One Palliser, two Pallisers…

Three weeks ago I last wrote here, in a blithely optimistic tone

No posts last week between some mix of the war news (including related economics and financial markets news) being more interesting, and Covid – in our house that is. Not being too sick, but not being entirely well either I wasn’t concentrating very hard for very long. Fortunately, the isolation is now half over and no one’s health is particularly concerning. So back to some domestic economics and policy.

When our isolation began I’d picked off the bookshelves the first of the six of Anthony Trollope’s Palliser novels. Having been on the shelves for almost 20 years it seemed like a good opportunity to make a start on the series.

Unfortunately, although the whole family got Covid to one degree or other and all of them recovered fully, I – quite a bit the oldest, and perhaps previously prone to slow recoveries – did not.

And this morning I’ve just finished the last of the six Palliser novels (an enjoyable read if, perhaps, not as good as his Barsetshire novels).

As those who follow me on Twitter will know, it is not as if I have lost all interest in economic policy etc, but have just lost the ability to concentrate on anything more taxing than Trollope for more than perhaps 10 minutes without feeling really quite unwell and needing to lie down. Reading one 8 page memo bright and early yesterday morning completely did me in for the day.

There are many people much less well positioned than I am (including that I have an ample supply of novels etc on the shelves), so this is really just an advisory that it seems likely to be a few weeks at least before there are any other posts here. Which is a shame, as interesting issues abound (should, for example, the MPC consider a 75 or even a 100 basis point increase in the OCR next month?), but for now it is the way things are.

Not being entirely straightforward

No posts last week between some mix of the war news (including related economics and financial markets news) being more interesting, and Covid – in our house that is. Not being too sick, but not being entirely well either I wasn’t concentrating very hard for very long. Fortunately, the isolation is now half over and no one’s health is particularly concerning. So back to some domestic economics and policy.

The leader of the National Party yesterday gave what he billed as a “State of the Nation” speech. You can read it all here. It was, however, largely a tax speech. And – and I say this as someone who would really really like to be able to vote for National – it was pretty disappointing.

It wasn’t that I disagreed with any of the tax ideas – none of them very radical anyway. So when he committed to repealing “each of these new taxes implemented by Labour”

I was quite pleased. On Radio NZ this morning he also committed to getting rid of the “ute tax” as well, and I was pleased to hear that as well. One might debate the merits of some of these measures at the margin (eg I’d be happy to limit interest deductibility – for all businesses – to real interest, not nominal), but none of them really represented good tax policy, and they make the economy work less efficiently.

I was also quite keen on the idea of adjusting income tax thresholds to take account of inflation since 2017 (although would be rather keener if that included a commitment to legislate indexation of the thresholds as a permanent feature of the income tax system). That is simply fairly good tax policy.

So far, so positive, although do note that all these proposals involve turning back the policy clock to 2017. National was the government then, so no doubt they look back fondly on that time. But our structural economic performance (productivity growth, business investment etc) wasn’t much chop then – as Labour then used to point out, before becoming indifferent to such trifles when in office, and implementing policies – and running into circumstances – that are likely to have made things worse.

My concern is the fiscal and macroeconomic aspects of what National is saying – in Luxon’s speech yesterday, and (on the other hand) in every second parliamentary question for weeks.

Of all those tax promises listed above, only the one-off indexation of the income tax thresholds is costed, presumably because they are actively calling for the government to adopt this proposal in this year’s Budget.

National has been trying to make a thing of the size of the operating allowance ever since it was announced in December. But doing so isn’t entirely straight. Here a couple of paragraphs from my post at the time

To illustrate the practical implications, here is a chart from that post.

The simplest explanation is simply that when there is a lot more inflation, things cost a lot more – the same bundle of goods and services (or real transfer) cost more – and the way the government’s systems are set up, most of that “cost more” has to be met through the operating allowance. I thought it was a daft system when I worked at The Treasury, and I still think it is a daft system – presentationally – but it is the system and both National and Labour-led governments have used it. When inflation is very low (eg undershooting the target), operating allowances can be low without any great austerity, and when inflation is very high (eg overshooting the target, operating allowances can look (and be) very high without any great fiscal extravagance. As the graph shows, if the government keeps to the plans announced in December, government spending will be falling (modestly) as a share of GDP over the next few years.

And what has happened (and is forecast to happen to) the price level?

