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

Executive Summary

This Statement is about the factors that the Treasury expects to influence New Zealand’s fiscal position over the next 40 years.

It is part of a suite of documents that the Public Finance Act requires the New Zealand government and its advisors to produce. These documents report on the government’s fiscal position and fiscal intentions and its performance against these intentions. They are part of a wider set of provisions of the Act that require governments to operate policy in accordance with principles of responsible fiscal management.

Criteria for responsible fiscal management

Future New Zealand governments will have many policy choices open to them, leading to a wide range of fiscal results. Judging between these options requires some sense of what makes a “good” fiscal outcome. The principles of responsible fiscal management contained in Part 2 of the Public Finance Act provide guidance on this matter.

These principles require governments to pursue their policy objectives so as to achieve and maintain prudent levels of debt; ensure, on average, that spending does not exceed revenue; achieve levels of net worth sufficient to provide a buffer against future shocks; manage risks prudently; and have predictable and stable tax rates.

Governments to date have focused on reducing debt to levels judged to be prudent, because these were high in the early 1990s. As set out in the 2006 Fiscal Strategy Report, the current Government has concluded that maintaining gross debt at around 20% of Gross Domestic Product (GDP) is prudent for the coming decade. The Government also intends to continue building up net worth by accumulating financial assets in the New Zealand Superannuation Fund to help contribute to the costs of an ageing population.

Allowing some variation in debt could be consistent with responsible fiscal policy, as could alternative levels of spending and revenue. What is a prudent level of debt may vary through time as circumstances change.

In this Statement, the level of debt is used as a guide to responsible fiscal management. Policies resulting in an ever-increasing level of debt (or indeed assets) would not be consistent with the principles in the Act.

The approach to preparing this Statement

Over the past 15 years, the Treasury and others have produced reports on New Zealand’s long-term fiscal position. Governments in other countries - for example, Australia, the United Kingdom, the United States and all 25 members of the European Union - also prepare projections of their long-term fiscal position. Some, like New Zealand, are required to do so by legislation.

The common approach in these studies is to express the long-term implications of continuing with existing policies. This approach is not an entirely straightforward task. First, there is the challenge of projecting forward the costs for different policy areas. Second, in addition to these policy intentions, governments also have fiscal objectives (such as those to do with overall levels of debt, and levels of taxes), which may not all be consistent.

Accordingly, this Statement adopts two broad approaches to looking at the future fiscal position. Put simply, the first is to carry on as we are, assuming no constraints, and see where it takes us. This involves looking at how existing policy in current spending programmes and revenue affect the aggregate fiscal measures. This is called the “bottom-up” approach. The second is to decide where we want to be and see how we can get there. This involves rolling forward current fiscal objectives indefinitely and looking at how spending and taxes would need to be changed in order to remain within the fiscal limits of the objectives. This is called the “top-down” approach.

Both these approaches use the same modelling framework for calculating the future fiscal position, but give different insights into the fiscal challenges that may lie ahead.

The addition of a top-down approach is an advance on previous reports on New Zealand’s long-term fiscal position. Its particular attraction is that it is closer to what happens in the actual budget-setting processes that governments have been using over the past decade.

The modelling starts with projections of the population and combines these with assumptions of future productivity growth and labour force participation to produce projections of GDP. These projections are used in both the bottom-up and top-down approaches.

It is assumed that recent trends in participation and productivity will continue.

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