Are tax cuts a good idea?

The following commentary is provided by Professor Norman Gemmell, Chair in Public Finance.

Before John Key resigned as Prime Minister there were plenty of hints he favoured income tax cuts in 2017, while Finance Minister Bill English was rumoured to be less keen. So how will the partnership of English as Prime Minister and Steven Joyce as Finance Minister approach tax cuts and would they be a good idea?

Most voters probably now recognise that the economists’ adage ‘there is no such thing as a free lunch’ definitely applies to tax cuts. There are only three options if a government cuts taxes: it eats into its budget surplus—if it has one; it spends less on things it presumably thinks we need or want; or it borrows more now but raises tax later when the borrowing has to be repaid with interest. (Cutting tax rates but managing to raise more revenue is sometimes possible, but it’s pretty rare.)

So are tax cuts a good idea? Before answering that question, it is worth recalling that if the Government does nothing it will generally end up each year with more tax revenue than the year before. That is because, whenever wages and salaries go up (whether to compensate for price rises since the last wage increase or because real wages rise), the income tax we pay goes up more rapidly, due to the progressive nature of the tax schedule and some taxpayers shifting into higher tax brackets. Read more