Tax Cuts: How Much Would It Cost?

The Treasurer, Bill English, has announced that a future National Government would make it a priorirty to lower the business and top personal tax rate to 30 cents, while at the same time matching any cuts with increased social spending - dollar for dollar. The Scoop looks at how much a Government would need to fund such a promise.

Working out bottom line impacts on changes to tax rates is notoriously difficult because of the complex interactions in an economy and the changes themselves cause changes in behaviour, which in turn move the bottom line in unexpected ways.

For example, a decrease in personal income taxes has a direct effect on consumption and
thus on GST collections. These changes would flow on to affect business sales and hence company tax.

However for the sake of argument, Treasury does do stab-in-the-dark predictions on what small changes would have on government revenues

In the 1998/99 year, Treasury predicted a one-percentage-point change in the top individual rate would cost $105 million and a one per cent change to the company rate would cost $120 million

This estimate allows for effect on indirect taxes through changes in consumption and on direct tax through changes to company profits, but does not incorporate possible second round effects on wages and profits. Fiscally neutral changes in tax paid on benefits are excluded and the labour supply response is assumed to be zero in the short term.

Treasury would probably frown, but if we multiply this by three to get the Treasurer's hoped for fall of three per cent in the top rates we get a total of $675 million dollars required, double this to meet the dollar for dollar pledge and you get a total of $1,350 million extra required to fund National's pledge.

To go to the next stage, both the Treasurer and the Prime Minister have said such moves would be funded by economic growth.

The last Budget outlined three scenarios, the most optimistic had four per cent growth in real GDP in 2000 and 2001 and this would deliver a $1.7 billion operating balance surplus in 2000/2001. The central forecast would have a $1.5 billion surplus by 2001/2002. Under the weak recovery forecast the pledge could simply not be met.

Looking at the figures it is clear why both the Prime Minister and Jenny Shipley have added the rider - 'better than expected economic performance is required'.

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