Inflation v Tax Cuts

I want to say something about the statement 'tax cuts increases inflation' that is being thrown around a lot lately. This is being used, particularly by Cullen in New Zealand, to justify not cutting taxes (and criticising National's not yet promised tax cuts - something I will touch on below).

Inflation is caused by general demand exceeding supply. According to those using inflation as the spectre to justify not cutting taxes, demand increases as the supply of money increases and the supply of money in the economy increases when taxes are cut as the amount of money that taxpayers has increases.

Thus the statement 'tax cuts increase inflation' rests on the assumption that tax cuts will increase demand, presumably because all the tax cut money will be spent where as it would not have been if it was not cut. This is what I have an issue with... the fact that it is assumed (by Cullen, the media and those that just accept what they are told) that not only will all money returned to taxpayers be spent, but that money that is not returned in tax cuts will not be spent.

From financial year end 2006 to financial year end 2007, New Zealand government expenditure increased by 5%, from $65,422,000,000 to $69,017,000,000. Year on Year inflation in March 2007 was 2.5%. This means that government expenditure increased by 2.5% in real terms (i.e. negating the effect of inflation. The effect in real terms will be the real effect of growing government expenditure on demand and inflation) over the same period of time.

Therefore not cutting taxes is not demand nor inflation neutral, unless government expenditure grows at the same rate as inflation, inflation will be influenced. If expenditure grows slower, demand caused by the government decreases; if expenditure grows faster, demand caused by the government increases.

Growing government surpluses can reduce demand by taking money out of the economy, but such growth in surpluses has to outweigh the increase in government expenditure. Also the only place a growth in surplus in real terms can come from is by taking money out of the non government economy. The non-government economy will have to have decreased by 2.5% in real terms between 2006 and 2007 to offset the growth in government expenditure with regards to increasing inflationary pressures.

I also have issue with the assumption that all money returned through tax cuts will be spent increasing demand. Much may be said about (New Zealand's in particular) woeful savings rates, but it is unlikely that every cent will be spent. Some will be saved for those that can afford to save and some will be used to retire debt, which does not increase demand. All increases in government expenditure are spent, increasing demand.

The statement 'tax cuts increase inflation' also ignores the supply side of the inflation equation, as if supply increases relative to demand then inflation should decrease. As government expenditure is unlikely to be efficient or productive expenditure (feel free to let me know if you disagree, I have not yet examined the numbers for this) but rather redistributive, it is unlikely to influence supply. Tax cuts, and especially tax cuts for business or aimed at higher income earners, on the other hand at least have the opportunity of being put to productive use through investment in productive business, increasing supply and lowering inflationary pressure. I say tax cuts aimed at higher income earners, as it is higher income earners who can afford to, and are more likely to, invest in shares and business rather then just pay off a little bit more of the mortgage

Cullen has used the inflation spectre to criticise Key's Freudian slip that National's tax cuts will be around $50 a week. Cullen said:

"Mr Key has not yet seen up-to-date inflation forecasts, he has no idea
what Treasury is predicting by way of economic or revenue growth in the year
ahead and no idea if his $50 a week or more in tax cuts would result in higher
interest rates for New Zealanders."

Even $50 a week tax cuts will apparently cost only $5 billion, only slightly more then the increase in government expenditure from 2006 to 2007. The increases in government expenditure has had more of an influence on inflation and raising interest rates then even National's not yet promised tax cuts.

Finally, it annoys me that a rise in interest rates for those who hold mortgages becomes a burden every tax payer has to bear. But that is a blog topic for another time.

Round and round some of the (Australian) budget forecasts

The Australian budget was released Tuesday, and why in the most part I (and the commentators) thought it was a sensible budget, there were a few things that looked a bit convenient...

First the budget forecast 3.25% inflation for next year where the Reserve Bank of Australia last week forecast 3.5%. The budget based this lower forecast on its conservative growth forecasts. This is good for the government, as the government wanted this to be a 'low inflation budget' (although 3.25% is still above the target). But the budget is slightly circular, the low growth forecasts and budget itself will lead to lower inflation as forecast in the budget, which justifies an inflation fighting budget, which is based on the forecast of lower inflation. The difference in forecast is also a part of the government saying to the RBA, "look please please don't raise interest rates again, we are doing our best".

It will be interesting to see whether the RBA agrees with this lower forecast in its next monetary statement. Assuming that nothing else fundamental changes, then this will be a major independent test of the budget... and not everyone thinks that the budget was enough for the RBA to lower interest rates.

The budget also forecasts unemployment to grow from 4.25% to 4.75%, a growth of .5%. Once again this growth is based on the very conservative growth forecasts that the budget has adopted, as lower growth leads to lower employment growth, leads to growing unemployment (leads to lower growth). Once again this benefits the government as it leads to lower inflation forecasts, wage moderation and justifies family welfare increases.

Swan probably is the 'luckiest incoming treasurer in Australian history', given he could afford to spend big and tax less. However sometimes the rhetoric around the budget has made me think of the Disraeli quote 'lies, damn lies and statistics' (or is that 'politics'), for all the anti-inflation / slashing government spending talk its very similar to what Costello would have done.

Lost my stupid post

Was going to post on some of the forecasts in the budget, in fact had written the post, found all the links to the budget, RBA statements etc and hit "publish post".

The damn blogger had logged me out and it lost the post!!!!

So ridiculously frustrating, 2 hours work down the drain, no recovery, spent 45 mins trying to find it it is no where!

I shall try to do it again tomorrow as I am far to tired today. But it is damn hard to do, working 12 hour days at the moment. My only free time was to relax and write a post.... and its lost!!!!!!!!!!!!!!

Grrrrrrrrrrrrrrrrrrrrrrrrrrghhhhhhhhhhh

Australia v NZ: Swan's budget

The Australian budget has been released today. As expected Australia is cutting taxes. I myself am receiving $1,100 extra in the year from July 1 (although hopefully my salary will go up too) through threshold movements, plus the 1.5% medicare surcharge will disappear.

However, lots and lots of money is going to 'working families', as if they didn't get enough extra
compared to us productive childless earners anyway. Read here and here for a nice criticism of family friendly tax regimes; they really don't make any economic sense.

A note on the tax cuts and inflation, inflation (currently at 4%) will erode about $3000 from my purchasing power overt the next year, the threshold movements will redeem a bit of that, but (like the problem in NZ) bracket creep is robbing more than the threshold movements. Therefore the tax paid as a proportion of total income grows each year. At least Australia has been increasing these thresholds over the last few years unlike NZ, but the movements have not been enough to prevent bracket creep completely. It will be interesting to see what Cullen does on the 22nd, I think he will probably raise the thresholds (at least the low ones).

P.s. I am watching Malcom Turnbull trying to rip apart the budget, unfortunately he is not very convincing.