Easton on tax cuts

Brian Easton has an interesting paper on "what the tax debate is really about" up on Scoop. He begins by comparing Labour and national's plans, and concludes that a) Labour's targetted assistance, while close to the edge, is "probably within the acceptable fiscal parameters", while National's $10 billion splurge is not; b) borrowing will be much higher under National, as it struggles to cover the shortfall; and c) that this will lead to higher interest rates:

[I]ncome tax cuts will increase household’s incomes. Consumers will spend most of the additional income. But with unemployment as low as 3.7 percent (apparently the lowest in the word) , the economy cannot produce much more. That means that either there will be severe inflationary pressures, or that the extra consumption will be provided by imports or – and this is the most likely – both. Second, there is the additional government borrowing.

The two sides lead to the same prediction. Domestic interest rates will have to rise. They will have to rise as the Reserve Bank takes measures to restrain an overheated economy. They will have to rise because the government will have to persuade overseas investors to hold more New Zealand government debt. Both ways New Zealand borrowers will be hit by higher interest rates. That means mortgage holders will have higher mortgage repayments, and businesses will pay more for their borrowing and defer productive investment.

(Original emphasis) This will in turn cause the exchange rate to rise, and lead us straight into the high interest rates - high exchange rates trap that strangled economic growth in the 80's. In other words, National's plan would lead to a severe economic crisis. So why is Brash - a former governor of the Reserve Bank who knows very well the consequences of is actions - pushing it? Easton concludes

I can't help thinking that National’s underlying agenda is the oft stated right wing strategy of giving substantial tax cuts and then forcing public expenditure cuts to rebalance the budget.

The strategic deficit, in other words - with the end goal of savage but "necessary" cuts to social services, just as Ruth Richardson did in 1991.

The silver lining in this cloud is MMP. Any government is highly likely to be dependent on other parties in order to push its policies through, and this means that

It is possible that the economic individualists could find themselves in office without the power to implement their policies.

Given the noises Winston is making about National's tax plans, I regard that as highly likely. But it's better not to take the risk.