National's big test: A 'brave budget' with no tax cuts

Unless the G20 saves the world or the recession suddenly does the u-turn, National has only got a month before it must bite the bullet and cancel next year's tax cuts

This week the country will gather round the much-anticipated tax cuts like a family around a fire, taking what comfort they can from its heat in these cold financial times. But the wise will be looking beyond the circle of light created by this fiscal spark to the coming winter and its bleak forecasts.

Most importantly, it's now less than two months to this administration's first Budget, which will be the greatest test thus far of its mettle and avowed pragmatism.

I can imagine John Key and Bill English huddled together night after night watching the overseas markets, waiting and hoping for a glimpse of the bottom, something to tell them how and when this global recession might end.

Call me a Pollyanna if you like, but maybe, just maybe, that turning point will come later this week at the G20 meeting in London. If a path towards some substantial international financial regulation can be agreed upon, some bad credit contained and good credit set free, the IMF and World Bank re-jigged and some new trade initiatives agreed to, well, there could be a glimpse of a corner to be turned.

But if there's not, English and his leader will have to prove what stern stuff they are made of and either cancel or re-think their tax cuts for 2010 and 2011. Even apart from the fact they're overly generous to the rich, they're just the wrong sort of stimulus right now because they are permanent, cutting the government's revenue for ever and ever, amen.

Without signs of a recovery before the budget, the government will have to use the Budgetary pulpit to explain to New Zealanders that the tax cuts they have planned and promised for many, many years simply aren't affordable after all.

It will feel like a deep betrayal, and will be regarded as such by the zealots of the right. So be it. They can package it as the 'Brave Budget'.

Former Finance Minister Michael Cullen was courageous for many year as resisted calls to spill open the government's treasure chests in the good times, repeatedly saying their contents would be needed when times got tough again.

He was right and surely now deserves some credit when even the IMF says New Zealand "is in a better position than most advanced countries to face the global storm" thanks to "sound macroeconomic policies" and a "low level of public debt".. But in taking his stance Cullen was only disappointing his opponents. Key and English will have to disappoint their friends and allies; a much harder ask.

Looking again at the Budget Statement, their commitment to three years of tax cuts is repeated as often as possible. Tax cuts has been National's mantra and, long before Winston Peters became such a liability, it was the line of attack that got the party back in the game after its historic loss in 2002.

Heck, even following Cullen's style of fiscal management, you'd have thought now would be exactly the time for tax cuts. A recession looked to be a hand-picked gift for National; a time when no-one could criticise lowering the government's take.

That is, until this little recession we were having turned into, well, the mother of all recessions, to paraphrase another former Finance minister. The IMF report last week predicted our GDP would fall by two percent this year, and went on to say:

On current policies, staff projects a deficit of 1½ percent of GDP in 2008–09 and about 6 percent of GDP by 2012-13, with gross public debt getting close to 50 percent of GDP by 2013.

Brian Fallow reported in the Herald on Friday that our "ballooning" annual deficit has reached $16 billion. It's now one of the largest in the developed world. The next day Vernon Small in the DominionPost suggested this week's tax cuts could be the last for some year, as the number of unemployed rose from 100,000 to 150,000.

In short, no government worth is salt should commit this country to more than a decade of deficits in such perilous times. When risks are extreme, costs are rising and income is already falling, no sane person willfully cuts their revenue even further and whips out the credit card.

John Key has twice now refused to confirm that these tax cuts will go ahead. That's not done lightly, and time's fast running out on his "watch and hope" approach to this recession. This Budget must go beyond his constant cheerleading to show leadership, laying out a coherent strategy for the next 24 months, not just the scrambled mass of tactics the government has tried thus far.

What should it do? It seems to me that, unless something dramatic happens in the next three or four weeks, the government must either cancel the tax cuts or design them expire in, say, four years. That would be roughly half way through the next parliamentary term, so is the safest political option.

It's a fine balance. Because while we're up against it in terms of what we can afford to borrow, we do need to spend. The government should be offering fiscal stimuli, poking a stick into the side of demand to get it up and running. As Martin Wolf has written in the Financial Times, monetary policy is almost exhausted. He continues:

The right thing to do is more than enough. It will always be possible to withdraw stimulus a year or two hence. It will be far more difficult to make action effective if depression, both economic and social, takes hold.

Tax cuts are the wrong sort of stimulus in large part because they're so hard to withdraw in a year or two. So enjoy the extra money in your pocket this week. By the time of the Budget on May 28, National needs to have come up with a better plan.