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New Zealand's Long-Term Fiscal Position [June 2006]

Preface

This Statement is about New Zealand’s long-term fiscal outlook and what drives it.

In 2004, the Public Finance Act was amended to require the Treasury, at least once every four years, to prepare a statement on New Zealand’s long-term fiscal position. The Statement must look out over at least a 40-year horizon. This is the first such Statement.

It is impossible to predict with any accuracy what governments will be doing in the next 40 years. Modern governments do a myriad of things, in areas as diverse as foreign aid, taxes, health and road-building. Therefore, rather than attempt to make such predictions, we have used the available information to make projections of the fiscal consequences of particular scenarios. These scenarios set out the implications of possible policies and patterns of development of the economy. To pick up the uncertainty around these, we have used a series of “what if” questions; for example, what if economic growth is higher than we assume, what if fertility increases, and what if governments choose to spend more on education?

The starting point for our analysis is Statistics New Zealand’s work on the future size and structure of the New Zealand population and Treasury’s assumptions about the future size of the economy. Using this information, we have made projections of major spending categories and taxes, based on assumptions derived from history, current policy settings and judgements.

The purpose of this Statement

We see the purpose of this Statement as being to increase the quality and depth of public information and understanding about the long-term consequences of spending and revenue decisions. This will assist governments in making fiscally-sound decisions in the decades ahead.

The material presented here should be useful as the basis for discussions about the fiscal and other consequences of different policy settings.

The Statement builds on past work

This is not the first time the issue of New Zealand’s long-term fiscal position has been placed in the public arena, although it has been some time since such studies were done, and the fiscal position has strengthened considerably over recent years.

Over the past 15 years, many reports by the Treasury and other agencies have thrown light on the long-term fiscal position. Some have looked at the impact of an ageing population and others at a wider range of drivers of the fiscal position. The common approach of these studies (like those undertaken in other countries) is to project the path of expenditure and taxes based on some notion of “current policy.” The idea is to investigate the impact of external drivers on the overall fiscal position. Often, these drivers are demographic but sometimes they are economic, like the cost of health care.

Using this Statement to assess policies

The projections in this Statement do not draw conclusions about whether an individual policy is appropriate or affordable. Often such conclusions will depend on knowing what else the government is doing, or on having a view on the preferred role of government, an appropriate level of taxes or the overall state of the economy.

Material in this Statement will help people to make their own judgements about what they think are appropriate policies.

We present a range of scenarios of future policy settings to demonstrate the effect that drivers of different combinations of policies have on the fiscal position.

The trend towards taking a long-term view

Future governments have plenty of time to plan for the future. Demographic change is, by its nature, a slow process and New Zealand’s public finances are in sound shape. Debt is low and assets are being built up to meet the future needs of society. That said, there is often a case for adjusting policy slowly or early to meet future changes, rather than waiting and making a sudden and larger adjustment.

Successive New Zealand governments have increasingly looked to the long term in setting their policy objectives. Part 2 of the Public Finance Act requires governments to look to the future when making decisions today. It does this by requiring them to set objectives for at least a 10-year horizon and to report their actions against these. This Statement, mandated by a new section of Part 2 of the Act, is a natural extension of this reporting framework, although it differs in that it looks out over a very long period, and across many parliaments and governments.

As well as extending reporting, governments have acted to strengthen the Crown’s fiscal position. At a macro level, the Crown’s accounts have moved from a position of persistently large operating deficits, high debt and negative net worth to the current strong position, in which net debt is zero.

At a more detailed level, perhaps the two most prominent examples of governments taking a long-term perspective are in the area of superannuation. The first was the increase in the age of eligibility for New Zealand Superannuation in the early 1990s. The second and more recent was the establishment of the New Zealand Superannuation Fund, which invests a proportion of current taxes to contribute towards the costs of New Zealand Superannuation in the future.

Demographics are changing

World-wide, population structures started to change hundreds of years ago, and New Zealand has been part of this trend. The Statement shows how this demographic shift is expected to affect the government’s finances in the years ahead.

Demography directly affects the Crown’s financial position in areas such as superannuation, education and health. In superannuation, the impact of demography is potentially very large: the proportion of people over 65 years is expected to double in the next 50 years. In education, the proportion of school-age children is set to fall by five percentage points over the same period. In health, the impact is not as clear-cut. Falling levels of disease and mortality are positive fiscally, while others, such as the increase in the numbers of very old people, may be negative.

Demography is, however, only one driver of government spending. While it is important for some programmes, it has little or no impact on others. It is important not to lose sight of the broader issues that matter for the long-term fiscal position, such as overall economic performance and productivity.

New Zealand’s population is still relatively young compared with those of some other countries. Accordingly, those countries have to make policy adjustments more rapidly than we have to. We can learn lessons from them about how to harness the benefits of economic growth and meet the challenges posed by demography.

Preparing this Statement is not an end in itself

This Statement is a resource for policy makers, commentators and the general public. We hope that they will find it a useful addition to the information they use in making policy choices.

John Whitehead

Secretary to the Treasury

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