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Pre-Election Economic and Fiscal Update 2008

2 Fiscal Outlook (continued)

Medium-Term and Long-Term Outlook

Medium-Term

The preceding parts of the Fiscal Outlook chapter have focused on the fiscal forecasts covering the period 2008/09 to 2012/13. This section provides medium-term fiscal projections, covering the subsequent 10 years (2013/14 to 2022/23). In previous Pre-election Updates these projections have been published separately on the Treasury website. For this and subsequent Pre-election Updates, the projections are incorporated into the document, to make this information easier to access and to provide a fuller picture of the medium-term implications of developments in the fiscal forecasts.

The forecasts are based on comprehensive modelling of the macroeconomy, which flows through into forecasts of tax revenue and the overall fiscal position. The projections, on the other hand, extrapolate the conditions existing in the final year of the forecast period, using assumptions about how elements of revenue and expenditure will change over time.

Updated medium-term projections

Building on the deterioration since the Budget Update in the fiscal outlook in the forecast period discussed earlier in this chapter, the medium-term projections show that this deterioration continues throughout the 10-year projection period.[6]

Figure 2.12 - OBEGAL (excluding NZS Fund retained revenue)
Figure 2.12 - OBEGAL (excluding NZS Fund retained revenue).
Source:  The Treasury
Figure 2.13 - GSID (excluding Settlement Cash)
Figure 2.13 - GSID (excluding Settlement Cash).
Source:  The Treasury
Figure 2.14 - Operating balance, OBEGAL (excluding NZS Fund retained revenue), NZS Fund contributions
Figure 2.14 - Operating balance, OBEGAL (excluding NZS Fund retained revenue), NZS Fund contributions.
Source:  The Treasury

OBEGAL (excluding NZS Fund retained revenue) is forecast to be 1.5% of GDP in deficit in 2012/13. In the projection period, we assume that revenue growth exceeds expenditure growth, largely because personal income tax revenue grows faster than the allowance for new operating spending. This sees OBEGAL (excluding NZS Fund retained revenue) move into surplus in 2017/18, and end the projection period with a surplus of 1.2% of GDP in 2022/23.

Figure 2.15 shows GSID (excluding Settlement Cash) and net core Crown debt continuing to grow as a share of GDP at the start of the projection period, because of the scale of borrowing required to cover OBEGAL deficits and the Government's capital programme. As OBEGAL moves back into surplus towards the end of the projection period, GSID and net debt begin to fall as a share of GDP.

Figure 2.15 - GSID (excluding Settlement Cash), net core Crown debt, net core Crown debt including NZS Fund assets
Figure 2.15 - GSID (excluding Settlement Cash), net core Crown debt, net core Crown debt including NZS Fund assets.
Source:  The Treasury

Figure 2.16 shows that core Crown expenses are projected to stabilise and then fall slightly as a percentage of GDP. This is because the allowance for new operating spending grows at the rate of inflation, which is assumed to be lower than the rate of GDP growth.

Figure 2.16 - Expenses
Figure 2.16 - Expenses.
Source:  The Treasury

Figure 2.17 shows that from the start of the projection period until 2020 the tax-to-GDP ratio is assumed to rise as fiscal drag pushes people into higher tax brackets. From 2020 the tax-to-GDP ratio then flattens as fiscal drag is assumed to be mitigated by changes to personal tax rates and/or thresholds. This is assumed so that the tax-to-GDP ratio remains at average historical levels.

Figure 2.17 - Revenue
Figure 2.17 - Revenue.
Source:  The Treasury

The projections are sensitive to the assumptions used …

The projections are dependent on the assumptions chosen about how elements of revenue and expenditure will change over time. Differences in these assumptions would result in different medium-term fiscal projections.

The Treasury has decided to use the same assumptions in the Pre-election Update projections as those used in the 2008 FSR. These are outlined in the annex below. This reflects the Treasury's best judgement as to the most appropriate interpretation of current policy for the purposes of medium-term budgeting decisions. This is because medium-term assumptions around operating and capital allowances reflect the budgeting approach currently used and also applied in the forecast period.

Figure 2.18 - Changing the real GDP growth assumption in the projection period
(impact on GSID excluding Settlement Cash)
Figure 2.18 - Changing the real GDP growth assumption in the projection period (impact on GSID excluding Settlement Cash).
Source:  The Treasury

To illustrate the sensitivity of the projections to assumptions, Figure 2.18 shows the impact on GSID (excluding Settlement Cash) of real GDP growth in the projection period being 0.5% higher or lower in each year than the 2.5% rate assumed in the central projection. In this scenario an increase in real GDP growth is assumed to be driven by an increase in productivity, which flows through into higher wages and nominal GDP and higher tax revenue. Because in the projections most expenditure is not linked to wage growth and instead grows at 2% per annum, the overall impact would be to reduce GSID (excluding Settlement Cash) as a percentage of GDP by ten percentage points by the end of the projection period.

… and to the starting point

Figure 2.19 - Changing the starting point: GSID (excluding Settlement Cash) with a higher or lower starting point in 2012/13
Figure 2.19 - Changing the starting point: GSID (excluding Settlement Cash) with a higher or lower starting point in 2012/13.
Source:  The Treasury

The projections are also dependent on the fiscal forecasts for the period 2008/09 to 2012/13, as these are the starting point from which the projections grow. If fiscal results turn out to be higher or lower than in the forecasts, this would result in a different debt ratio in 2012/13, and debt would then develop from that higher or lower starting point.

To illustrate this, Figure 2.19 shows how GSID (excluding Settlement Cash) as a share of GDP would evolve in the projection period if the starting debt ratio in 2012/13 were to be four percentage points higher or lower.

Long-Term

Beyond the 10-year projection period presented here, the proportion of New Zealand's population aged over 65 will start to rise significantly relative to the working age population. In the Treasury's 2006 Statement of the Long-term Fiscal Position we outlined how this will put pressure on the costs of health care and New Zealand Superannuation in particular, under the assumption of continuation of existing policies and cost trends over the next 40 years. The long-term fiscal situation is still subject to the same challenges outlined in the 2006 Statement, particularly the pressures of an ageing population. We have not updated the 2006 report, but our preliminary assessment is that the long-term fiscal position has deteriorated, in that debt rises more quickly than was set out previously. A full statement is likely to be published in 2009.

Notes

  • [6]The projections show that the deterioration in the fiscal outlook, which is driven by the weaker economy, is expected to be long-lasting. The projections are dependent on the starting point and there is considerable uncertainty around the short-term economic outlook. The extent to which the weaker economic outlook affects the short-term fiscal outlook can also be approached by considering estimates of the cyclically-adjusted balance. As has been the case in recent Updates, information on this is included in the Additional Information for the 2008 Pre-election Update, which is available at www.treasury.govt.nz/budget/forecasts/prefu2008
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