Transition of economic variables from the end of forecast
Given the difficulty in projecting cycles and shocks beyond the forecast horizon, the projections use trend or long-run averages for the growth rates or levels of key variables.
In previous forecast rounds the five-year forecast period was generally sufficient for the effects of current cycles and shocks to have worked their way through the economy. By the end of the forecast period key variables such as unemployment, the terms of trade and labour force participation have usually returned to trend growth rates or levels.
In recent forecast rounds, shocks to the economy, either on the demand or supply side, have caused key variables to remain above or below trend at the end of the forecast period. For example, in Budget 2010, some of the key economic variables were not predicted to fully converge to their long-term values at the end of the forecast period, owing to the persistent effects of the recession. Those variables were adjusted from their end-of-forecast values to the long-term averages, using a relevant convergent rate for each variable.
In the Budget 2011 forecasts, the flow-on effect from the earthquake rebuild is assumed to continue into some early years of the projection period. Accordingly, real GDP growth for these years is assumed to grow above the trend rate until 2018/19. Labour productivity growth is adjusted to reflect the faster real GDP growth track.
Four other economic variables have also been adjusted from their end-of-forecast values. These all contribute to the projection of nominal GDP, which is both a driver of a number of important fiscal variables, such as tax revenue, and the denominator in key fiscal ratios (ie, debt-to-GDP). These variables are:
- age-and-gender group labour force participation rates
- CPI inflation
- unemployment rate, and
- average hours worked.
From 2015/16 to 2018/19, labour productivity growth is modelled as a function of real GDP growth and labour force. From 2019/20 onwards, labour productivity growth is assumed to return to the estimated long-term value of 1.5% per annum.
For labour force participation rates, the adjustment technique involves using growth rates for participation rates from projections produced by Statistics New Zealand.
For the other three variables - CPI inflation, unemployment rate and average hours worked - a long-term average is determined, together with a convergence path. The long-term averages are based on historical data, making allowance for factors that could alter their future values, such as the Policy Target Agreement with CPI inflation.
By 2019/20, all these variables have returned to their trend rates or levels.
| Tax revenue | Linked to growth in nominal GDP. Source deductions (mainly PAYE tax on salary and wages) is grown using employment growth and nominal average hourly wage growth. The latter is multiplied by a fiscal drag elasticity of 1.35. The two other major tax categories, Corporate tax and Other taxes (dominated by GST), are gradually returned, from their end-of-forecast values, to long-term constant ratios to GDP. This transitional adjustment is to ensure that tax revenue projections are based on ratios to GDP that are neither higher nor lower than would be expected when the economy is performing at its potential. Both tax categories change at a rate of 0.2% of GDP per annum, with final ratios-to-GDP of 4.5% for Corporate tax and 13% for Other taxes. The long-term ratios are based on historical data, taking into account tax rate and policy changes that could affect these. Once the long-term ratios are reached the tax types remain at them in later projected years. |
|---|---|
| New Zealand Superannuation (NZS) | Demographically adjusted and linked to net wage growth, via the “66% wage floor”. The latter refers to the net (after-tax) weekly NZS rate for a couple being constrained to lie between 66% and 72.5% of net average weekly earnings. As tax on average weekly earnings, being a part of overall PAYE, increases owing to fiscal drag, the net average weekly earnings do not grow as quickly as the gross earnings. |
| Other benefits | Demographically adjusted and linked to inflation. |
| Health and education | Held constant at the end-of-forecast values, because their growth is assumed to come from a share of the projected Operating Allowance annual increment. |
| Other expenditure | Held constant at the end-of-forecast values, because their growth is assumed to come from a share of the projected Operating Allowance annual increment. |
| Finance costs | A function of debt levels and interest rates. |
| Operating allowance | $1.21 billion in 2015/16, which is equivalent to the Budget 2010 Operating Allowance of $1.1 billion, growing at 2% per annum in intervening years. Operating Allowances for subsequent projected years grow at 2% per annum from this value. |
| Capital allowance | $0.936 billion in 2014/15. This is based on $0.9 billion in Budget 2014, growing at 2% per annum. |
| Surplus NZDMO financial assets | Nil. |
| NZS Fund | Contributions to the Fund suspended until 2015/16. Contributions begin again in 2016/17, and are consistent with the New Zealand Superannuation and Retirement Income Act 2001. |
| Emission Trading Scheme (ETS) | The fiscal impact of the ETS depends on several highly uncertain factors, most notably future carbon prices and New Zealand's emissions targets from future international climate change agreements. The ETS has been modelled as having no net fiscal impact in the projection period (expenses equal revenues), as the net impact of the ETS and future international obligations is highly uncertain. Any net revenue (the value of credits received after free allocation of credits to participating industries) is assumed to be required to meet future international obligations, or alternatively used for fiscally equivalent, unspecified tax reductions or spending increases. |
| Future emissions liabilities | The Kyoto liability included in fiscal forecasts reflects the Government's obligation for Commitment Period 1, which is for the period 2008 to 2012. Projections beyond 2014/15 do not incorporate a quantitative estimate of any net emissions liability that may eventuate from New Zealand's obligations under future international climate change agreements. |
