C. New Zealand faces a growing fiscal challenge - continued

The current fiscal strategy as an example of early action

In its 2013 Fiscal Strategy Report, the Government indicated that it intends for net government debt to be no higher than 20% of GDP by 2020.[34] By stating this goal, the Government is signalling that it will adopt a more constrained - and prudent - fiscal path than this Statement's "Resume Historic Cost Growth" scenario implies.

The current fiscal strategy involves firm expenditure control through annual operating allowances (best thought of as discretionary new spending),[35] coupled with ongoing efficiency savings by finding new ways to work with existing spending (for example, the "Investment Approach" to welfare spending), as a way of reaching net government debt at no higher than 20% of GDP by 2020. The strategy also involves government spending falling as a share of GDP.

This approach is not the only way to reach a goal of net government debt at no higher than 20% of GDP by 2020, and other governments might make different - and equally prudent - choices.

Following the fiscal strategy in the medium term would put future governments in a stronger position

Figure 4 Three "what if" paths for net government debt[36]

If we followed this fiscal strategy, it would make a significant - and positive - difference to the fiscal position of governments in the 2020s and beyond. The size of the difference depends on exactly how long we follow this strategy for.

Figure 4 sets out three "what if" tracks for net government debt:

• the net government debt path in the "Resume Historic Cost Growth" scenario (which assumes that we follow the current fiscal strategy until the end of 2014/15)
• the net government debt path we could have if we followed the current fiscal strategy until the 2016/17 fiscal year, and
• the net government debt path we could have if we followed the current fiscal strategy until the 2019/20 fiscal year.

Figure 4 shows that the longer governments follow the current fiscal strategy - or something like it - the more the fiscal position in the 2020s and beyond improves. Long-term cost pressures would still exist and need to be addressed, but a prudent fiscal strategy over the medium term will give future governments a wider range of choices about how to address them and more time over which to do it.

The current fiscal strategy will require ongoing prioritisation and some trade-offs among competing priorities

Sticking to the current fiscal strategy over the medium term puts future governments in a stronger position than they would be under this Statement's "Resume Historic Cost Growth" scenario. But in common with all ways of managing future fiscal pressures, this strategy is likely to require trade-offs.

In order to meet a goal of net government debt at 20% of GDP or under by 2020, and assuming governments make no changes to taxes, total spending growth will need to be restricted to an average of just over 2% each year in nominal terms (that is, without adjusting for inflation).[37] This growth rate compares to an average nominal annual growth rate of total government spending of over 5% since 1997.

Total spending growth is only part of the story, however. The parameters of some spending areas are set in legislation - for example, working-age welfare benefits and NZ Super. Those expenses grow (or in some cases shrink) automatically as people become eligible for them, and the only way governments can control this growth is by changing legislation. Other expenses - such as spending on healthcare, education, and justice - are in a sense discretionary in that they grow only if governments decide to spend more money on them. Governments allocate new spending to these areas by operating allowances.

The amount spent on NZ Super will grow significantly over the rest of this decade. In just one year, between February 2012 and February 2013, the number of people receiving NZ Super payments grew by over 27,000, which is close to five times the annual rate of growth of a decade previously. Between now and 2020, we can expect the number of people receiving NZ Super to grow by over 150,000. These increased numbers translate into increased spending. As Table 1 earlier showed, NZ Super expenses were 4.3% of GDP in 2010 but are projected to be 5.1% of GDP in 2020.

In a world where total government spending must be constrained in order to achieve a prudent level of government debt, growth in numbers receiving NZ Super means that NZ Super payments will start to take up a bigger share of total government new spending than they have in the past. The amount available for discretionary new spending on healthcare, education, justice, and all the other areas of government spending that are controlled via operating allowances will shrink over time relative to GDP. The 2013 Fiscal Strategy Report reflects this - it uses the same expense track for NZ Super as the "Resume Historic Cost Growth" scenario, and accordingly shows relatively small operating allowances over the next few years.

Figure 5 sets out the projected rates of growth (in nominal terms) across the categories of NZ Super, welfare benefits and transfers, debt-financing costs, and expenses that are controlled by operating allowances if net government debt is to reduce to under 20% of GDP in the 2020/21 fiscal year, assuming no tax increases.[38] It sets out these growth rates alongside the growth rates these expense categories experienced between 1997 and now.[39]

Ongoing efficiency savings and trade-offs between different priorities are likely to be required in order to achieve this implied path for the expense classes that are controlled by operating allowances.

Figure 5 Implied growth in different expense categories between now and 2019/20 versus actual growth in different expense categories from 1996/97[40]