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Dr Muriel Newman

Election 2011 – “it’s the economy, stupid”

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As predicted, the biggest issue of the 2011 Election campaign is the economy. And the major question on people’s minds is which party is better placed to run the economy and protect us from the sort of disasters that we can see playing out in the Euro-zone.

Greece, Italy, Spain – Europe’s problems just keep on growing, and it is hard to see when or how it will all be brought back under control. And while New Zealand is in a stronger position than those faltering economies, we should not ignore the warning we received from the ratings agencies Standard and Poor’s and Fitch, which both issued a one-notch downgrade to our credit rating in September. The drop from AA+ to AA was our first credit downgrade in 13 years. It puts us on par with Kuwait and Abu Dhabi, behind the USA on AA+ and Australia on AAA, but ahead of Japan on AA-.

As we consider our election choices it is worth reflecting on the reasons for the downgrade, so we can better assess whether the various parties political agendas will strengthen our economy or make the situation worse.

In essence both ratings agencies were concerned about New Zealand’s debt levels. To be fair, household debt has been falling over recent times as families have been lowering borrowings and spending less. But they remain concerned about growing government debt – especially once the impact of the Christchurch earthquake is factored in.

The reality is that New Zealand’s debt problem will not go away until the government learns to live within its means. There are two basic approaches for tackling this problem – either reduce government expenditure or raise income. The question is, given that some parties are calling for a reduction in spending while others are calling for the “rich” to pay more, which of these two approaches is the most effective?

Fortunately economist Veronique de Rugy, a senior research fellow at George Mason University, has been looking into this issue in response to the USA’s recent credit rating downgrade. In an article in this month’s Reason Magazine she has provided a rundown of research into the best way of reducing debt ratios without hurting the economy.1

In 2009, the National Bureau of Economic Research examined over 100 attempts to reduce debt in 21 OECD countries between 1970 and 2007 in order to establish whether government spending cuts or tax increases were the most effective way of reducing debt, and whether the most effective economic stimulus comes from tax cuts or increases in government spending. Their analysis revealed that spending cuts, not tax increases, are more likely to reduce debt, and that fiscal stimuli based on tax cuts are more likely to increase growth, than those based on spending increases. They also found that adjustments based on reducing government spending are less likely to create a recession than adjustments based on increasing taxes.

In 2010, the American Enterprise Institute looked into 100 instances where countries attempted to reduce their budget gaps, essentially concurring with the earlier research to find that countries that reduced spending were far more likely to reduce their debt than countries that chose to raise taxes. They concluded that “the typical unsuccessful fiscal consolidation consisted of 53 percent tax increases and 47 percent spending cuts. By contrast, the typical successful fiscal consolidation consisted of 85 percent spending cuts.” Further, they found the most effective spending cuts are those that focus on two areas – reducing the cost of social transfers and the cost of the public service.

Berkley economists David and Christine Romer also found that not only are spending cuts far more successful than tax increases in boosting economic growth, but tax increases can cause considerable damage to an economy: increasing taxes by 1 percent of GDP – for deficit reduction purposes – leads to a 3 percent reduction in GDP. This finding adds to the widely accepted view that lower flatter taxes boost growth, while steeply progressive taxes, which attempt to raise higher levels of tax from higher income earners, destroy growth.

With all this in mind, let’s examine the economic-related policies of the political parties to see what is on offer.

National’s focus is on lowering government spending. They intend to continue to reduce government bureaucracy – which over the nine years term of a Labour government had ballooned by 55 percent from 29,000 to a peak of over 45,000 employees in 2008 – to undertake the partial sale of four state-owned enterprises to fund essential capital spending without the need to borrow overseas, and they have also launched a programme of welfare reform that they believe will save an estimated $1 billion over four years, by refocussing the system onto ensuring those who are capable of working get jobs.

In contrast, Labour’s approach is on increasing government spending – funded through overseas borrowing until their tax increases kick in. They plan to make New Zealand’s tax system more progressive by taking the tax off the first $5,000 of income while increasing the top rate, introducing a capital gains tax, removing GST off fruit and vegetables, and bringing agriculture into the Emissions Trading Scheme two years earlier than National. In addition they would increase the minimum wage to $15 an hour.

