Why John Key's letter and his 2010 Budget misses the mark

By Neville Bennett

I had a terrific thrill last week when John Key wrote to me. It soon emerged however it was not personal but to everyone over-65.

He told me that the Government was focussed on economic growth and it would boost incomes, create jobs and raise living standards.

It also said my pension on October 1 would rise because of lower tax and compensation for a GST increase.

I have a few niggles with Budget 2010 - what it means for Superannuation which is the title of the PM’s letter:
•  will the budget lift economic growth ?
•  will it boost incomes and raise living standards ?
•  is it "fairer" ?
•  will it encourage saving ?
•  does a 2.02% increase in benefits compensate for a rise in GST ?
•  is the government “on track to reign in growing debt”, as the letter claims ?

Will the budget lift economic growth?

It has little to do with economic growth which is concerned with the more productive use of capital.

It helps a bit with R&D. It has helped to keep capital from moving into the housing market, but not as much as a capital gains tax would.

It does not leave more or less money in citizen’s pockets (which they could use more profitably than the government). The tax take is neutral.

But higher income earners are winners, so there will a boost in some kinds of consumption and possibly more saving.

I think it is basically neutral as far as growth is concerned, although it has a bias towards growth in lower corporate tax.

Will it boost incomes?

It is based on “trickle down” theories. These philosophers say encourage through tax polices the emergence of high income earners. Their spending will bring benefits which will trickle down to lower income workers.

J.K.Galbraith called it the “horse sh*t” theory: feed oats to horse and scavenging sparrows reap some benefit.

Lower tax does, however, increase incentives, so some people will work harder. Incomes will be higher after income tax but not necessarily after paying GST.

Is it "fairer" ?

Taxes play an important role in income distribution. I recognise that high and middle income earners deserve some relief. It is usually easy to tax them unlike others who rely on capital gain to increase their assets.

I am also aware that the changes have done nothing to reduce inequality in society.

This budget reduced progressive taxes and increases regressive taxes which can be regarded as retrograde. Richard Wilkinson’s "The Spirit level: Why more equal societies almost always do better" shows how New Zealand is very unequal, and this reduces performance.

I think a lot of lower income earners and students will suffer as GST rises, and my compensation for a married person with an "under-age" wife might come to $10 a week.

But inflation could hit 6% next year, and there will be extensive price rises … rates, power, ACC, public transport and the Emissions Trading Scheme. I expect groceries, retail items and services to rise too. Prices rises will leave pensioners/beneficiaries out of pocket.

Will the budget increase saving ?

It will only increase saving by reducing the direct tax-take and assuming people save more instead of consuming and paying a 15% consumption tax.

The Government missed the chance of allowing a tax holiday on interest-bearing deposit accounts. At present people with a small deposit get close to a zero real return as interest rates are low, tax is applied and inflation bites. It will be worse next year when inflation runs at 6%.

Is the government on track to reign in debt ?

This is an extraordinary claim. Government debt is increasing by NZ$250 million a week. The crown’s net debt, which was NZ$5 billion in 2008, will increase 12 times to NZ$63 billion in 2014.

Debt will soar to 100% of GDP.

This government has no plan to reduce debt. Moody’s and Standard and Poors will inevitably downgrade our credit rating by then. Meanwhile, the crown’s core assets will also decline sharply.

Anything else ?

Yes: I think the Budget will stimulate an inflationary boom next year and add a chapter to NZ’s record of budget deficits, high current account deficits and serious debt servicing problems.

I have had a look at Treasury projections on growth after the budget. It expects typical over-spending to continue, so private debt will hardly reduce.

In 2009 the average household spent $113 for every $100 received, and this should fall to $107 by 2014. I suspect we will have big imports of cars and kitchen appliances as the better off pay less tax. Treasury expects “residential” investment to be very high.

One wonders if continued budget deficits are in the country’s best interests. I suspect they will cause international comment as our external position is like Greece’s and Hungary’s.

The IMF has drawn attention to our “key vulnerability”: 44% of our debt has maturity dates of less than 12 months.

Treasury has opted for economic growth forecast of about 3% p.a. in the medium term. This is above historical trends and optimistic in view of the global slowdown.

Its assumptions are based on robust exports, especially dairy, but I have argued elsewhere that dairy will also strike headwinds as lower cost producers enter the market. Our land costs are completely out of kilter with competitors.

I am disappointed with New Zealand's current direction of low growth and high debt.

Debt servicing is going to take a big chunk out of the budget leaving less for education and welfare.

It is going to be tough times for a lot of lower income people in the years to come, especially as I think the global recovery is slowing right down and I have noticed signs of recession here in Christchurch.

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* Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR.
neville@bennetteconomics.com
www.bennetteconomics.com