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Modelling New Zealand's Long-term Fiscal Position - PP 06/01

6.   Conclusions

This paper has been written to explain our modelling strategy for the Statement on the long-term fiscal position. The first Statement must be tabled by 30 June 2006.

Our modelling starts with demographic projections of the population (adopting the official Statistics New Zealand projections), uses these to produce projections of GDP and then adds the central government sector.

The population modelling is based on continuing the present low fertility/low mortality state, following the transition from a high fertility/high mortality state over the past century. This transition is not unique to New Zealand. Importantly, it is not a demographic “bulge” that will reverse in time.

The economic model is based on the three Ps of Population, Participation and Productivity. The population component is derived from the Statistics New Zealand demographic projections, while for participation and productivity we are projecting a continuation of recent trends.

Modelling government spending for over 40 years into the future presents considerable challenges. We illustrate these by presenting examples of four different types of expenditure programmes:

  • New Zealand Superannuation: Projected expenditure is driven by existing scheme parameters and our population and economic projections. The result is that spending on this programme increases as a proportion of GDP.
  • Education: Future expenditure is driven off a combination of demographic factors (numbers of students) and assumptions about real spending per student driven by wages, resulting in a declining level of spending relative to GDP.
  • Core government services: Spending is projected at a fixed proportion of GDP.
  • Health: We combine a set of projections around demography, costs and policy choices to derive a level of spending that is increasing as a share of GDP.

We also illustrate our approach to projecting tax revenue, where we expect the tax-to-GDP ratio to increase slightly over time (the reason for the increase is that we are projecting that most tax bases grow in line with GDP, but that New Zealand Superannuation and other benefits, which are both taxed, will increase faster than GDP).

These examples also show how different parameters affect the projections in different ways. For example, our estimate of labour productivity has little impact on spending on New Zealand Superannuation as a proportion of GDP. This is because growth in GDP enters both the numerator and denominator of the spending-to-GDP ratio. In the numerator (spending), the level of benefits is linked to wage levels, which in turn is linked to productivity. GDP, the denominator, is similarly linked to productivity. Thus any change in productivity has an equal, and thus off-setting, impact on both spending and GDP.

Demographic projections can, however, affect the final results. Using Statistics NZ’s low mortality (higher longevity) assumption, rather than its preferred medium assumption would, for example, mean a greater proportion of elderly, a relatively smaller labour force, and a larger population by 2050. This is likely to place more pressure on the fiscal position.

The final Statement will include projections of all government spending programmes. Our plan is to present the results of the full model in two different ways.

We will start with a top-down approach, where the current set of fiscal aggregate objectives (most notably long-run spending-to-GDP, tax-to-GDP and debt-to-GDP ratios) is projected to continue. We will use the model to determine what spending or revenue track would be required to continue to meet these objectives, given likely demographic changes.

There are a number of different ways the top-down results could be modelled. For example:

  • With tax rates fixed, we could allow debt to move and see how it measures up to the long-term objectives.
  • With debt fixed, we could allow tax rates to move to accommodate the objectives.
  • With tax and debt ratios fixed, we could see just how much current spending ratios need to be pared back to satisfy our present long-term fiscal objectives.

We will then present a set of bottom-up projections, where we model the effect on the aggregate fiscal results of current policy in individual spending programmes and the current tax system projected forward on the basis of demographic and other assumptions.

Because the fiscal position is the result of policy choices, we also plan to accompany our projections with a discussion of how the current policy settings have evolved over the past few decades and where the spending share is likely to be heading. This will allow us to describe how different policy settings might impact on the fiscal position.

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