Why Rudd's tax cuts are grubby politics and bad economics

Don't be taken in by the efforts of Kevin Rudd and Wayne Swan to portray their persistence with the promised tax cuts as a matter of good economics and high principles.
They're trying to dress up an irresponsible promise born of grubby political manoeuvring which, apparently, they don't have the courage to ditch and face the electorate's ire.
Let's start with the politics. Why would any Treasurer with a claim to being responsible lock himself into a promise to cut tax by a given amount in the coming financial year, the year after that and the year after that?
It's hard to be confident of what state the economy will be in at the end of the first year, let alone what it will be like in 2010-11. Why commit yourself so far into the murky future?
Worse, why would any Treasurer with a half a brain promise tax cuts at the top of a boom, when the Reserve Bank and his own Treasury secretary had been banging on for ages about the high risk of an inflation break-out with the economy close to full capacity?
I'm talking, of course, about Peter Costello. And I'll tell you why. Mr Costello knew that when the Treasury secretary and the Finance secretary produced their Pre-election Economic and Fiscal Outlook report a few days after the start of last year's election campaign, they'd make significant upward revisions to the budget surpluses projected for the following three years.
Mr Costello was terribly afraid that, if so, his Labor opponents would leap in and try to buy votes by promising to spend all the extra revenue. He was obsessed by this fear because of his belief that the Kennett government's surprise defeat in Victoria in 1999 had been caused by Labor stealing its surplus, so to speak.
So Mr Costello decided to get in first. He pre-empted the econocrat-controlled PEFO by bringing forward the report he controlled, the Mid-Year Economic and Fiscal Outlook, and including within it a Howard government decision to cut taxes by $34 billion over three years.
By being first to act irresponsibly he was trying to snooker Labor. He'd kicked off the campaign with a huge tax bribe. Labor pondered for a few days before deciding its best response was to ditch whatever tax changes it had been planning and say "me too" to the Liberals' cuts. It made a few changes at the edges for appearance's sake.
In terms of short-term tactics - of political expediency - this was undoubtedly a smart move. Labor wasn't prepared to occupy the high ground by offering a smaller tax bribe than its opponents. Because the punters always view the Libs as the better party on taxation, it knew it couldn't win a game of my-tax-cut's-better-than-yours.

By simply saying "me too", Labor totally neutralised tax cuts as an election issue. Since they weren't a point of difference, they were never mentioned again, which suited Labor fine. Costello's first strike had been turned away.
So that's the political origin of Labor's promised tax cuts. Any fancy economic arguments are mere rationalisations after the political fact. Labor knew that if it won the election it would be taking over at a particularly daunting point in the cycle but, in the heat of the campaign, it wasn't fussed. First win the election, then worry about whether your promises were responsible.
But let's look at the economic arguments Labor is raising in defence of the indefensible. The key to evaluating them is to remember that neutralising the effect on demand of the promised $7 billion tax cut in 2008-09 would require about two 0.25-percentage-point rate rises.
Such rate rises would increase the payments on a $300,000 mortgage by about $103 a month, whereas the tax cuts would be worth $50 a month to people on incomes around the middle, $92 a month to people on incomes between $80,000 and $150,000 a year and $217 a month to people on incomes above $180,000.
First point: Mr Swan says one reason the Government is "emphatic" the tax cut will be delivered is that it "rewards the hard work of the great bulk of lower and middle [income earners] … who have worked to make this economy strong, who haven't [had] a fair share of tax cuts in my view in recent years. They have earned them."
This misrepresents the (odd) shape of the cuts. It's true that, having been conceived in an election campaign, they are, for once, quite generous to people on incomes below the middle, who save up to $88 a month.
But Mr Swan carefully fails to mention that a key feature of the cuts is the raising of the cut-in points for the top two tax rates (making well-paid economics editors major beneficiaries). Lower and middle, did you say?
The arithmetic simply doesn't support the claim that the cuts will somehow take a bit of heat off hard-pressed working families with mortgages. What would best reduce the heat they'll be facing - and spread the pain more fairly - would be to ditch the tax cuts and thus avoid adding to the need for further rate rises.
The same goes for the argument that going ahead with the tax cuts will "relieve pressure in the wages system". That's true only if you delude yourself that the cuts have no opportunity cost.

I'd have thought the presence of two more interest-rate increases would be likely to do more to fuel a wage break-out than the absence of a tax cut of $10 to $20 a week.
Finally we have the argument that the tax cuts will help on the supply side by raising participation in the labour force. Labor has embraced Mr Costello's claim that the three-year cuts will encourage an additional 65,000 people into the workforce. There's no denying that raising the effective cut-in point for the 15 per cent tax rate and raising the nominal cut-in point for the 30 per cent rate can be expected to encourage more mothers and students to work part-time or work additional part-time hours.
But there's no empirical evidence to support the fond belief that cutting the tax rates faced by people earning more than $75,000 and $150,000 a year would encourage them to supply more labour - and I doubt if any of them are included in the 65,000 figure.
In any case, getting extra part-time hours from 65,000 people "over the medium term" (however long that is) is quite a modest supply-side gain in return for a $31 billion addition to demand.
In other words, the supply-side argument is a mere fig leaf, which fails to cover the naked political motivation that gave birth to the tax-cuts promise and is prompting the Government to dig in its heels for fear of the electorate's ire.
At the very least, Mr Swan could make a more honest man of himself by reneging on the generous tax cuts going to higher-income earners. You don't need them yourself, Wayne, and neither do I.