Revenue in, expenditure out — economics editor Brian Fallow investigates how the political parties plan to juggle those numbers

Every year, vast sums flow into and out of the Crown's coffers, but the amount of new money available for fiscally responsible political parties to fight over - call it the fiscal battlefield - is quite small.

New Zealand has not had a fiscally irresponsible Government since Sir Robert Muldoon's, says Labour's finance spokesman, David Parker.

At the heart of all the political arguments about fiscal policy is a line item in the Budget called the operating allowance.

That is a provision for new spending in future Budgets - "new" in the sense that it has not yet been allocated to anything.

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Budget 2014 increased that operating allowance from $1 billion to $1.5 billion per future Budget (plus 2 per cent a year for inflation).

Why $1.5 billion? Because the Treasury calculated that was the most a Government could get away with, without triggering an interest rate rise from the Reserve Bank, which always has to consider how government spending and tax flows will affect total demand in the economy, when it sets monetary policy. To make sure, the Treasury ran its sums past the bank.

Labour's alternative Budget kept the $1.5 billion operating allowance each year, but acknowledged that two-thirds of it would be needed not for new initiatives, but for business-as-usual things like pay rises for nurses, teachers and cops. It has expressly allocated $1 billion of new money in each Budget for maintaining the real value of spending on public services.

Both National and Labour are committed to running surpluses and paying down debt, so any increase in operating spending above the $1.5 billion allowance would have to be funded in one of two ways: higher taxes, or by robbing Peter to pay Paul within existing budgets - what the bureaucrats describe as "reprioritisation".

The public sector has seen a lot of reprioritisation in recent years as Finance Minister Bill English has kept a tight rein on spending, emphasising effectiveness, outcomes and value for money. Tucked away in Labour's alternative Budget is more of the same, $100 million it reckons it will be able to find in current government initiatives that could be better spent.

On Monday, the National Party announced that, in effect, for the next two years it would restrict its new spending to the $1 billion it had been content with in the last two Budgets. That will mean real per capita cuts in public spending and a marginally more contractionary fiscal policy.

But by forgoing the other $500 million of the $1.5 billion annual allowance, it might - "providing fiscal and economic conditions allow" - have enough fiscal headroom for "modest" income tax cuts kicking in on April 1, 2017. Those could amount to perhaps $1 billion a year.

The rest, including any additional money from positive revenue surprises, would be used to reduce debt.

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If divided equally among all 3.2 million income tax payers, $1 billion of tax cuts would be worth $6 a week.

Any tax cuts would focus on low- and middle-income earners, English said this week. "We will consider the details of a possible tax package closer to the time."

A ready reckoner the Treasury publishes to indicate the fiscal impacts of adjustments to income tax scales indicates that $1 billion a year would, for example, just about fund a cut of 1c in the dollar in the two lowest income brackets (up to $48,000 a year).

However the perfunctory information National released this week suggests that adjustments to thresholds are envisaged, to address the fiscal drag that happens when even modest pay increases push people into higher tax brackets.

Taking the Treasury's forecasts for wage growth, someone working 40 hours a week on the average wage (and ignoring any other income or tax credits) will be earning $5300 a year more (gross) in three years' time, but paying $1600 a year more tax. In other words, the taxman would get 19c of every dollar they earn, compared with 18c now.

So Monday's announcement could be seen as an acknowledgment that by 2017, seven years after the last major changes to the income tax scales, fiscal drag will need addressing. But such calculations are an exercise in counting chickens whose mother hens have not hatched yet.

The caution about economic and fiscal conditions permitting is important. While $1 billion is a lot of money by anyone's standards, for a Government the sums involved fall within the margin of forecasting error.

For example, the pre-election economic and fiscal update reduced the forecast for core Crown revenue in 2017-18 by $500 million from what it was in May's Budget. Now you see it, now you don't.

Both National and Labour recognise that the lion's share of the operating allowance will be needed not for genuinely "new" spending, but to offset the impact of inflation, especially pay rises for public servants.

The Budget baselines do allow for some increase in spending, but generally only to allow for demographic effects already known, and not for pay increases.

For example, the Treasury's pre-election economic and fiscal update forecasts health spending in 2017-18 to be just 1.4 per cent - or $200 million - higher than in the current year. And that is the second biggest-ticket item of public expenditure.

The largest item, social security and welfare, by contrast gets 9.4 per cent or $2.25 billion more in three years' time than this year. But that includes $2 billion more for New Zealand Superannuation, reflecting an ageing population and indexation to the average wage.

