The Treasury

Global Navigation

Personal tools

Treasury
Publication

Briefing to the Incoming Minister of Finance 2008: Medium-term Economic Challenges

Delivering quality public services over the long term requires changes that address the sustainability of the fiscal position

Population ageing will change the ratio of people in work to those in retirement

Ratio of working age population to total population
Ratio of working age population to total population.
Source: Statistics New Zealand
Older age groups grow
Older age groups grow.
Source: Statistics New Zealand

While the fiscal position has strengthened considerably over the past 15 years, this has occurred in a time of favourable demographics and a strong international economy. Ageing of the population will begin to accelerate significantly in 2011. The proportion of the population aged over 65 is projected to double, from 12.6% in 2008 to 25% in 2050. Associated with this change will be rising pressures on government expenditure, particularly health and New Zealand Superannuation. These pressures are reinforced by public expectations of increasing state services as technology improves and incomes rise. Our assessment is that the longer-term fiscal outlook has worsened in the two years since the Treasury published the Statement of the Long-term Fiscal Position, mainly due to changes in policy.

The fiscal position will need to adjust in response to expenditure pressures from demographic change

Projected spending pressures are most significant in health and pensions

Projected core Crown spending changes between 2008 and 2050 (% GDP)
Projected core Crown spending changes between 2008 and 2050 (% GDP).
Source: Treasury Long-Term Fiscal Model

If no changes are made to moderate the rates of growth in spending experienced in recent years, then future governments will face very difficult choices about making real cuts in spending or increasing taxes, in order to stabilise debt in the longer term. The longer governments delay adjustments to address long-term spending pressures, the larger the adjustments to spending or taxes will need to be in the future.

Smaller, incremental and earlier changes to expenditure and tax policies will be less costly

Early and gradual adjustments to spending areas are likely to result in a more stable environment for individuals and firms to plan and make long-term decisions about savings and investment. The establishment of the New Zealand Superannuation Fund is one measure that seeks to ease the adjustment in the longer term, although it only funds around a fifth of the estimated cost of New Zealand Superannuation in 40 years time.

Preparing now for future fiscal pressures by maintaining a low level of debt and contributing to the New Zealand Superannuation Fund allows some flexibility to make wise spending and tax adjustments over time. Low debt also provides insurance by allowing debt to be raised when economic shocks occur without placing significant upward pressure on interest rates, and without requiring sudden changes to tax rates or government spending.

Debt or taxes will need to rise unless projected growth rates of spending slow

Revenue and expenses (% GDP)
Revenue and expenses (% GDP).
Source: Long-term Fiscal model (as at Budget 2008)

A strategy for addressing fiscal pressures

Although some reprioritisation is desirable in the short term, large and sudden changes in spending are not necessary to address the longer-term fiscal outlook. A strategy for addressing these longer-term pressures would include the following actions:

Elements of a strategy would include a mix of expenditure control and identifying how some policies need to adjust over time

  • Identifying changes that are best signalled in advance: In areas where individuals need time to be able to respond to changes, these are better signalled well in advance so that people can adjust their plans in anticipation. For example, signalling changes to retirement income policies many years in advance allows people sufficient time to adjust their work and saving plans. Strains on fiscal expenditure could mean that programmes like New Zealand Superannuation have to become less generous in the future. Higher levels of private saving will increase the options available to government to ensure the fiscal position is sustainable in the long term and would contribute to income adequacy in retirement.
  • Maintaining a level of net debt which provides greater scope to adjust policy: Overall, we consider the total amount of government saving that would occur by achieving the long-term gross debt objective of around 20% and making contributions to the New Zealand Superannuation Fund to be about right.As mentioned above, maintaining a low level of debt gives government the flexibility to adjust to emerging fiscal challenges over time.
  • Restraining expenditure: Expenditure growth in key spending areas at the rate experienced in the past five to 10 years is unsustainable in the longer term unless taxes or debt rise significantly. In the Pre-election Economic and Fiscal Update, the Treasury assumed that new spending initiatives are met within a $1.75 billion operating allowance, growing at CPI. This level of spending restraint will be challenging, particularly in health where spending increases have been substantial in recent years. Living within these fiscal parameters, while delivering the health services and outcomes that New Zealanders want, will require transformational change in the performance and productivity of the health sector on an ongoing basis. It is important to build a degree of consensus around the need to moderate spending growth to manage long-term spending challenges in health and in other areas.
  • Recognising the importance of economic performance: Higher growth will deliver higher living standards and make us better placed to meet future economic challenges. Tax and spending decisions can enhance New Zealand's growth performance. But while economic growth has many benefits, it may only help ease future fiscal pressures at the margin. This is in part because the increases in demand for government services have tended to be closely related to increases in income. A significant part of government expenditure is spent on wages which tend to rise with economic growth. However, the link between economic growth and higher spending can be weakened to the extent that explicit decisions are made to moderate increases in services and control public sector wage growth.
  • Ensuring the sustainability of the tax base: A declining proportion of working-age people and the long-run pressures on expenditure mean that it is important to protect and sustain New Zealand's tax base. The direction of tax strategy identified above includes base-broadening measures and moving the tax system from one based on internationally mobile factors to one more weighted towards tax bases that are less mobile.
Page top