Everything you need to know about the Budget, including why your tax cut might shrink next year

ANALYSIS

Everyone likes to tell a story from a Budget.

They seem to beg narrativisation: this Budget hurts people, this Budget helps people, this Budget robs people.

But Budgets aren’t really like that. If there
is a big story in the Budget, it’s one that can only be told through lots of little ones – little stories that often contradict each other.

With that in mind, here are some of the most interesting bits of the Budget, which try to tease out its story – if not always a cohesive one.

Tax cuts fit one definition of affordable and neutral, but not others

The Budget did not provide a satisfying conclusion to the debate that has raged over whether the Government’s tax cuts were “fiscally neutral” and whether Finance Minister Nicola Willis was “borrowing for tax cuts”. If anything, it proved that both statements were true, possibly at the same time.

Budget documents showed the $14.7 billion cost of the tax cuts was paid for by $14.8b of savings (over the four-year forecast period).

That’s fiscally neutral – and a win for Willis.

However, the Government bond programme (borrowing) increased by $12b relative to the HYFEFU forecasts from last December, and forecasts for core Crown debt show the Treasury expects the Government to be $17b more indebted by 2028 than it was expecting as recently as last December.

So if we’re not borrowing for tax cuts, we’re definitely borrowing for something.

The answer really depends on the way you look at it. From an accounting perspective often used by politicians, “neutrality” means one thing goes out of your spending track to fund another thing that costs an equivalent value. This is why Labour struggles to make the “borrowing for tax cuts” argument, because its own election tax cut (axing some GST) used the same logic – in fact both Labour and the Government planned to make their schemes neutral by cutting the same thing: commercial building depreciation (the Government’s plan obviously adds many more cuts on top of that). The Greens and Te Pāti Māori used the same logic, increasing taxes somewhere to pay for cuts somewhere else.

A win for Willis.

Many economists are unsatisfied with that, however. They point to the fiscal impulse, a useful if imperfect measure of the Budget’s impact on aggregate demand, or to put it crudely, whether the Budget is helping fight inflation or not relative to the last year. This metric is caveated to death by Treasury, blunting its impact as a political tool, but if it shows anything, it shows the current Budget certainly isn’t helping fight the battle against inflation, even if the decisions made by the ministers aren’t making anything worse.

A win for the Opposition.

The economy has hit a wall – with consequences for every political party

You might remember that after the pandemic, New Zealand enjoyed an unexpectedly golden economic era. The Government benefited from this too, with tax revenue often exceeding Treasury’s forecasts. The economy was going better than expected and the Government was a key winner.

That changed inApril last year, when Treasury noticed some changes. It revised its forecasts, showing tax revenue would be a whole $9b lower over the forecast period than expected. pushing the return to surplus out another year (it’s been pushed out further subsequently, and now expected in 2028). The reason for these revisions is that the economic recovery from Covid-19 was softer and more stimulus-dependent than expected. As interest rates went up and that stimulus was withdrawn, the economy was revealed to be much weaker than Treasury had counted on a few years ago.

That trend has continued in subsequent forecast revisions. In the six months since Treasury’s December HYEFU forecasts, Treasury has revised economic growth downwards; GDP will now be $10b lower by 2028. That is despite higher population growth in the current year.

This had had a consequence for the Government. Treasury reckons tax revenue in the next four years will be a massive $28b lower relative to the last set of forecasts. This is a detail that hasn’t received enough attention. In just six months, Treasury shaved $28b – about 50 per cent more than was spent on the Covid-19 wage subsidy – off the Government’s revenue forecasts for the next four years.

A third of that is the Government’s fault – it’s losing that revenue due to its decision to cut taxes.

But two-thirds of it is due to the weaker economic outlook and “significantly” lower taxes being paid by businesses.

The Government is clawing back some of this shortfall by trimming future new spending by $5.5b over the forecast period (more on that later). It’s an open question what Labour would have done had it won the election. It may very well have done the same thing; faced with declining revenue forecasts last year, Grant Robertson did exactly what Willis did, and trimmed his future allowances.

The rightness or wrongness of the tax cuts is… complicated

Every Government needs to adjust tax brackets eventually, or risk creating an effectively flat tax system where everyone pays basically the same portion of their income. The longer you leave it, the more painful it gets.

It is especially painful now, as many income earners earn significant portions of their income above $48,000 and $70,000, which carry rates of 30 and 33 per cent . That punishes a lot of earners who are earning incomes that no longer qualify as “high” while rewarding the Government, which takes roughly a third of most full-time workers’ pay increases each year.

Had the brackets not been changed, someone earning the minimum wage this year would have faced having a small portion of their pay taxed at 30 per cent, and pay rises in subsequent years taxed at 30 per cent.

That level of high taxation on low incomes is unsustainable. Some in Labour know it, which is why the wealth tax plan was designed to pay for a big reduction in income tax rates.

Advice from Treasury and IRD ahead of the Budget actually made this point: “The increase in annual tax liability from fiscal drag is uneven across income levels, with the greatest impact occurring as the $48,000 income threshold is crossed. Full-time minimum-wage earners will therefore be heavily affected in coming years,” they said. IRD calculates a median worker’s average tax rate had increased 5.1 percentage points to 20.6 per cent in the time thresholds were last adjusted.

That would have caused a real bind for Labour had the party won a third term. The party fought hard for big annual increases to the minimum wage when in government, staring down business opposition. Is it worth the political fight when 12.5 per cent less of that increase would end up in full-time workers’ hands than before?

