister about National's new attack adverts, "rather a wastemaster than a toxic waste dump."

And promptly following the release of the Pre-EFU Dr Cullen, The Prime Minister and Steve Maharey held a press conference to announce a $1.3 billion (over four years) policy of increased tax relief for 170,000 families with children, essentially an addition to the Working For Families package increasing the threshold for the beginning of abatement up to $35,000 PA and reducing the abatement rate from 30% to 20%. (Click here for details – Clark & Cullen & See the Scoop Front Page for live reaction.)


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