OnPoint by Keith Ng

JTF: Four Tests

“Four tests will need to be met – we’re not going to pay for tax cuts by increasing borrowing; we’re going to make sure any tax cuts don’t lead to a cut in social services; we’re going to have to ensure that there is a fair and just element in any tax cuts; and we’re going to have to be satisfied that any tax cuts will not add to the imbalances and pressures in the economy.” - Dr Michael Cullen, Minister of Finance, 4 November

That was 6 months ago, when the weather was warm, the cheese was plentiful and Labour was only 13 point behind in the polls. Back then, Cullen's tests read like a political haiku: simple, elegant and open to any interpretation you want.

But with this week's $10.4 billion tax cut package has turned it into a riddle. If it's not coming from increased borrowing or a cut in social services, where's the $10.4 billion coming from?

Most of it has come out of the surplus, which has been milked dry by this tax cut. The surplus in 2012 was predicted to be $3.9 billion, but with the tax cut, the latest forecast puts it at $154 million.

But the surplus wasn't big enough. To make the tax cut fit into the surplus, Cullen had to cut the allowance for future spending. That's the money that we see every budget for new initiatives. Cullen sliced $250 million off that allowance. But that allowance “stacks” – that is, every year where it's taken out, it impacts on the following years, too. So the effect would be twice as big in the second year, three times as big in the year after that, and so on. That adds up to $1.1 billion less spending in the next four years.

It's not a “cut in social services”, says Cullen. It's “a slower rate of improvement in social services than would otherwise occur”. It's some seriously dodgy ground.

And still, after eating up the surplus and cutting down the allowance for future spending, that still wasn't enough. Less taxes mean less revenue for the government. After 2009, there won't be enough cash for the NZ Super Fund, so that's going to have to be funded out of debt.

Gross Sovereign-Issued Debt (excluding settlement money held by the Reserve Bank) is forecasted to rise from $31.8 billion to $35.5 billion in 2012 – and it's virtually all because of the tax cuts. Does that mean it's failed the “increased borrowing” test? Not quite. The Government's debt target is fixed to 20% of GDP, so as GDP rises, the Government can borrow more money without “increasing borrowing”, since it's still within its “20% of GDP” limit.

It might sound like a whole lot of bollocks, but to be fair, the Government has aimed 20% of GDP target for a while now, and debt as a percentage of GDP is a fair way to judge the size of the debt relative to New Zealand's ability to pay for it. So as a percentage of GDP, debt is actually expected to drop from 18.2% in 2007 to 16.8% in 2012.

Despite all the numbers pointing in the other direction, the bottom line is that the debt track has not gone up – which means that in the grand scheme of things, there has not been increased borrowing. National have yet to release their economic policies, but unlike Labour, they see the 20% of GDP debt target as arbitrary and will have no qualms if it goes higher.

The fairness test is passed with flying colours – though everyone expected the brackets to shift, the changes to the lowest rate was unexpected. It benefits every tax payer, and it's a particular relief for low-income earners.

As for the final test, Cullen is counting on the economic cooldown counter the inflationary pressures of the tax cuts, but the pundits are not so sure. It's bigger and comes sooner than the Reserve Bank had expected, which puts pressure on them to keep interest rates higher for longer. The jury's still out on this question, but we're sure to know before the election.