Budget 2010

Apologises for the EPIC delay in doing this.  I wanted to have comments up by 6 (it was not out till nearly 10), but a meeting ran overtime, work servers went down, and my trip home from work on this was slower than expected. [ed. And the site went down …]

First here are links to other round up post round the country as of now:  Offsetting Behaviour, The Standard, Red Alert, Kiwiblog (*,*,*,*), Dim Post, NZIER, Infometrics, Rates Blog (*,*,round up post!), NBR, Not PC (*), Public Address, Education Directions (*,*,*).

So far we’ve done a review of the ACT and Libertarian alternative budgets.  Now it is time for the actual Budget, and then if we see any other alternative budgets we will have a look of them too 🙂  When reading all these reviews, keep in mind that I am aiming to be critical – I am putting up trade-offs so I will NEVER say “that is a good policy”.  I am not trying to say I hate any of these groups by doing this, I am just trying to describe other ways to look at policies to give them context.  If you keep that in mind when looking, then hopefully it will be useful.

Ok, so let me roll with my personal opinions – hopefully supported by a sound economic framework 😉

Also note that this is a first brush on what seem to be the main issues.  Over the next few days I plan to get down into more specific policies – and I will see if I can discuss some things through the weekend.

Was it a surprise?

Generally it wasn’t in my opinion.  The cut to the second tax bracket was bigger than expectations, not letting rental property owners claim losses to get WFF was harsher, and it was generally more “stimulatory” than expected.  Overall, it will act as a slight upward surprise for the RBNZ when setting monetary policy – so interest rates might be marginally higher.

It was definitely a shift in policy – although I would argue that the magnitude of the shift is being heavily exaggerated.

For example, everyone talking about the increased incentive to work forgets that we are paying for income tax cuts with consumption tax increases – implying that the buying power of said income is likely to drop.  There will be a shift, but it will come from the fact that GST doesn’t tax interest while income taxes do …

And the suggestion that this is going to completely change the equation regarding whether to move overseas – LOL.  It is such a marginal factor.  I can’t see why we are so concerned with individuals making choices about where to live – if we are worried they are taking skills we invested in the issue is to do with society paying too much for skill training rather than people have the freedom to move …

On marginal factors – what about the cut in the corporate tax rate.  What was the estimated benefit from it?  Or were we just trying to match Aussie 😉 .  It may be a good idea, but its not going to lead to a flood of investment – and whatever investment turns up on the basis of a slight cut in corporate taxes will only be a very marginally profitable investment opportunity right …

How would you rate it – like you have the other “alternative budgets”

By default this budget has the advantage of being based on an elected mandate – and as it stuck to election promises it is likely to support whatever social preferences are in some sense.  People can debate this, and they should, but this is not an issue for an economist.

As a little old economist, it is alway important to point out what the policy decision will do – and what these trade-offs are. In that sense, it will get rated just like the ACT and Libertarian budgets – with description and criticism.  Given that this budget has more detail, the post is going to be longer though 😀

Just let me find some old TVHE blog posts to help inform this 😉

The compensated lift in GST: In terms of a proportional tax on lifetime income, both GST and income tax do the trick.  The main issues are regarding the timing of tax payment in a persons life, the relative tax treatment of interest, the choice of where to produce/consume, and the idea that the tax may fall more heavily on exports/imports.

The first issue, timing, is a very difficult one and the welfare consequences are not clear.  Read some concerns here.  Also, when changing those that have saved are punished, those that have borrowed are rewarded.

The second issue is one of interest.  Income tax falls on interest, consumption tax does not.  Therefore income tax creates a wedge between interest rates received and paid – which is inefficient.  However, GST needs a higher base rate as it does not tax interest income.  Overall, through this channel a switch to GST will improve savings incentives.

The third issue is that GST does promote more “production” in the country directly.  It also promotes less “consumption”.  This is weird as production is the creation of goods to consume – which we get value from.  Fundamentally, the idea is that – by putting the tax burden on when you buy instead of when you earn – people can avoid tax by moving away when they are in low earning stages.  It will be interesting to see how significant this issue is – my feeling is not very at present levels.

The forth issue involves the idea that switching to GST is (relative to income tax) a subsidy to exports and a tax to importers.  I have said in the past I think it functions this way.  The eminently more intelligent Greg Mankiw has said this is not the case.  I agree with him that the real exchange rate is what matters.  My main point is that, by not taxing value added on exports and taxing some portion of value added on imports twice it seems to be that the real exchange rate would be different.  However, hearing him say otherwise definitely reduces my faith in my own logic 😀

Investment (Housing):  Housing got a little more slammed than I expected in the Budget.  Namely this puppy “preventing property investors from using rental losses to inflate Working for Families eligibility and payments”.

Personally I don’t understand it.  If people can use other losses to induce payments why exclude a single asset type?  If it was only housing that allowed this – then I say fair game right.

New Zealand has “overinvested” in residential housing.  Prices are likely inflated.  Sure.  But we should look at the reasons why housing as an asset class has got preferential treatment – and then make sure all asset classes are treated the same, rather than throwing in hodge podge attacks.

Here is a question, why do we tax interest (the return on one type of asset) and not the rate of return on many other assets.  If we should be treating asset classes equally – that is where the focus of policy should be.  If we shouldn’t be treating assests equally, we should say why before we introduce/keep distortionary polices!!

Now before anyone calls vested interests, I have no house – so I am effectively “short-housing”.

Also, before anyone says housing isn’t a productive asset – it produces a service called “somewhere to live”.  So it is a productive asset 😉

Investment (Corporate Tax):  And more investment news.  Corporate tax rates were cut.  Rightio.  I am a little strange for an economist it seems as I’m not very excited about corporate tax cuts per see – I just think that the tax system as a whole should more clearly represent what we are after.

The way I see it is here.  Corporate tax cuts will let marginal projects go ahead – but it isn’t going to lead to a massive “flow” of capital.  People that think we need the same rate as Australia are dreaming.

Conclusion

As you will note, all three of these policy initatives were focused at tilting consumption away from now and towards the future (through investment).  There was a distinct lack of other policies, which is fine.  Overall, this was the sort of direction that was signalled and expected.

The surprise has to be the lack of fiscal neutrality in the short term.  Something that will lead to a sharper reaction by the RBNZ – although off the top of my head I think that at this scale this is a very minor issue (especially given the medium term supply side impact of the tax cuts.

Now, I think the Budget was fairly well put together.  My post may have seemed very critical – but that is just because that is how I have to do these budget discussions.  There is NO budget that would have lead me to start going on about how great it is.  Given that it is in line with expectations, I have linked above to many posts where I have discussed the policy issues previously.  Feel free to read them if my criticisms seem to lack context in these posts.

The key point is that there are trade-offs, and its up to society to decide whether they think the government has gone too far one way, or not far enough.