Key Points:

The big operating surplus that both Labour and National will have to calculate their election year tax cut packages from is shrinking fast, as the effects of weaker global stock markets start to impact on the Government's books.

Finance Minister Michael Cullen yesterday revealed that the Government's operating balance for the six months ended December 31 would be just a third of the forecast $2.511 billion - making it around $837,000.

The Government's books are being closely monitored this year as Labour prepares to outline a programme of ongoing personal tax cuts and as National assesses whether it has the financial flexibility to trump whatever Dr Cullen offers.

Dr Cullen said that since he delivered the half-year fiscal update in December, the New Zealand Superannuation Fund had suffered at the hands of falling world stock markets.

The fund suffered unrealised losses in the fourth quarter of last year, and worse was still to come - it would have "suffered quite strong unrealised losses in January of this year given that it has high exposure to international equities markets", Dr Cullen said.

The super fund's earnings roll into the Government's operating balance, which has registered a series of large surpluses under Dr Cullen's watch as Finance Minister.

But he also said that uncertainty in the world economy had increased in recent months, and it was clear the local housing market was turning down faster than the Reserve Bank and Treasury had anticipated at the end of last year. "That could have some consequences," he said.

Appearing at a select committee yesterday Dr Cullen moved quickly to say the narrowing operating surplus would not necessarily mean he had less money to spend in this year's Budget and in the election campaign.

That was because the figure he used to calculate what he could spend was the operating surplus excluding gains and losses - which eliminated the impact of the super fund's volatile results. That figure was virtually "bang on" forecasts, he said.

Whichever figure is used, the narrowing surplus will be top of mind for politicians on all sides of the House as they prepare to fight it out in the upcoming election.

The prospect of an increase in levels of Government debt in order to fund election pledges as well as tax cuts could move to the front of the political debate if the surplus continues to narrow.

Dr Cullen has repeatedly said he will not offer tax cuts that result in additional Government borrowing, or which cause cuts to services, increase inflationary pressures or inequalities.

National's finance spokesman Bill English yesterday sought to dismiss as "irrelevant" Dr Cullen's talk about the four tests he would apply to tax cuts. Mr English said the tests were pointless because Prime Minister Helen Clark had already announced there would be tax cuts - meaning they would go ahead regardless of whether the tests could be met.