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Budget Policy Statement 2010

Fiscal Strategy

The Government is committed to sound finances

In Budget 2009, we took a range of decisions to ensure a sustainable long-term fiscal position. It was appropriate for the Government to absorb some of the shock of the recession on our balance sheet. However, the Government does not intend to saddle future generations with ever-increasing debt repayments, which would leave them vulnerable to future economic crises. Even with the tough decisions we took in Budget 2009, net debt is still forecast to treble from 2008/09 levels to $64.9 billion before turning around.

Figure 3 - Net debt and net worth
Figure 3 - Net debt and net worth.
Source:  The Treasury

In the 2009 FSR the Government set out a plan to contain net debt so that it peaks below 40 percent of GDP and reaches 30 percent of GDP no later than the early 2020s. Over the longer-term, the Government believes net debt should be closer to 20 percent of GDP.

This Budget Policy Statement confirms that we are on track to achieve that strategy and we will continue to be prudent managers of public finances. Budget 2010 will follow the approach of the previous Budget, and include future operating allowances of $1.1 billion each year, growing by 2 percent per annum thereafter. New spending in Budget 2009 was $1.45 billion. The Government managed to operate within this while fulfilling pre-election commitments. With those commitments met, and recognising that there is considerable scope for productivity improvement within the public sector, a smaller allowance is now appropriate.

The Government strategy of delivering better, smarter public services for less is based around a three to five year programme of reform within the public sector. Most agencies will receive no new money for several years. This will require them to prioritise within existing funding, including dropping low-priority, ineffective expenditure and redirecting resources to the frontline. Public sector operations will have some flexibility to adapt; for example by investing in technology or better ways of working.

Figure 4 - Core Crown expenses to GDP
Figure 4 - Core Crown expenses to GDP.
Source:  The Treasury

Over time, the size of this allowance makes a material impact on the level of government expenditure. Over the next five years core Crown expenditure is projected to grow by only 19.1 percent. This is projected to produce a decline in the expenditure/GDP ratio, as set out in Figure 4.

The undisciplined approach of recent years has greatly contributed to the current deficit position, the squeeze on the productive sectors of the economy and the erosion of New Zealand's estimated trend growth rate noted above. Future budgets need to address this in a measured way.

For these reasons, we will meet new spending pressures from within this $1.1 billion in Budget 2010.

Spending priorities in 2010

The 2010 FSRwill continue the Government's practice of scrutinising the whole of its spending, rather than just new spending. In our first Budget, we redirected $2 billion from lower-priority activities to essential frontline services. This close scrutiny of taxpayer value needs to continue. We cannot afford to fund programmes and activities that offer poor value for money.

Figure 5 - Budget new operating spending
Figure 5 - Budget new operating spending.
Source:  The Treasury

In Budget 2010 the Government will prioritise new funding for Health and Education within the $1.1 billion allowance.

The new capital allowance will remain at $1.45 billion in 2010, as signalled in the previous Budget. This will be prioritised to effective investments that lower the costs of doing business in New Zealand or support the delivery of essential public services. It is expected that the majority of this expenditure will be allocated to improving New Zealand's productive infrastructure.

Updated fiscal outlook

Based on current forecasts, the operating deficit (before gains and losses) in 2010/11 will be $6.7 billion, narrowing to $4.9 billion by 2013/14. Net debt, which was $17.1 billion or 9.5 percent of GDP at June 2009, will increase to $64.9 billion or 29 percent of GDP by June 2014.

Figure 6 - Revenue and expenses
Figure 6 - Revenue and expenses.
Source:  The Treasury

Figure 6 shows that even with the stronger growth anticipated in 2010 through 2013, the forecast increase in revenue is not enough to match expenditure.  The operating deficit is inherently structural.  It is possible that growth could surprise and be stronger than anticipated.  However, stronger growth alone will not restore the Crown accounts to balance if expenditure growth is not kept in check.  There is also a growing drag from rising finance costs as debt increases.  Core Crown finance costs are projected to increase from $2.4 billion in 2008/09 to $4.6 billion by 2013/14 - more than the combined spending on Police and Defence.  Rising finance costs simply displace more worthwhile uses of Government resources.  This highlights the ongoing need for restraint and the dangers of funding current spending from debt accumulation.

