C. New Zealand faces a growing fiscal challenge

We have started and will continue to face increasing pressures in some areas of government spending. These pressures are partly owing to the permanent change to our population's structure, the ageing process. Some entitlements - notably NZ Super - will become more costly as more people move into older age groups, and as the ratio of younger people paying taxes declines relative to older people.

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.

How big are these cost pressures? This Statement gives an idea of the size of our fiscal challenge, as well as some options for addressing that challenge. To show the size of the challenge, we project how government expenses might grow from the 2015/16 fiscal year if they were to revert to their historic rates of growth per recipient (different periods of history are relevant for different expense categories), including how we think those historic growth rates interact with demographic and key economic variables. We also assume no change to current legislative settings. We call this scenario the "Resume Historic Cost Growth" scenario.

We use slightly different methodologies for projecting the future path of different areas of government spending. Historic rates of growth are relevant to different extents in different categories. For example, when we project the possible future path of public spending on healthcare, we rely heavily on how spending on healthcare has grown in the past. On the other hand, when we project how NZ Super costs will grow, historic growth is almost irrelevant. The main considerations are the current legislative settings for NZ Super, the future demographic structure of our population, and future average wages (as NZ Super payments are pegged to the average wage). Other expense categories have their own unique cost drivers.[29] Despite these differences across subject areas, for simplicity we call our scenario "Resume Historic Cost Growth".

We find two areas of significant growth:

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.

Table 1 Treasury projections for government expenses, revenue and debt as % of nominal GDP under the "Resume Historic Cost Growth" scenario

Our full projections under the "Resume Historic Cost Growth" scenario are set out in Table 1 (this is the same table that appeared in the Summary). 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. Table 1 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.

This table does not explicitly set out amounts used for capital expenditure (that is, spending on buildings, roads, and other infrastructure). The "Total government expenses" line is just what we call "operating" expenses. But we do make some assumptions about capital spending when we produce these projections. Amounts borrowed for capital expenditure are reflected in the "Net government debt" line, and accordingly affect the size of the expense category "Debt-financing costs".

Higher-than-anticipated productivity growth (within reasonable bounds) would not alter these projections significantly. If our economy grows more quickly than expected, on a permanent basis, the higher tax revenue would be useful in managing future fiscal pressures. However, most spending areas would face additional pressures - both from wages being higher and from payments such as NZ Super being linked to wage growth.

Similarly, a birth rate that is higher than we expect would not make much difference either. Before they become taxpayers, contributing to government finances, those extra children would need medical care and education, increasing cost pressures in those areas. Eventually they would become taxpayers, but we will need to address our long-term fiscal pressures before then.