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Challenges and Choices: New Zealand's Long-Term Fiscal Statement

6 How would spending have to change?

An alternative to using higher taxes to achieve a sustainable fiscal position is to slow the rate of growth in government spending.

Where does the money go?

Figure 6.1 shows the main areas of government spending now, and in 2050, in the historic trends scenario. The areas that grow the most are NZS, because of the ageing population and wage indexation of NZS; health, reflecting changing demographics, increased costs and demand for new services; and debt servicing. Benefit spending is projected to decline as a share of GDP because of the way it is indexed. Spending on education declines as a share of GDP, as changing demographics offset increased costs. The "Other" category includes spending on justice, defence and transport, as well as specific policies, such as KiwiSaver and the Government Superannuation Fund. This category declines slightly as a share of GDP between 2009 and 2050. The individual spending areas of health, justice, education, NZS and benefits are discussed in more detail in section 7.

Figure 6.1 - Spending - historic trends
Figure 6.1 - Spending - historic trends.
Source: The Treasury

The Government's Fiscal Strategy Report in Budget 2009 sets out a medium-term spending approach where debt is constrained and that results in net debt peaking at 36% of GDP in 2017, and trending lower thereafter. The Fiscal Strategy Report projection was based on new spending in each budget being limited to $1.1 billion (growing at 2% a year) from 2010 until 2023.

This forms the basis for our second main scenario - the sustainable debt scenario. Beyond 2023, and consistent with the Government's Fiscal Strategy Report, this scenario projects net debt declining to around 20% of GDP in 2050.

Figure 6.2 - Net debt
Figure 6.2 - Net debt.
Source: The Treasury

But achieving this level of debt - or any other fiscally sustainable target - is not simply a matter of drawing a line on a graph. Living with the $1.1 billion operating allowance over the next 15 years means reducing some public goods and services. We illustrate this by looking at the basket of publicly-funded services in Figure 6.3.

Figure 6.3 - What individuals receive from the Government - inflation-adjusted
Figure 6.3 - What individuals receive from the Government - inflation-adjusted.
Source: The Treasury

Because we assume that NZS and benefit policies remain unchanged - as explained previously, these traditionally sit outside the budget process - the fiscal constraint reduces the amount of all other public services. Through to 2023 these would decline by around 10%. Put differently, the $1.1 billion operating allowance is not enough to cover increased public service costs and increased demand created by the growing and ageing population, so the amount of publicly-provided services to the average New Zealander would have to decline.

Beyond 2023, we project an increase in the operating allowance, to bring the annual increase to over $2 billion. The allowance is then projected to grow with GDP rather than inflation (2%). As a result, the basket of services starts to grow again, but it does not return to its 2013 level until just before 2050.

Having a slightly higher net debt target (say 40% of GDP) does not materially change the picture, with the basket of services increasing only a further 6% by 2050. This is because the higher debt level results in higher financing costs, leaving less money to spend on goods and services.

Achieving this sort of change in spending patterns is certainly possible, but realistically it would need to involve changes in the mix of services provided by government as well as delivering current services better.

Figure 6.4 shows how spending across the sectors changes under the two scenarios. Our assumptions about NZS and benefits mean that these components are the same in both scenarios. This means that growth in the other components under the sustainable debt scenario is more constrained than in the historic trends scenario. For illustrative purposes, we continue to let the different demographics affect the various components, but scale back the services per person in each spending area by the same proportion relative to the historic trends scenario. Our assumption is that future governments would apply constraints across spending areas relatively equally, apart from demographic pressures. Future governments may choose to allocate available funds differently due to changes in societal preferences or as-yet unknown factors affecting the cost of services.

Figure 6.4 - Spending - sustainable debt and historic trends
Figure 6.4 - Spending - sustainable debt and historic trends.
Source: The Treasury

Under the sustainable debt scenario, education and other spending decline as shares of GDP, relative to 2009. Health increases as a share of GDP, due to the relatively larger impact of demographic changes on health care, but the growth is much lower than under the historic trends scenario. Debt servicing costs remain stable, reflecting the constraint on debt over the long term. The conclusion is that, given current policy settings, NZS continues to grow at the expense of other public services, such as health and education. This raises questions of intergenerational fairness, given that services for other age groups will decline over the next 15 years and grow only slowly thereafter - and as mentioned, the projections assume rising tax rates through to 2023.

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