When the current government Budget, and appropriations, were decided, Treasury thought that the price level (CPI) by June 2023 would be 6 per cent higher than it was in June 2020. By HYEFU time – when they decided on the operating allowance – they thought the increase would be 11.9 per cent. We don’t have new Treasury forecasts, but the Reserve Bank’s MPC published forecasts recently (and recall that the Secretary to the Treasury sits on the MPC) and they expected a 12.7 per cent increase. It isn’t impossible that events of the last 10 days – including last week the biggest weekly rise in commodity prices in 50 years – will have pushed those numbers higher again.

Things will cost more. That is true of things you and I buy (a point Luxon has, fairly, been keen to stress) but it is also true of things the governments buys or spends money on.

A very large proportion of that $6 billion operating allowance will be required simply to keep real spending at the levels the government had in mind in last year’s Budget. It is a really big price level shock, at a time when – almost every year – nominal GDP is at record highs, so it is hardly surprising that the operating allowance is itself a record high. It tells one nothing about fiscal profligacy. I suspect Labour is already finding putting together this year’s Budget quite a bit harder than they planned in December – harder that is if they are going to stick to the $6 billion.

I’m not suggesting that when the $6 billion was announced in December there was no room for new government discretionary initiatives. I’m quite sure there was (as pretty much every government ever has done). And it is quite likely that adjusting the income tax thresholds – for that big price level shock – is at least as good a use as whatever Labour has been cooking up. But……as the graph shows, Labour’s spending plans for the next few years were hardly looking reckless.

Here it is also worth repeating that National has not offered costs, or funding ideas, for their other tax promises. For some it doesn’t matter – the “Light Rail Tax” is vapourware at present anyway – but we know that the 39 per cent rate is pulling in a lot more people than initially envisaged, and probably a fair amount of money. Unless National proposes to run larger deficits/smaller surpluses in the out-years than Labour is planning/forecasting, the money needs to come from somewhere – presumably lower (than otherwise) government spending.

National has for months been running the line that high government spending is to blame for much of the surge in domestic inflation. I’ve been quite sceptical (and critical) of that view, including in a couple of recent posts, here and here).

If were a serious line of attack – as distinct from something that looks a lot like rank opportunism – one might have supposed Luxon and his party would be identifying significant areas where they would cut government spending. But this all they had to say

I’m not a fan of any of those policies, although it is hard to conclude that either the water system or the health system are just fine as they are, and (at least as far as I’m aware) daft as the “underground tram” might be, little is yet being spent on it, so it isn’t an explanation for the inflation we are now seeing. There was reference to welfare dependency – and again I agree it is a real issue – but no concrete ideas for materially cutting those outlays.

So we seem to be left with:

  • claims that high inflation –  even high domestic inflation –  are substantially the responsibility of high government spending, but (a) no serious analysis in support of the proposition, and (b) no substantial or material proposals for cutting government spending now, and
  • for the future, tax cuts promises that, while individually sensible and perhaps even laudable, aren’t supported either by burgeoning projected surpluses or by even a hint as to what expenditure will be cut (bearing in mind that demographic pressures on spending are likely to rise, not fall).

At best, even in the shorter-term we are left with an Opposition that wants to run no smaller deficits than Labour (operating to the same operating allowance for the coming year), and – on the things actually announced yesterday –  smaller surpluses or larger deficits than Labour in the years to come.  And all this while standard macroeconomic forecasters will put MUCH more weight on deficit/surpluses (and changes in them) as an influence on aggregate demand –  something the Reserve Bank needs to respond to in setting monetary policy – than on the level of government spending in isolation.

Ideally, National would now use this as an opposition to pivot and move on, abandoning the “government spending explains inflation story”, shifting their inflation focus back onto the Reserve Bank’s failings (and the government responsible for holding them to account), and if they are serious about future tax cuts, start telling us how they plan to pay for those cuts.  A serious move on the NZS age –  a fairly prompt lift to 68 and life-expectancy indexation from there –  would be a good place to start (as distinct from National’s policy hitherto of doing nothing at all for another 15 years or so).

Finally, as I noted earlier the speech seemed to involve turning back the policy clock to 2017.  But productivity growth –  the foundation of longer-term improvements in material living standards – was nothing to write home about back then either.  One hopes –  probably against hope – that before long Messrs Luxon and Bridges might let us on on their thinking on how we might do rather better over the medium-term than simply turning back the clock to five years ago, how we might at last begin to close those yawning economywide productivity gaps between us and the rest of the advanced world.