2.4  Fiscal sustainability outcomes

New Zealand’s fiscal position is sound by historical and international standards. New Zealand is amongst a small group of OECD countries with a positive net financial asset position (see, for example, 2007 FSR, page 40 of Budget 2007). Figure 1 shows that there has been a steady decline in the public gross debt-to-GDP ratio over recent years.[16] Gross Sovereign-Issued Debt (GSID) has fallen from 37.7% of GDP in 1998 to 23% of GDP in 2007.[17] Simultaneously, large operating surpluses over recent years have allowed the accumulation of around NZ$13 billion of financial assets through the NZS Fund.[18]

The strength of the fiscal position has been noted by international credit rating agencies and has been a determinant of New Zealand’s sovereign credit rating. For example, Standard and Poor’s recently maintained New Zealand’s sovereign credit rating whilst noting that current macroeconomic imbalances meant that there was some potential that a shock to the economy could have a negative impact on government finances. However, they remarked that “the low level of net debt provides a strong buffer to absorb any such shock without threatening credit quality” and hence “only a significant and unexpected weakening of government fiscal policy is likely to lead to a down grade in the next few years” (Standard and Poor’s, 2007).

These achievements have been associated with a strong period of economic growth and Budgets that helped achieve the transition to higher surpluses required to finance the NZ Superannuation Fund. The reduction in the public debt-to-GDP ratio has occurred as a result of nominal GDP growth rather than a reduction in the level of nominal debt. Higher than expected GDP, and hence tax revenue growth, have resulted in Government achieving its fiscal objectives faster than expected at the start of the millennium.[19]

Projections of the government fiscal position are used to assess the medium and long term sustainability of government fiscal policy. The modelling approach is applied in two different ways. First, the Fiscal Strategy Model is used for the purpose of providing projections for the FSR, and hence assessing how government intends to meet its 10-year objectives.[20] The model used in the Statements of Long Term Fiscal Position uses the same projection methodology but makes different assumptions about the level of new government initiatives.

The modelling approach applied in each model is to take the government flow budget constraint (expression 1) and project revenue and expenses forward. The projections of GDP, , are based on demographic projections (including some allowance for changes in labour force participation across cohorts) and constant productivity growth. This provides the base for taxation projections,. The models include debt finance dynamics,, and trace out the debt ratio for each future period, . The modelling approach reveals the projected time path of each component of the flow budget constraint (including the components of taxation and government spending) and the implications for the debt ratio in each future time period.

The difference between the FSM and the model used in the statement of the long-term fiscal position (LTFP) is in the assumptions relating to the growth of Government expenditure, . In the model used in the LTFP statement, all expenditure projections are developed from a “bottom-up” approach. Given current fiscal parameters, government expenditure, is grown based on demographic projections, relative price changes for some components of government spending (notably health) and assumptions about the income elasticity of demand for the current portfolio of public goods (Rodway and Wilson, 2006; The Treasury, 2006). In contrast, the FSM is consistent with the Government’s approach to fiscal management, and assumes a degree of fiscal constraint in order to meet Government’s stated 10-year objectives. Baseline spending, at the end of the forecast period, is projected forward assuming that current policies continue. New policy initiatives are assumed to be funded from an operating or capital allowance. The assumed allowances are reassessed during the Budget process to ensure consistency with the fiscal strategy. The different assumptions relating to growth of new initiatives in the model imply that the present values of the operating balances produced by the models and projections of debt will differ.

The modelling approach applied in the Statement is similar to techniques used by the OECD, and the Australian and UK Treasuries. Nevertheless, there are a number of issues that need to be recognised when considering the robustness of the fiscal projections and policy insights. These include, for example, the extent to which Ricardian behaviour could result in offsetting responses by individuals to emerging fiscal deficits (including, for example, changes in private savings and labour force participation), feedback effects of government expenditure paths on productivity growth, and feedback effects of rising debt levels on interest rates. These issues are also relevant to estimates of the present discounted values that enter calculations of the IBC and the fiscal gap (expressions 2 and 3).

The different assumptions relating to the growth of new initiatives in the models represent the different information purposes of the models. As FSM projections are used for the FSR, the assumptions as to growth of new initiatives are set by the Government of the day. These projections therefore provide a means for the Government to communicate how it intends to meet its 10-year fiscal objectives. The modelling approach in the statement of LTFP provides a projection of outcomes if fiscal parameters remain essentially unchanged and policy behaviour is unchanged. This approach highlights future policy challenges by, for example, revealing future gaps between the projected debt outcome and the present debt objective if government followed a particular expenditure path. Although the Treasury is still developing its thinking about how to best utilise the insights from the LTFP statement, it has the potential to help communicate the timing and reasons for changes in policy parameters.

Projections from the FSM are published in the annual FSR. These projections have consistently shown Government achieving on its long term objectives. For example, projections in the 2007 FSR (see for example the 2007 FSR, page 48 of Budget 2007) show a level of debt consistent with the Government’s objective to maintain GSID-to-GDP at around 20% over the projection period.

The first statement of the long-term fiscal position (LTFP), published in June 2006, shows that the fiscal position is strong over the medium term. However, the statement projects a higher path for gross debt from the 2020s. The ratio of GSID-to-GDP is projected to be around 25% in the mid-2020s and rising thereafter (Figure 2). On the assumption of no change in policy, operating expenditure is projected to grow as a percentage of GDP and is projected to exceed operating revenue from around 2030. Two of the main influences on government expenditure growth are spending on health and superannuation (Figure 3). Superannuation spending is significantly influenced by the ageing population structure. Health expenditure has grown significantly over recent years owing to increased coverage and rising costs and these are key influences on the projections. Partly in response to this Statement, the current Government has recognised the need to address the growth in health expenditure (see for example the 2007 FSR, page 48 of Budget 2007).