John Armstrong: Tax is all hiss but no roar

What chance in next week's Budget of Michael Cullen swallowing his pride and gently floating the possibility of limited tax cuts at some stage in the next parliamentary term if Labour wins the election?

Not much, given how sharply his hackles arch when the subject of tax cuts is mentioned.

Neither, for that matter, is Cullen going to allow himself to be endlessly taunted with cries of "U-turn" from adversaries on Budget Day of all days.

Yet this Government is so pragmatic, so willing to bend to the politically smart thing to do, that no one would wager against it making some concession to the desirability of cuts in income or company tax rates down the track, if not on Thursday then closer to the election.

The absence of even a token nod in that direction is the yawning gap in Labour's re-election strategy - one Cullen's colleagues must feel sorely tempted to fill before the National Party unveils its package of across-the-board reductions and the gap in the polls narrows further.

As is the habit of finance ministers ahead of any Budget, he was silent on the matter when questioned in Parliament this week, instead telling Opposition parties they would have to wait until Thursday when all would be revealed.

If that sounded tantalising, his next breath had him repeating his mantra that substantial changes to tax rates would be irresponsible because they could plunge Government accounts back into the red, especially when the long-predicted economic slowdown may finally be happening.

However, Cullen has never completely ruled out the possibility of tax cuts at some point. And though he says there is little room for the kind of large initiatives National is planning, that is not to say he does not have some room for small ones.

For example, raising the threshold at which the top 39c rate takes effect from $60,000 to $65,000 would cost him a paltry $75 million. He could also easily argue that there should be an easing of the threshold at which the 33c rate applies. This has not been adjusted since 1997, when it was raised from $34,200 to $38,000.

That would be a lot more expensive, however. He would jib at foregoing the nearly $400 million in revenue that lifting that threshold - to, say, $42,000 - would entail. And chopping a cent off company tax would cost him about $200 million.

But Cullen's hissing at the notion of tax cuts goes beyond mere revenue considerations. His scathing tone has in effect backed him into a corner where any sudden entertainment of the idea is not going to sound particularly credible.

That is a problem for Labour.

The party has put all its income-assistance eggs into the targeted basket through its Working for Families package, which largely benefits working households earning between $25,000 and $45,000. That leaves a considerable number of voters - about 350,000 earn between $45,000 and $70,000 - who would deem themselves middle-income, but who miss out.

These people are starting to feel the financial squeeze from things such as rising petrol prices and mortgage interest rates, while wage rises are pushing increasingly more of them into Labour's $60,000-plus top tax bracket. National sees handsome pickings here. It believes these people are far more open to tax cuts than they were when Bill Birch slashed taxes in the 1990s. Back then, National was handicapped by the public perception that it was running down state-funded social services in order to give a tax break to the rich. This was fertile ground for Labour, which responded by pumping billions in extra spending into hospitals and schools.

Now, the quality of some of Labour's spending is under scrutiny, such as the millions squandered on sub-standard tertiary education courses.

National is now rehearsing a potent campaign theme, one which asks voters whether they still think Labour knows best how to spend their money - increasing amounts of it - when that cash is funnelled into Labour's pet projects, many of which fit the politically-correct category.

The burgeoning tax take will come into even sharper focus on Thursday when the Budget surplus is likely to come in even higher than the $6.4 billion forecast last December. This will only intensify the pressure on Cullen for tax cuts. But there is an extra danger for Labour lurking in what is supposed to be the Budget's showpiece - a workplace-based retirement savings scheme. This will offer National another route into the tax-cut debate by arguing that people cannot afford to save because they do not have the cash. To spare Cullen's blushes over the surplus, this year's Budget documents will instead concentrate on the much smaller "cash" position which he argues is more accurate in taking account of capital spending, student loans and contributions to the New Zealand superannuation fund.

The cash position could be in deficit next year.

If Cullen gets a consensus that this is the figure that matters, it will be much easier for him to argue the unaffordability of tax cuts.

He has long cautioned that fiscal forecasts show surpluses drifting off current highs - making significant structural tax cuts impossible without pushing up debt levels or slashing Government spending.

FOR ADDED effect, he has also warned that tax cuts would be counter-productive because they would further stoke an already-overheated economy, forcing the Reserve Bank to lift interest rates to contain inflation.

That won't spook National, which will say it will time tax cuts so they are not inflationary. It can argue that Cullen's warnings of fiscal irresponsibility are a bit rich given his spending binges.

Don Brash knows National's tax policy will have to be robust. He cannot risk devaluing his biggest asset - his economic credibility. However, National cannot afford to let Cullen turn the debate about the desirability of tax cuts into one about economic management.

There is no point in National trying to compete with Labour as to who is the better economic manager when the economy has been so buoyant. As the governing party, Labour wins by default.

The slowdown is coming, however. The primary task of the Budget lies in convincing voters that Labour's fiscal prudence is the safe pair of hands needed for a period of relative uncertainty ahead, whereas National comes with a risk premium. To suddenly climb on the tax-cut bandwagon for the sake of political expedience risks cutting right across that message.