It’s election year – should the government surplus be used to a) cut taxes, b) help the poor or c) repay debt?
Listener: 5 June, 2014
Keywords: Macroeconomics & Money;
Just before the Budget there seemed to be a public disagreement on economic policy between Prime Minister John Key and Finance Minister Bill English. Key took the view that some of any fiscal surpluses should be given back in tax cuts; English said he wanted to repay debt first. What’s the big economic picture behind their contretemps?
The question is not whether the surplus should be used for income tax cuts on middle incomes, as the PM was proposing, or whether extra money should be targeted at the poor or on increased government spending, as others are advocating.
The issue is whether the Government should be running a fiscal surplus at all, as is forecast in the 2014/15 year. We may not only be counting the chickens before they hatch but also be spending the proceeds from eggs yet to be laid.
Key’s public stance that some of the surplus should be given back arises from an ideological, but politically seductive, view of government. It’s “our” money it raises in taxes, so as soon as it can, it should return it.
English’s public stance is that this may be so in the long run, but a government, like a family or business, needs reserves for unfortunate events. Unlike Greece, say, during the global financial crisis in 2008, New Zealand was able to borrow reasonably easily because it was not carrying a lot of public debt. So we did not have to implement overly harsh measures to trim the economy. English and Key may chuckle and say, “That is why we are still in Government.”
But there could always be another financial crisis – we can’t rule one out in the next five years. And there are other risks to the economy such as foot and mouth disease, the collapse of key export prices, earthquakes, volcanoes, tsunamis and who knows what else. The Government needs a prudent debt level to be able to deal with such uncertainties.
There may be a more subtle analysis underpinning English’s view and reflecting those of some macro-economists. When we think of the economy as a whole, especially the monetary, fiscal and exchange rate system, we should be looking not merely at public debt and public saving – the surplus – but at the private sector ledger as well. Although the Government’s books look good, many households are running up debt. That is the driver for our high external deficit – why we are not paying our way in the world. In turn, the external deficit drives up the exchange rate, weakening the economy.
There was once an argument that what the private sector did was no concern of public policy. If people borrowed too much, that was their problem and that of those foolish enough to lend to them.
The theory looked pretty tatty as the financial crisis unfolded and the entire New Zealand financial system was compromised by our heavy private borrowing. Our low public debt enabled the Government to adjust more easily than some other countries, offsetting the excessive borrowing by the private sector. But it had to run up public debt to do so.
As long as there is private profligacy, we may need to do it again; that means getting back to a low debt level.
Most people think that when families are productive, they should build up their assets for emergencies and retirement. The Government doesn’t retire, but shouldn’t it follow the same saving strategy? Most people think a sound business should not pay out all its profits in dividends. Doesn’t the same apply to government surpluses?
English will be quite familiar with such issues. Reducing government debt is easier to argue; in the short run, it has the same outcome as the macroeconomic imperatives. My guess is that Key understands them well too. But it is election year, so it is seductive to promise the possibility of tax cuts. No doubt after the election Key will once again support English.