5 Conclusions
New Zealand potentially faces a large, demographic-driven, increase in public expenditure. We have addressed the question, from the perspective of economic efficiency, of whether to smooth tax rates or run a balanced budget in the face of that eventuality. Compared with previous studies, we have found significantly higher welfare benefits from tax smoothing (around 3% of 2000/01 GDP in present value terms for a balanced financial portfolio). Furthermore, our results understate the potential benefits considerably (by a factor of three) since we have ignored the effect of a much stronger balance sheet position relative to balanced budget moving forward from 2050.
However, realisation of the welfare benefit relies heavily on achieving a credible long-term commitment to the tax smoothing strategy, particularly to maintaining tight budgetary control in the presence of a very strong balance sheet. The efficiency gains of tax smoothing are completely eroded when we relax the assumption of exogenous government expenditure and assume that political decision-makers spend a proportion of the financial assets required to smooth taxes. Hence, strong fiscal institutions are a prerequisite for achieving the welfare gains from tax smoothing.