At the same time – turn to the child poverty report in the Budget (it’s easy to miss at four pages of text, less than half the size of Jacinda Ardern’s last child poverty report in 2022), and you see no forecast path to reduce child poverty.

Child poverty reduction got some attention in the Budget. According to a Treasury Regulatory Impact Statement, the $25 bump in the In-Work Tax Credit – a policy National nicked from Labour and watered down – will reduce child poverty by around 14,000 children (+/- 6000 by one measure, ACH50, and 3000 by another, BHC50). Thanks to a quirk in the way child poverty is measured, it might actually increase child poverty by another measure.

But part of this undoes the impact of the Government’s decision last year to change the benefit indexation formula, which was estimated to increase child poverty by 7000 (+/- 4000 by one measure, ACH50) and it would still leave more children in poverty by another (BHC50) where there would still be 4000 more children in poverty after the impact of both changes was netted out.

Even more controversially, one of the ways the Government is paying for the plan is cutting a Working for Families tax credit abatement threshold change Labour and National had both promised for 2026, which likely would have had an impact on child poverty. The change will see some families miss out on $38 a week by 2026.

The trouble with tax cuts is that they are ferociously untargeted and very expensive, and leave little money left in the kitty for targeted social spending.

Not quite austerity, and why some people’s tax relief will nearly halve in coming years

The Government said this Budget would shift spending from the back office to the frontline. This is difficult to measure, regarding some of what qualifies as “back office”, such as certain functions of Oranga Tamariki, Corrections and DoC. Other spending lines look to be “frontline” in the books, such as the former functions of DHBs, now rolled into Health NZ, but are probably more accurately described as “back office”.

Nevertheless, in two of the biggest spending departments, health and education, there has been a shift from what might be called the “back room” to the “front line”.

In health, departmental expenses, mainly money that goes to the Ministry of Health to manage the health system, decreases from $269 million in the year just gone to $232m in the coming year, and $214m in 2026 (although this may change in the next Budget).

Meanwhile, core health and disability spending, which mainly goes to Health NZ to deliver healthcare through hospitals and clinics, increases each year by slightly more than Labour had promised at the election from $27.9b in the year just gone, to $28.6b in the coming year and $29.8b in 2026 thanks to the new multi-year funding for healthcare. National railed against this in Opposition but has now come round to it (in her 2022 Budget speech Willis said Robertson’s use of multi-year funding was an example of him being so “ill-disciplined and careless has this Government become about its spending that he’s raiding next year’s Budget kitty as well”).

Education is similar but less stark: departmental expenses fall from $2.5b to $2.3b this year, while spending on primary and secondary schools increases from $9.7b to $10b. Spending per student is expected to be the same in the coming year as it was under Labour.

The challenge is that the money to pay for these spending increases in 2025 and 2026 is very tight. Willis has opted for operating allowances of $2.4b in the next two Budgets. With the exemption of benefits, almost all cost pressures will need to be funded from that $2.4b pot of money. Health has already had its “cost pressures” of $1.37b in 2025 and 2026 precommited from those allowances, leaving $1.03b left to fund cost pressures in education and everything else.

That is extremely tight. Treasury thinks $2.5b would be needed to “maintain the existing level of services”, leaving Willis $100m short to begin with – and that figure does not include any unexpected demographic changes, such as the high migration we are currently expecting. More people means more pressure on the limited pool of funding the Crown pays to operate the health and education systems.

Treasury says further money will need to be freed up in “savings, reprioritisation or revenue raising measures”. That means cutting even further in coming years, or looking at new taxes, perhaps levies on mineral extraction, or taxing charities, as Luxon has hinted. A cursory look through the Budget documents shows there isn’t much “back room” left to trim.

The other painful challenge for coming years is to do with the clever way the tax package was structured to provide rather large tax cuts to middle-income New Zealand at lower cost to the Crown. Typically, the more you earn, the greater your tax cut. This means that to provide big tax cuts to middle New Zealand, the Government has to cut tax rates or lift brackets quite steeply.

Not so this plan, which takes a fairly modest tax cut and bolts on a powerful but cost-effective tax credit.

Willis has expanded access to the $10 a week Independent Earner Tax Credit up to $70,000 (although it begins to abate at $66,000). This means that “middle-income” New Zealanders get more from the package than people earning million-dollar salaries. It’s a clever tactic, targeting tax relief at people who earn between $48,000 and $70,000.

The problem with this method is that it won’t take long for the effect of that tax credit to shrink as the person’s income pushes them into brackets where they no longer receive the credit. This is the opposite to what usually happens with tax cuts, which is when you earn more, you get more.

Someone on $62,000 today would see their $50.75 tax cut this year start shrinking after four years of average wage growth (3 per cent on Treasury’s most recent forecast), before reducing to just over $30 after about five years. During those years, that person would face an effective marginal tax rate of 43 per cent because of the rate at which their IETC is withdrawn (this is why Treasury advised against using the IECT for the plan). The person is still a middle-income earner, but they’re only getting slightly over half the tax relief promised to middle-income earners a few years earlier.

Set that against a few tight Budgets and you have a recipe for some grumpiness on the part of the electorate, particularly should this Government win a second term.

Thomas Coughlan is Deputy Political Editor and covers politics from Parliament. He has worked for the Herald since 2021 and has worked in the press gallery since 2018.