Summary

On average, we will be healthier, richer, and will live longer in the future. But the future will also require some adjustments. Population ageing, rising demand for certain services, and increasing prices of those services mean that some things that the government provides will become more expensive - indeed this process has already started. These cost pressures create a fiscal challenge, which a growing economy will not fix. This Statement aims to give people a sense of the size of the fiscal challenge we face and what we might do to address it.

Prudent fiscal management is important for New Zealand

Over the last two decades, New Zealand governments have run prudent short- and medium-term fiscal strategies, including achieving and maintaining prudent levels of government debt, as required by the Public Finance Act 1989.

Prudent fiscal management is important because New Zealand is sensitive to financial and economic shocks, as well as natural disasters. Also, our economy carries high levels of net external debt. We saw, in the global financial crisis, how investor sentiment can turn sour quickly on economies with these characteristics, and how easily private debt can become government debt. We have needed the buffer a low level of government debt provides.

Reaching a prudent level of government debt in the medium term and maintaining it thereafter will continue to be crucial for New Zealand. As a medium-term goal, the Treasury has advised that New Zealand should aim for net government debt to be 20% of gross domestic product (GDP) or below by 2020.[1]

Fiscal pressures will make achieving and maintaining a prudent level of government debt more challenging

The fiscal pressures we are starting to face partly result from population ageing. Some entitlements - notably New Zealand Superannuation (NZ Super) - will become more costly as the nation continues to become older.

Cost pressures in public healthcare also drive this challenging fiscal outlook, because of increasing demand for healthcare services, new technologies, and the rising prices we will need to pay for those services.

This Statement gives an idea of the size of the fiscal challenge we are facing and illustrates some options for addressing that challenge. We project a "what if" scenario that shows how government expenses might grow from the 2015/16 fiscal year if they were to revert to their average historic rates of growth (different periods of history are relevant for different expense categories), taking into account demographic and other key economic variables, and assuming no change to current legislative policy settings. We call this scenario "Resume Historic Cost Growth". This scenario is different to the Government's fiscal strategy, which involves firm control of expenditure growth.

Two areas of government spending are projected to grow significantly in the "Resume Historic Cost Growth" scenario:

• Government spending on healthcare is projected to grow from 6.8% of GDP in 2010 to 10.8% in 2060, an increase of 4 percentage points.
• Spending on NZ Super is projected to grow from 4.3% of GDP in 2010 to 7.9% in 2060, an increase of 3.6 percentage points.

Our full projections under the "Resume Historic Cost Growth" scenario are set out in the table below. We assume that we collect tax revenue equal to 29% of GDP over most of the projection period. This percentage is roughly consistent with our tax take in recent history, but of course different governments may wish to collect more or less tax in the future. One consequence of holding tax revenue constant as expenses increase, however, is that from the mid-2020s revenues become insufficient to cover expenses. Accordingly, governments must borrow to make up the difference. The table below reflects the cost of this borrowing in the line "Debt-financing costs", which shows these costs increasing over time. The bottom line "Net government debt" also increases as a consequence.

The projections in this table are of course very sensitive to our assumptions. But changing our assumptions within realistic bounds makes little difference to the overall message: some major expense categories are growing. A higher birth rate or higher economic growth (within reasonable bounds), two things that might seem intuitively helpful for reducing fiscal pressures, in fact would do little to affect underlying trends.

Early adjustment is crucial

In the 2013 Fiscal Strategy Report, published in May, the Government said it aims to run budget surpluses from 2014/15 so that net government debt eases down to no higher than 20% of GDP in 2020. This approach is consistent with the approach of all governments over the past two decades.

By stating its 20% goal, the Government is signalling that it will adopt a more constrained - and prudent - fiscal path than our "Resume Historic Cost Growth" scenario shows.

The Government's fiscal strategy is one way of reaching a prudent level of debt over the medium term. It is not the only way, and other governments might make different choices. But the essential point is that a prudent medium-term fiscal strategy puts future governments in a stronger fiscal position and gives them a wider range of choices.

Delaying adjustment, and adopting a path like the "Resume Historic Cost Growth" scenario rather than the current fiscal strategy (or an equally prudent alternative), makes the fiscal challenge harder, owing to the compounding effect of debt-financing costs. If we delay, when we eventually make an adjustment we first will need to address the existing deficit. But that will not be enough, as we will then need to address the debt we have let accumulate during the period over which we ran deficits. Delaying adjustment turns one task into two, and means that the eventual adjustments will have to be more significant and will take longer to implement. For example, if we delay five years and keep to the fiscal path set out in the "Resume Historic Cost Growth" scenario, it could take us 10 years to get back to net government debt at 20% of GDP (assuming that annual adjustments cannot be too steep).

This Statement sets out examples of how we could achieve a more sustainable fiscal position

The Treasury has modelled some illustrative examples of the type and scale of policy adjustments that governments might consider both before the end of this decade and into the 2020s. These are not Treasury recommendations. They are designed to help people flesh out the implications and trade-offs that should be thought through before adopting alternative policy options. They are by no means the only policy changes that governments might adopt.

Our illustrative options show that we cannot achieve a sustainable fiscal path without trade-offs. These might be trade-offs between fiscal sustainability and equity, or between fiscal sustainability and economic growth. But at the same time there might be complementarities. This Statement uses the Treasury's Living Standards Framework to illustrate the different implications that various options involve. If we are aware of the trade-offs we can make informed decisions about what is best for New Zealand overall.

We recommend that governments develop plans to address these cost pressures over the course of the rest of this decade. The Treasury will advise governments as they make such plans. But it's not just up to governments. Parliament has given the Treasury a mandate to analyse the future financial pressures New Zealand is likely to face, in order to increase public understanding of the situation and what might be done about it. This Statement aims to explain and share information about our long-term fiscal future with all New Zealanders.