The Green Party would increase government spending and introduce a myriad of tax increases. They would make the tax system even more progressive – the first $10,000 of income would be tax free (the current rate is 10.5 percent tax up to $14,000), tax on income up to $42,500 would rise to 19.5 percent (currently 17.5 percent up to $48,000), income up to $80,000 would be taxed at 33 percent (currently 30 percent up to $70,000), and income above that at 39 percent (currently 33 percent over $70,000).

In addition, the Greens would introduce eco taxes on water, commercial fishing, mining, pollution, and waste, and a Tobin Tax on international currency movements. They would extend the $2 billion Working for Families scheme to all beneficiaries with children, they would introduce a new universal child benefit paying all families with children $18.40 a week for their first child and $13 for subsequent children, they would raise welfare benefit levels, and they would pay beneficiaries for doing voluntary work. In addition they would increase the minimum wage, shorten the working week, introduce a Code of Corporate Responsibility on all businesses, write off all student debt, introduce a universal student allowance set at the level of the unemployment benefit, and eliminate all student fees.

The ACT Party’s focus is on lowering government spending from the present level of 35 percent of GDP down to the 29 percent it was in 2005 to create jobs and growth. They would reduce the red tape and regulation that ties up the productive sector, suspend the Emissions Trading Scheme, and lower taxes. They would sell off State assets such as power companies and they would like to see more mining where the economic benefits outweigh the environmental costs. In addition they would reform welfare and re-introduce a youth wage.

The Maori Party’s focus is on Maori and Maori privilege in particular. They want new management powers for everything from making the teaching of the Maori language and “Treaty studies” in schools compulsory, to special Maori seats on all statutory boards including Health Boards and School Boards, to Treaty clauses in overseas investment legislation so iwi have the first right of refusal on the sale of assets, to stronger Treaty clauses in all Free Trade Agreements.

The Maori Party would remove GST off all food, make the first $25,000 of income tax free, and introduce a financial transaction tax. They would increase the minimum wage to $16 an hour, extend Working for Families to beneficiaries with children, lower the age of superannuation to 60 for Maori, introduce a universal student allowance set at the same level as the unemployment benefit, provide government subsidies on household internet connections, establish government funded deep sea fishing vessels and fish processing plants, and write off local body debts for overdue rates on Maori land.

United Future’s major focus is on income splitting for parents with dependent children. According to Treasury, the cost of this policy is around $500 million.

The Mana Party would make the tax system more progressive by setting a tax-free threshold of $27,000 with taxes rising steeply after that, abolishing GST, and introducing a capital gains tax, a ‘Hone Heke’ financial transaction tax, and an inheritance tax. They would increase social welfare benefit levels, extend the Working for Families package to beneficiaries with children, and increase the minimum wage to $15 an hour.

New Zealand First would reduce the size and cost of government, lower taxes, and raise the minimum wage to $15 an hour. In addition, they would push for the reduction of student debt through a one for one government subsidy.

The Conservative Party would cut spending in preference to raising new taxes or increasing borrowing and would prioritise the repeal of the Emissions Trading Scheme.

In looking at the policy options it is clear that pork barrel politics is alive and well in New Zealand today. The question is we can afford profligate spending when the world is going through tumultuous times? We certainly need to check out the details so we know exactly what agendas we are supporting before we cast our vote on Election Day.

With election policy announcements coming thick and fast, I asked this week’s NZCPR Guest Commentator, welfare researcher Lindsay Mitchell, if she would provide an analysis of the welfare policy National released last week. While some have said the changes do not go far enough, it is a least a start in addressing what has to become one of the biggest impediments to progress this country faces – the problem of entrenched intergenerational dependency and the disastrous impact it has on the lives of children.

As Lindsay notes in her article National’s welfare reforms – lots of smoke but not much fire, “What’s more interesting is National acknowledging and addressing the issue of people continuing to have children on a benefit – around 23 percent of current recipients. The work-testing which would normally kick in when the youngest turns 5 is suspended for one year only, if another baby comes along. There is a mixed message here however. It is OK for the new baby to go into care at one but not the older sibling? And again, the Welfare Working Group recommended that for a child added to a benefit, the mother should only get 14 weeks before work-testing – in line with Paid Parental Leave. But National took a softer option.”

Finally, the New Zealand Centre for Political Research is also getting into the election spirit. This week we have attached the Coastal Coalition’s Election 2011 Report for your interest. Just click the file attached to this email to read the report – and please feel to forward it on to others.

  1. Veronique de Rugy, Upgrading the USA