Longer-term expenditure control

Not all increases in expenditure are funded from within the new spending allowance. For example, some demand-driven expenditure such as superannuation, income support benefits and KiwiSaver are not captured. In addition, the new spending allowance does not include finance costs. Under the previous administration a significant part of the growth in government spending occurred outside the new spending allowance. While it makes sense for some spending to be demand-driven, this needs to be balanced against the poor discipline and accountability that can occur when there is little restraint. The spiralling liability of ACC is an example of not properly managing such expenditures.

We want to facilitate a more stable fiscal - and therefore, economic - environment. Controlling the growth of, and getting better value from, government spending should be a permanent feature of the economic landscape. Maintaining discipline over spending, while also allowing automatic stabilisers to help absorb shocks to the economy, requires a careful balance. Some countries have had success with a spending cap - a limit which the Government is required to keep spending below. Others have had success with multi-year expenditure rules and targets. The Government will consider what tools may be required to help strike that balance.

Improving monitoring and risk management of Crown operations

In the 2009 FSRthe Government began to widen the fiscal toolkit for managing the Crown's operations. The Public Finance Act requires that FSRs state the Government's long-term objectives for:

  • total operating expenses
  • total operating revenues
  • the balance between total operating expenses and total operating revenues
  • the level of total debt, and
  • the level of total net worth.

In practice debt has served as the primary fiscal anchor. However, the whole of the balance sheet matters. As at 30 June 2009, the Government's assets totalled $217 billion and liabilities $118 billion. Net worth was therefore $99 billion or 55 percent of GDP.

Not only is the balance sheet large, but changes in asset and liability values matter. The past year illustrated this. The Crown suffered, for example, losses of $2.6 billion on its investment assets, and impairments of $2.5 billion on its tax outstanding and student loan portfolios. Over time, taxpayer assets such as TVNZ and KiwiRail have permanently declined in value. The ACC liability increased by some $5.8 billion last year alone.

All of these movements ultimately impact upon the Crown's solvency and the tax burden faced by future taxpayers. The Government has an obligation to taxpayers to manage these exposures in a prudent, responsible and professional manner. Poor management of assets simply creates a problem that all New Zealanders will ultimately pay for - in lower-quality services and higher taxes. Better management will benefit all New Zealanders. For example, just a 1 percent improvement in the efficiency of the Crown's assets could more than pay for the Crown's entire investment in the ultra-fast, nationwide Broadband network.

For these reasons future FSRs will include increased emphasis on net worth as a fiscal indicator. Changes in net worth represent, in the long run, higher or lower burdens on future taxpayers. These can be material. Over the past year the Government has incurred large contingent liabilities through its banking sector liabilities. A complete picture of Crown solvency is critical to the Government's ability to manage these.

Future FSRs will elaborate on the role and definition of net worth in the suite of fiscal indicators. Treasury's half-year projections include an initial estimation of a net worth indicator. Issues to be addressed include how short-term volatility should be absorbed, and the appropriate treatment of those assets that produce social rather than financial returns. Ultimately the Crown's single largest asset remains its power to tax.

Alongside improving its asset management, the Government will also improve its risk management. The Public Finance Act requires that the Government identify and manage prudently all risks, including changes in the value of assets and liabilities and the potential for off-balance sheet items such as guarantees to give rise to liabilities. This naturally links back to the Crown balance sheet, since all assets and liabilities carry some risk. This is by no means a complete description of risk, which would also include items such as unsustainable policies, contingent risks, operational and liquidity risks. The Government’s intention is that these various risks be more systematically identified, monitored and managed, and that the quantum of risk be better incorporated into fiscal decision making.

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