Plenty of money but no tax cuts

Finance Minister Michael Cullen is expected to repeat his "no money for tax cuts" mantra in tomorrow's fiscal update.

However, more than a third of the way through the budget year, he seems to be heading for another embarrassingly large operating surplus.

The May Budget forecast an operating surplus of $5.6 billion (excluding the revaluation of liabilities to ACC claimants and public service pensioners) which would be $1 billion less than the 2003-2004 year.

But for the four months to October 31 the operating surplus was already $2.5 billion, which means it is running more than $700 million ahead of budget.

Tax revenue was 9.1 per cent or $1.2 billion larger than in the same period last year and more than $400 million ahead of forecast.

That mainly reflected higher PAYE deductions because of the strong labour market, growth in company tax driven by strong profits and more GST fuelled by the continued strength of consumer spending.

At the same time health and welfare spending was down by just over $200 million, mainly because of delays in implementing programmes but also because unemployment benefit payments were lower than forecast.

Cullen argues that the operating surpluses are no guide to the affordability of tax cuts.

After allowing for the temporary cyclical component of the surpluses, the need to put away $2 billion a year to partly pre-fund New Zealand Superannuation, and to fund capital spending, student loans and the like, the kitty is almost empty, he says.

National Party leader Don Brash predicted on Friday that political pressure would force the Government into "some gesture of tax reductions or bracket adjustments next year".

But unless the National Party was breathing down Labour's neck they would be small and grudging.

"With the biggest Budget surplus in our history there is scope for a tax cut for all working New Zealanders," he said.

Cullen's response was that December's economic and fiscal update would show tax cuts of that magnitude were not affordable over the longer term - "not without savage spending cuts or spiralling public debt".

At the time of the Budget the Treasury was expecting an economic slowdown to arrive in the second half of the year; it forecast gross domestic product growth of 2.8 per cent for the current March year and 2.5 per cent next year.

But the economy has confounded forecasters with its continued strength. So, like last week's forecasts from the Reserve Bank, tomorrow's update is expected to revise the short-term growth outlook upward, but with the payback of weaker growth further out.

That implies a fatter surplus in the short term and leaner ones later.

As a rule of thumb, the Treasury says, 1 per cent less economic growth subtracts around $440 million from the operating balance.

The Reserve Bank now expects growth of 4.75 per cent in the year to March 2005, dropping to 2 per cent in each of the following years.

Westpac economists expect the Treasury to revise its growth forecast up to 4 per cent for the current March year, then 2.5 per cent next year and 3 per cent the year after.

Risks to those forecasts are likely to focus on the international environment, with uncertainty about the track of the United States dollar, oil and commodity prices, China's slowdown, and terrorism.

"We'll get a 'covers' version of the 2004 Budget to ensure it wasn't a one-hit wonder," said Westpac chief economist Brendan O'Donovan.

"We'll be reminded of the extent of the spend-up relating to the Working for Families package."

While new initiatives were unlikely to be costed, some had already been flagged, including removal of capital gains tax on the managed funds industry, changes to the depreciation rules and fringe benefits tax, and first home assistance.

National Bank economists said this year's Budget included additional spending rising to $3.8 billion by 2008.

"A package of this magnitude will keep the Reserve Bank watchful but not have major implications for the conduct of monetary policy. Nonetheless fiscal policy is shaping up as an important source of demand support to the economy over the coming two years."

It would represent a boost to the economy of the order of 0.5 per cent of GDP.