A package of income tax cuts and credits will kick in at the end of this month, saving wage earners about $20 a week and costing the Crown about $2.3 billion each year.
An awful lot of ink has been spilled debating whether or not this policy change will add to inflation pressures and hold interest rates higher for longer.
Most recently an NZ Herald columnist called for the Beehive to release a memo, titled ‘inflationary impact of PIT package’, which was given to Finance Minister Nicola Willis back in April.
We know broadly what it will say. Tax cuts are inflationary relative to paying down debt, but are mostly neutral or disinflationary relative to Government spending that money itself.
There are also timing issues to worry about. If tax cuts arrive in the real economy before the corresponding spending cuts, then that might have a temporary stimulus effect.
But all of this is just messing about on the margins of a $400 billion economy. The package starting at the end of this month is only worth about 0.6% of annual gross domestic product.
It is highly unlikely to be the deciding factor when the Reserve Bank decides to loosen monetary policy, although it is one thing the Monetary Policy Committee is considering.
The committee members discussed fiscal policy at their July meeting and noted the “positive impact” of tax cuts on spending was still uncertain — but definitely positive.
Kelly Eckhold, the chief economist at Westpac NZ, said the committee’s broader comments on fiscal policy suggested they were less worried than he had expected.
That may be because consumers are becoming increasingly reluctant to spend any extra money while dark storm clouds are still gathering in their economic skies, he said.
It is almost becoming a consensus view that the Reserve Bank may have cracked down on demand too hard and could be causing lasting damage to the economy.
If that turns out to be correct, some fiscal stimulus from tax cuts could be a lucky accident.
Preventing scarring
Politicians are constantly fighting the last war. Inflation has been enemy number one for households and the Government doesn’t want to be blamed for making it worse.
But that war is almost over and it is time for policymakers to shift focus. No cannon can fire backwards in time and there is a new enemy amassing its forces on the border.
Monetary policy, which takes 18-months to work, and Budget 2025, which is just under a year away, both need to be targeted at helping the economy return to its full potential.
Recessions can cause ‘economic scarring’ aka persistent output losses. Studies show some advanced economies took more than a decade to recover from the Global Financial Crisis.
A 2015 research paper found 70% of all recessions are followed by permanent declines in the level of economic activity. New Zealand must strive to avoid that.
Economic downturns can cause long-term damage by reducing the workforce, leading to skill loss, and slowing down investment and technology adoption, all of which hurts productivity.
This is why a little boost from tax cuts could be good news, even if it makes the RBNZ nervous.
Politicians shouldn’t waste their time arguing about whether the package adds or removes half a pinch of inflation pressure, and should instead focus on the post-inflation recovery.
This will mean not shying away from making productive capital investments that compensate for weak balance sheets and poor sentiment in parts of the private sector.
It will also be critical to help the newly jobless New Zealanders stay connected to the labour market (hopefully using more effective tools than just benefit sanctions).
Actual experts can come up with a more comprehensive list of policy goals to to minimise scarring. But this is the war policymakers should be fighting, not inflation.
The Coalition Government will need to continue with fiscal consolidation but it shouldn’t be goaded into going any faster than is absolutely necessary.
We welcome your comments below. If you are not already registered, please register to comment
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.