The case for a tax cut in the Budget tomorrow is a distinct issue from repaying the recent large budget deficits and balancing the budget over the business cycle. Bill English should pay more attention to the concept of tax smoothing.
Unless something special is happening, income tax rates should be similar from one year to another. We should keep tax rates fairly smooth by borrowing during recessions and emergencies.
Necessary tax cuts have been postponed. Instead, the Government is not indexing the income tax thresholds for inflation and has collected $2.1 billion in extra revenue since 2008, according to Parliamentary Library calculations.
Raising the income tax rate thresholds is becoming more pressing. Income growth is starting to push many ordinary taxpayers uncomfortably close to the next threshold and a much higher marginal tax rate. For example, 30 per cent rather than 17.5 per cent is the income tax rate many taxpayers face.
New Zealand is already left behind on company tax rates; ours is currently 28 per cent. The Australian company tax rate may drop to 25 per cent; the British company tax rate is going down to 17 per cent by 2020.
Prudent public debt management dictates that governments run temporary budget deficits in recessions and other emergencies such as the Canterbury earthquake and repay that debt as better times return. Recessions and natural disasters are infrequent so this extra debt should be paid down at a measured speed, not a frantic pace at the expense of other tax policy goals.
An increase in the budget deficit smooths over these bad times and avoids taxes going up and down like a jack-in-the-box over the business cycle. Who raises taxes in a recession?
After the start of the recession in 2009, foul-weather fiscal conservatives wanted to do just that. The same usual suspects who always advocate bigger government argued for higher taxes rather than running a larger budget deficit, which Mr English did. Imagine the massive income tax rises required every recession and in the last recession in particular if the large budget deficits were not run.
The large public debt from the temporary budget deficits that smoothed over the last recession is no special or additional reason to postpone income tax cuts. A sound, long-term fiscal strategy has tax rates at levels that make up on the deficits in bad times with surpluses in the good times. Slowly repaying debts accumulated in a recession is a routine part of prudent public debt management.
There is room in the Budget for tax cuts. Every Budget allocates about $1.5 billion for new policy proposals that can be adopted without the Treasury thinking that they might harm long-term fiscal stability.
Mr English has spent up to $1.5 billion on new policies every year since the last tax cuts. If this new spending was justified despite the large public debt from the recent recession, some tax cuts are too. They could start with raising the income tax rate thresholds to make up for past inflation.
Jim Rose is an economic consultant in Wellington He has worked at various government departments including the Treasury and the Australian Productivity Commission.
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