Michael Cullen's Incompetence: Part 9482

Cathy Odgers has blogged on her site about the fallacy of tax cuts being inflationary, with a reference to Roger Kerr's excellent opinion on the subject. Because my motive is to drive readers to my site, and not Cathy's, I am pretending that I did not steal her idea by discussing the nonsense of Dr Cullen's claims on here.

Cullen is demonstrating with his statement that tax cuts are inflationary that he does not understand economics, and that academic historians should not be responsible for fiscal policy. Apart from the irony of a not-particularly-successful university lecturer-turned politician attempting to suggest that he knows more about monetary economics than a man who was singularly responsible for controlling inflation in New Zealand for fourteen years, I struggle with one conclusion: Is Michael Cullen lying about tax cuts being inflationary, as he has lied so extensively about the affordability of tax cuts, or is he simply incompetent by making that claim? And which is worse, to be a liar in charge of the public purse, or to be thoroughly inept?

I can only suggest that readers decide for themselves whether Cullen knows that he's wrong about tax cuts being inflationary and is lying about that fact, or that he simply doesn't know that he's wrong.

Michael Cullen is playing the gamble that voters get confused about the causes of inflation: that voters believe that he understands inflation, that they don't like inflation--due to its effects on prices and interest rates--and that whatever he says about inflation will scare them into believing what he says. In reality, inflation and its causes, are quite simple.

Traditional economics tells you that inflation is caused when the demand for goods and services exceeds the supply of those goods and services. When demand exceeds supply, prices will increase to dampen demand. Michael Cullen's argument is that lowering taxes puts more money in the hands of taxpayers, which increases demand, putting pressure on prices. It's a nice, traditional idea. It's also wrong.

It's wrong for these reasons. New Zealand is an open, relatively deregulated, relatively competitive trading economy. The biggest influence on supply prices is not domestic structural issues, but world commodity prices. New Zealand does not have a large impact on the price of goods and services traded internationally. When I go to the butcher to buy two steaks, the price I pay for those steaks is largely determined by how much the nearby butcher's competitor charges for those same steaks. The butchers are competing for my custom. The price they pay for the meat is determined by how much they pay the meat works for the meat. That price is in turn decided by how much the Indonesian butcher in Jakarta pays for that same piece of meat. If the butcher raises his prices because he thinks I can pay more, then I will have the choice to go to his competitor. If the competitor raises his price, then the Indonesian butcher can enter New Zealand and under-cut both of them. That is a function of operating within an open, trading world economy. Prices are decided by relative efficiency and international competition. If any one of those traders in the international market-place--including New Zealand traders--try to take advantage of the fact that I have more cash to spend, then I will simply shift my purchasing decisions towards somebody who can provide that product or service cheaper.

In reality, the supply of goods and services in the New Zealand market is largely based on a world supply chain. Increasing New Zealand demand for those goods and services does not affect the price in that supply chain. So simply giving New Zealanders more cash to play with does not stimulate higher prices.

The second part of Dr Cullen's flaw is just as easily debunked. What Dr Cullen refuses to admit is that taxation distorts the performance and efficiency of domestic markets. Taxation is, by its very nature, a means of distorting the decisions that individual consumers make. When the Government decides to spend a hundred million dollars buying computer equipment, the end users of that computer equipment are disempowered from the decision making process. They have become compulsory consumers of that equipment. Some may make good use of their share of the computers: others will have less use of that equipment. The end result is that the decision to bulk-purchase equipment for a large group's needs does not suit the needs of all users in the same way. On the other hand, if the Government says to that same group of people: "Here is a hundred million dollars. Buy whatever you think you need with it--be it computers, or whatever else you see is necessary for you to do your job." And that is what the government does with tax money. It makes less efficient decisions than what individuals are able to make, with the same amount of money.

So Government spending is less efficient than the decisions of individuals, because it takes on the supposed requirements of a whole group of people, as determined and decided by one decision-maker. There is no flexibility in the decision. Money is wasted. Growth is not as strong as it could be, because the individual needs of individual users are ignored.

When a Government taxes a person, that money gets spent. That is the nature of Government. Inevitably, Government spending rises in accordance with available money. So the more money that Government takes from individual taxpayers, the more projects it will find to spend that money on. The quality of those projects decreases--which is why we have seen the Government pouring ridiculous amounts of money into anything it can throw cash at. This non-productive spending does nothing to improve economic growth. This creates lower efficiency within the economy, greater capacity constraints, and higher structural inflationary pressures. The biggest contributor to inflation is not market behaviours, which are inflation-neutral, because they are highly efficient in a competitive environment. Rather, inflation is most often caused by Government making wholesale decisions--hugely inefficient decisions-- on behalf of consumers and place capacity constraints on the economy.

Conversely, lowering Government spending increases economic efficiency, and lowers capacity constraints. The economy is able to grow faster, because individual consumers are making their own decisions about how to spend their money, rather than the big-bang, one-size-fits-all Government approach to spending. And this extra growth can take place without inflationary effects.

The further impact of lowering taxation, apart from freeing up capacity constraints, is that it makes New Zealand consumers more internationally competitive. Because lowering taxation decreases business costs, there is more room for wage growth, and economic growth, without affecting prices.

Historical examples demonstrate clearly the positive--and inflation-neutral--consequences of lowering taxation on the economy. Reaganomics achieved it. So too has Australia. Reducing taxation at a time of large fiscal surpluses is the painless way of reducing the role of Government in the economy.

But now I'm ready to draw a conclusion, without asking you, the reader. I conclude that inflation is so easy to understand, that even Dr Cullen must be able to grasp it. Unless he's monumentally more stupid than we've been led to believe over the last six years, he's lying to us about tax cuts being inflationary. Again.