B. What is fiscal sustainability and why does it matter?
Fiscal sustainability is a term that is commonly used in relation to the affordability of government taxation and spending programmes. In simple terms, fiscal just refers to government spending and investing activities and how these are financed through taxes, debt and other liabilities. Sustainability means having the ability to maintain or support government programmes in the future. So, fiscal sustainability refers to whether the Government is able to maintain current policies without major adjustments in the future.[21]
Sustainability is a cornerstone of responsible fiscal management
The principle of fiscal sustainability is embedded in the Public Finance Act 1989, which requires governments to maintain a "prudent" level of government debt. Governments are free to define what is prudent. They are also required to set a long-term - at least 10-year - objective for debt, and must show how that objective will be reached. This requirement aims to protect the financial position of the governments of future generations.
This Public Finance Act requirement acknowledges that high government debt can have negative impacts. It can increase the cost of borrowing right across the economy, thereby restricting, or "crowding out", some potentially productive private sector economic activity. A higher level of government debt also means the Government faces higher interest costs each year, at the expense of other government spending. High debt burdens future generations with higher tax rates than would otherwise be the case, as debt eventually needs to be repaid. It also allows governments less room to borrow to respond to shocks.
The requirement for governments to achieve and maintain a prudent level of debt was introduced in 1994.[22] Since then, successive governments have remained committed to maintaining low debt levels. Figure 3 shows the recent history of government debt, since the introduction of the "prudent debt" requirement.
- Figure 3 The recent history of government debt
What is net government debt?
The principal way in which the Government borrows money is by issuing securities through the Treasury's Debt Management Office.[23] These securities are largely in the form of government bonds (coupon-paying securities with maturities of one year or more) and Treasury bills (maturities of one year or less with no interest payments, issued at a discount to the face value). Roughly two-thirds of New Zealand government bonds are held by non-residents.
When this Statement talks about net government debt, it means "net core Crown debt" as that term is defined in the Financial Statements of the Government of New Zealand. This particular debt indicator is used to represent the size of the buffer the Government has to respond to shocks.
Net core Crown debt is gross core Crown debt minus relatively liquid financial assets. Some significant financial assets are not subtracted from gross debt in the net debt measure. The Government's student loan portfolio is excluded, along with other core Crown advances, because we cannot rely on being able to cash up these assets sufficiently quickly in response to a shock. Financial assets held by the NZ Super Fund are also excluded. In this case it is not their lack of liquidity that is the reason, but because they are held for a specific future policy objective. This is to reduce the burden of the cost of funding the public pension on future taxpayers, in a period where the number of NZ Super recipients will be significantly higher than it is now.
There are many different alternatives for the definition of "net government debt". The net core Crown debt definition is the most suitable for this Statement, as we wish to use a measure that represents the size of the buffer the Government could have at different times to respond to shocks, but people use different definitions for different purposes. For example, for some purposes it might be suitable to net off assets held by the NZ Super Fund.
Allowing governments to determine a prudent level of debt, rather than enforcing a specific level of debt, acknowledges that a "prudent" level of debt will not be the same for all governments at all times. A number of factors are relevant to this calculation.
We would also not expect the level of government debt to remain constant over the tenure of one government. It is reasonable to expect government debt to be higher in an economic downturn as a result of government borrowing to cover a shortfall in tax revenue and higher spending to support the unemployed. Conversely, governments may take the opportunity provided by an economic upturn to reduce the level of government debt in anticipation of a future economic downturn.
It makes sense for governments to borrow to fund infrastructure, such as roads, schools and hospitals. This spreads the costs of these long-lived assets across the different generations expected to benefit from these assets. However, if a government needs to borrow to pay for day-to-day expenses - other than those associated with a short-term economic downturn or long-lived assets - it is living beyond its means.
There is no level of government debt that will be optimal for New Zealand in all circumstances. But New Zealand's particular characteristics suggest that a cautious approach, meaning a relatively low level of government debt, is appropriate. This has been the approach of successive governments over the past 20 years.
Notes
- [21]For a fuller discussion of fiscal sustainability, see Robert A. Buckle and Amy A. Cruickshank (2013). The Requirements for Long-Run Fiscal Sustainability. Background paper prepared for the 2013 Statement on the Long-Term Fiscal Position. Available at www.treasury.govt.nz/government/longterm/fiscalposition/2013. See also Controller and Auditor-General (2013). Public Sector Financial Sustainability. Discussion paper presented to the House of Representatives under section 20 of the Public Audit Act 2001, which contains a public sector-specific definition of financial sustainability.
- [22]The requirement was initially contained in the Fiscal Responsibility Act 1994. The Fiscal Responsibility Act was later incorporated into the Public Finance Act 1989, via the Public Finance Amendment Act 2004.
- [23]This is not the sole way in which the Government can borrow money. SOEs, which are part of the "total Crown" reporting entity but not part of the "core Crown" reporting segment (both terms are defined in the Financial Statements of the Government of New Zealand), can and do borrow.
