Participation rates

The base case uses age-group participation rates based on the so-called cohort method, which projects age-group participation rates using recent cohort entry and exit probabilities. The result is generally age-group participation rates that are higher than results from holding age-group rates static from about 2014 onwards (labelled “static”).

A further case (“high”) is considered where the participation rates of older age groups are raised above the base case: for age groups 55 to 59 and 60 to 64, from 2015 to 2025, half the gap between the base case and the next younger age group is closed, and for the 65 and older age groups, from 2015 participation is lifted so that by 2025 it is 20% higher than base-case values. This could happen with labour market changes brought about by greater workplace flexibility and changes in attitudes towards the retention of older workers as population ageing slows the growth of the traditional labour force.

Source: The Treasury

These two alternative cases, static and high, respectively lift (and lower) GDP by about 2½% of the base-case level in 2050 and create a rise (and a reduction) in primary spending to GDP. The rising wedge is amplified by debt servicing costs, which are cumulated into a difference in debt of some 24 percentage points by 2050. The increased labour market contribution by older workers, while increasing their own wealth, also benefits the fiscal position through reductions in social spending relative to GDP.

Conclusion

The starting point for preparing this Statement of the Long-term Fiscal position is the strong current fiscal position of the New Zealand Government.

Debt is low, by both historical and international standards, and the Government has started to build up assets in the New Zealand Superannuation Fund as a further buffer against future events.

This strong fiscal position has not just happened by chance. Since the early 1990s, and reinforced by the passage of the Fiscal Responsibility Act (now Part 2 of the Public Finance Act), successive New Zealand governments have worked hard to place New Zealand’s public finances on a sound footing. Since 1994, governments have run an operating surplus.

In the 2006 Fiscal Strategy Report, the Government stated its view that, at around 20% of GDP, gross debt had reached prudent levels (one of the principles of responsible financial management), meaning that it was now appropriate to see debt kept at around that level.

This Statement goes beyond the traditional “bottom-up” approach of using current policy as the sole basis of constructing the projections of the long-term fiscal position.

The “bottom-up” approach, which involves projecting future expenditure and taxes on the basis that current policy in each area will continue, is a powerful tool for examining the impact of changes in the population on individual policies. It is the approach that has been used in many studies of the fiscal position in New Zealand. It is also an approach commonly used by other countries; for example, the European Commission has recently published a set of bottom-up long-term fiscal projections for four expenditure categories for all 25 members of the European Union.

In an advance on previous New Zealand studies, the Statement uses projections made on a “top-down” basis. As the name implies, this projection method seeks to impose an overall set of fiscal constraints on the government and then looks at what various combinations of policies might meet these constraints.

The top-down approach more closely mirrors how governments actually prepare their budgets each year, as they seek to meet all the demands upon the revenue, including the requirement to follow the principles of responsible financial management set out in Part 2 of the Public Finance Act.

These projections, which are based on history, current policy and judgements, show that the Government’s strong fiscal position is likely to continue for a long time.

In common with many other countries, New Zealand is experiencing a shift in the structure of the population. We have completed a transition from a condition of high fertility/high mortality to one of low fertility/low mortality.

This transition is not a demographic bulge that will correct itself at some time in the future and is not just the result of the post-Second World War baby boom.

In time, the number of old people will increase as a proportion of the total population and, correspondingly, the number of young and working-age people will fall.

These projections show a continuation of solid economic growth, which means that the tax base also grows through time, giving governments the means to finance expenditures.

The combination of the projected structural change to the population and present policy settings is likely to lead to growing challenges to the fiscal position, and these pressures will accelerate in the 2030s.

These projections also assume that governments will continue to follow the principles of responsible fiscal management contained in the Public Finance Act. This means that they will act before this time to ensure that the fiscal position remains sound.

The largest single driver of the fiscal position is the policy choices governments make and this means that governments have the capacity to make the necessary changes.

The size of any policy adjustment need not be large. A number of small adjustments, starting early, will be sufficient to maintain the fiscal position. We are already seeing governments take a long-term view in setting policy and this trend is likely to continue.

Publishing a Statement on the long-term fiscal position is not an end in itself. What has been done here is present information that will allow readers to develop scenarios consistent with what they define as desirable fiscal results.