Michael Cullen’s self-proclaimed “bold” Budget last Thursday struck out an important principle. The question now is whether he will be bold enough to reinstate it next year. His junior partner, United Future, will push him to.
The principle was the one tepidly established in his 2005 Budget: indexation of personal tax thresholds to inflation — the so-called chewing gum tax cut. When — and some ministers insist it is a when not an if — he cuts personal tax next year, will he reinstate the 2005 initiative?
Indexing tax thresholds to inflation — as superannuation and petrol tax are — requires a government explicitly to reset the tax rates if it wants to raise or lower the personal tax take in real terms.
By not doing that, governments from time immemorial have feasted on bracket creep: the proportion of incomes taken in tax rises as those incomes rise. Bracket creep has helped fuel the huge revenue windfalls that have stoked Cullen’s massive surpluses.
Gordon Copeland, in 2005 a United Future MP, is Parliament’s firmest advocate of tax threshold indexation. In 2005 United Future got Cullen to incorporate the principle in his Budget, to take effect from 2008.
It was a half-pie indexation: tied to the 2 per cent midpoint of the Reserve Bank’s 1-3 per cent inflation target range. Since the Reserve Bank has run inflation mostly above the midpoint, Cullen’s adjustment was designed to fall short of the actual inflation rate. It was still further short of the more relevant, and usually higher, wage and salary inflation.
Copeland’s own calculation, issued the day before he went independent last week, was that to restore the proportion of income tax taken from someone on average earnings in April 2000 the present $38,000 cut-in point for the 33c tax rate would need to move to $46,588 in April 2008 and the 39c tax threshold from $60,000 to $73,560.
When Cullen took office, the 33c cut-in point was around $2000 above average earnings. It is now well below. As a result, Copeland estimates, real after-tax income has fallen $2400 for the average earner.
There are administrative arguments against strict indexation. Rejigging of tax scales each year would be a compliance cost for employers and the Inland Revenue Department.
But the compelling counter-argument is political. Bracket creep gives finance ministers fiscal headroom to use as they wish. In Thursday’s Budget, Cullen chose KiwiSaver, a company tax and more spending ahead of personal tax cuts.
Next year will be different. Thursday’s Budget could afford to look five to 10 years ahead and try to redress New Zealanders’ addiction to borrowing and spending. Cullen correctly argued that a personal tax cut right now would have poured fuel on those inflationary flames.
But next year he has an election to win and a reputation to recover after his 2005 pre-election Budget bombed politically.
If revenue rolls in as the Treasury forecasts, he will have the headroom for a significant personal tax cut. It will be astonishing, given the pressure from average wage earners through the union movement, if he doesn’t respond.
If need be, he can blame it on Peter Dunne who can claim most of the credit for the 30c company tax rate and all the credit for abolition of the cap on charitable donations.
Where does that leave National, which boxed itself into voting against the 30c company tax on Thursday? Its room for quick action on the company tax rate has gone and its scope for gazumping Labour on personal tax in next year’s election campaign will be far smaller than in 2005 if it is to be fiscally convincing.
National will calculate that doesn’t matter, that voters will associate future tax cuts with National, not Labour, which is saddled with a tax-and-spend history. National will pitch John Key and Bill English as younger faces of the future. In short, it will rely on atmospherics.
Cullen’s atmospherics are those of a mechanical engineer, tuning and reworking his economic engine. It makes his Budgets a treat to read and a challenge to dissect in an hour or two on Budget day. Thursday’s was no exception. Next year’s will be likewise.