5 Policy Priorities: A Resilient and Stable Macroeconomic Environment (continued)

Restoring New Zealand's fiscal buffer needs to be the medium-term goal ...

Returning the operating balance to surplus by 2014/15 will stop net debt rising as a percentage of GDP, but ongoing surpluses will be required to create a fiscal buffer against potential future economic shocks and to secure the restart of contributions to the New Zealand Superannuation Fund (NZSF). The depletion of the Natural Disaster Fund reinforces the desirability of rebuilding a fiscal buffer as quickly as possible. We recommend that the Government commits to reducing net debt (excluding NZSF) to no higher than 20 per cent of GDP by 2020, which is in line with current forecasts (figure 13), but a faster reduction than implied by the current medium-term debt objective. Pushing the no-higher-than-20-per-cent-net-debt-target out beyond 2020, would be inconsistent with the importance of restoring a stronger fiscal buffer and preparing for the effects of population ageing.

Figure 13: Net core Crown debt; 1997-2020

Source: Pre-election Economic and Fiscal Update 2011

Once net debt falls below 20 per cent of GDP on a sustainable basis, structural surpluses could be reduced by relaxing the fiscal constraint, providing room for additional expenditure or tax initiatives. Alternatively, structural surpluses could be retained to build additional resilience, and either allocated to further reducing net debt down towards the levels achieved in 2008 and/or matching/pre-funding future liabilities, such as adding to the Natural Disaster Fund or NZSF.

... further actions are required to prepare for the fiscal impacts of population ageing

Over time, the fiscal position will come under increasing pressure as the “baby boomers” move into retirement (figure 14). Many other developed countries are facing a similar challenge. New Zealand's “65 and over” population is projected to grow nearly four times more quickly than the total population over the next 15 years, contributing to a rapid rise in health, aged care and New Zealand Superannuation (NZS) costs in particular. The resulting fiscal challenge is considerable and there is no way to avoid making tradeoffs. Given the potential economic and social instability that could result from uncertainty about these tradeoffs, we think it is crucial that efforts be made to build broad public consensus on the way forward. The current acceleration in the growth of the older population means that building this public consensus is a matter of priority for New Zealand.

Figure 14: New Zealand's population age structure; 1990-2060

Source: The Treasury

Reforming retirement income policy settings is a key way of reducing future long-term fiscal pressures,..

A range of potential options for addressing long-term fiscal challenges will be offered in the next Long Term Fiscal Statement, which will be presented to Parliament by October 2013 as required by the Public Finance Act. Reducing the level of government funding allocated to retirement income is one key way that long-term fiscal pressures can be addressed while simultaneously boosting economic performance. Leaving current retirement income settings unchanged would necessitate increases in tax revenue, which would harm growth, or large reductions in other government expenditures, such as health or education.

.... increasing labour force participation, and encouraging greater household saving

There are various ways in which retirement income settings could be adjusted to reduce fiscal costs. The evidence, including the last increase in the age of eligibility for NZS from 60 to 65 implemented in the decade to 2001, indicates that reforms can encourage significant increases in labour force participation among older workers. A number of countries have already agreed to future phased increases in the age of pension eligibility as a way of ensuring they can provide other services sustainably and encouraging households to take greater provision for their retirement income (table 1). Certain types of reform can also have an impact on household saving behaviour, which could potentially help reduce persistent saving-investment imbalances and our net external liability. Early signalling of future adjustments to retirement income settings allows households time to adjust and prepare, and, as a result, can also lead to an earlier impact on saving.

Source: OECD

*Women's pensionable ages in 2010 were 60 and 62 for the UK and Australia respectively

Towards the other end of the age spectrum, the evidence available indicates that the introduction of interest-free student loans is likely to have discouraged saving for tertiary education and failed to significantly increase access to tertiary education. Reintroducing interest on student loans would create greater incentives for students and/or their families to save for tertiary education without significant adverse effects on tertiary education participation.

Changes to the tax system could also help saving and investment imbalances

Further reducing tax distortions is another important way the Government can help to reduce saving and investment imbalances in the private sector. The shift in taxes away from savings and investment and towards consumption, announced in Budget 2010, is likely to have added to the lift in household saving rates that has occurred over the last four years. However, the real effective tax rates that apply to some types of capital income remain high, and there is wide variation in the rates that apply to different investment types, with particularly low taxation on housing (figure 15). Reducing the rate and variation in capital taxation has the potential to both encourage greater saving and increase the attractiveness of non-housing investments, which should support the tradable sectors of the economy. The Treasury is continuing to examine a range of options for taxing capital more evenly, and at lower rates. Key questions that will need to be addressed before making decisions on tax reforms of this magnitude include the size of the economic benefits and fiscal costs, administrative feasibility, and implications for distributional equity.

Figure 15: Real effective tax rates at 33% marginal rate

Source: The Treasury

Key assumptions: rate of return on each investment 6%; assets held for 7 years; 2% inflation.  For shares, company invests in bonds and pays two-thirds of earnings as dividends.  Rental housing investments earn 50% of return in rental income, 50% in capital gain.  Results are sensitive to assumptions used.