Annex 3 Projection Assumptions out to 2026/27

The economic and fiscal forecasts, from 2012/13 to 2016/17, are detailed in the 2013 Budget Economic and Fiscal Update. The projection period begins in 2017/18 and ends in 2026/27. These post-forecast fiscal projections are based on the long-run technical and policy assumptions outlined below. The projection model can be found on the Treasury's website at www.treasury.govt.nz/government/fiscalstrategy/model.

1. Annual average percentage change unless otherwise stated
2. Unemployment as a percentage of the labour force (annual average)
3. Hours worked measure

Sources:  The Treasury, Statistics New Zealand

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 converge fully 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 2013 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. The unemployment rate, labour productivity growth and average weekly hours worked are adjusted to reflect the faster real GDP growth track. As well as this, age and gender group labour force participation rates and CPI inflation 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).

From 2017/18 to 2018/19, labour productivity growth is calculated from 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 cent 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 Targets Agreement with CPI inflation.

By 2022/23, all these variables have returned to their trend rates or levels.

Table A3.2 - Summary of fiscal assumptions

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 for the first four years of the projection period.  The latter is multiplied by a fiscal drag elasticity of 1.35.  After the first four years of the projection period, source deductions are returned to a long-term stable value of 11.2 per cent of GDP. The four other major tax categories, Corporate tax, Hypothecated Transport taxes, GST and Other taxes, 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.  All tax categories change at a rate of 0.2 per cent of GDP per annum, with final ratios-to-GDP of 4.4 per cent for Corporate tax, 1.4 per cent for Hypothecated Transport taxes, 7.4 per cent for GST and 4.3 per cent 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 per cent wage floor.”  The latter refers to the net (after-tax) weekly NZS rate for a couple being constrained to lie between 66 per cent and 72.5 per cent 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

$1.06 billion in 2017/18, based on 2 per cent growth from the end-of-forecast value.  Operating Allowances for subsequent projected years grow at 2 per cent per annum from this value.

Capital allowance

$0.936 billion in 2017/18.  This is based on a track of $0.9 billion in Budget 2016 as the starting point, grown at 2 per cent per annum.

NZS Fund

Contributions to the Fund suspended until 2019/20.  Contributions begin again in 2020/21, and are consistent with the New Zealand Superannuation and Retirement Income Act 2001.