On top of those baselines, Labour's alternative Budget sets aside a cumulative $10.6 billion over the next four years to maintain public services, especially in health and education.

And English says that over the next four years National will spend some $10 billion more in total, mostly on health and education.

Labour has allocated a further $2.6 billion for new spending initiatives, net of the $400 million it reckons it can claw back from reprioritisation. It has also allocated a cumulative $600 million to accommodate the policies of other parties whose support it would need to govern.

This is where the Greens come in.

National says the Greens' announced spending pledges, excluding policies they share with Labour, add up to $10 billion over the next four years.

But the Greens argue that their increased spending is more than covered by the operating allowances in the Government's existing fiscal track, plus the new tax revenues they would raise. As a result, argue the Greens, they would run larger surpluses, and pay down Crown debt faster, than existing policy would.

While their proposed carbon tax would be recycled by making the first $2000 of income tax-free (that's $4 a week in the hand) and by cutting the company tax rate from 28c to 27c in the dollar, the Greens would also raise the marginal tax rate on incomes over $140,000 a year to 40c in the dollar and raise the trust rate to match.

They would increase the royalties on oil and gas and, like Labour, they favour a capital gains tax.

When the Greens ran their numbers past Infometrics, the economic consultancy pointed out that they do not allow for "second round impacts" - that is, the results of taxpayers changing their behaviour in response to higher tax rates. Infometrics said that when it estimated that effect, the Greens' projected surpluses were smaller, but still materially higher than those in the pre-election economic and fiscal update.

Parker argues that it is not fair to add the fiscal cost of potential coalition partners' and support parties' policies to Labour's, and then brandish the resulting figure.

The leading party in a coalition gets to set the fiscal envelope, he says, and if the $100 million to $200 million a year his alternative Budget allows is not enough, then Labour will have to give up some of the programmes it wants.

If it were fair enough to tack other parties' fiscal cost on to the leading party's, Parker says, National would have to wear the cost of Act's policy of cutting the company tax rate. He puts that at $2.8 billion a year initially (when it is cut to 20 per cent), rising to about $5 billion a year when it is cut to 12.5 per cent.

Act leader Jamie Whyte says the company tax cut would be funded by eliminating $1.4 billion a year of "corporate welfare" and dropping the $1.5 billion operating allowance.

Another National support partner, Peter Dunne, supports income tax splitting, which would cost about $500 million a year on Treasury estimates, Parker says.

Labour's own tax policy includes measures which would cost revenue - R&D tax credits, accelerated depreciation in selected industries and additional tax credits as KiwiSaver is made compulsory - and others which would increase it.

Those tax-boosting moves include increasing the top marginal income tax rate to 36c in the dollar for incomes over $150,000 and a matching rise in the trust rate. The forecast revenue yield from those measures rises from about $400 million a year initially, to $600 million after three years.

The expected revenue yield from the capital gains tax rises fairly slowly, not reaching $1 billion until the sixth year.

The primary purpose of the capital gains tax, as Parker sees it, is structural reform. It is intended to remove a distortion in the tax system and encourage investment to flow away from the economically sterile and socially destructive bidding up of house prices, towards productive enterprise.

Over the next four years Labour would raise a cumulative $2 billion more in tax than existing policy settings are forecast to deliver. To put that in context, it is 0.6 per cent of the next four years' forecast revenue.

It would also have an interest bill $1.5 billion higher than the current Budget track over the four years. That is driven by such policies as resuming contributions to the Super Fund sooner than National would (so that gross debt is higher, but the assets side of the balance sheet is higher too) and the working capital requirements of the KiwiBuild scheme to build thousands of affordable homes.

That extra interest cost would represent half a cent in the dollar of forecast government expenditure over that period.

Parties and priorities

National says

The fiscal priorities are:

• First, to return to surplus this year and keep running surpluses.

• Second, to reduce net government debt to 20 per cent of GDP, down from 27 per cent now.

• Third, to cut levies on all ACC accounts, beginning in April 2016.

Only if those three priorities are achieved, and if economic and fiscal conditions allow, will modest tax cuts in April 2017 be on the agenda.

Labour says
It will also run surpluses and reduce debt faster than National's last Budget forecast.
Labour defines its debt target in terms of net debt, including the assets of the NZ Superannuation Fund. It says it would get that down to 3 per cent of GDP by 2020-21, from 15 per cent now.

National does not intend to resume contributions to the Super Fund until net debt gets to 20 per cent of GDP, which it expects to happen in 2019-20.