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Challenges and Choices: Modelling New Zealand’s Long-term Fiscal Position

2.6  Reconciling results: 2006 to 2009

Much has changed in the economic and fiscal environment since the 2006 Statement was published, and there have been improvements to the modelling approach. This section decomposes the differences between the 2006 and 2009 projections into some of these major causes of change, using the historic trendsprojection of core Crown net debt as the fiscal indicator. Specific changes addressed, in incremental fashion, are:

  • the change to International Financial Reporting Standards (IFRS) data in 2007 and the simplification of the model that accompanied that change
  • modelling changes, other than those related to tax
  • tax revenue modelling changes
  • updated demographic projections
  • new economic base, and
  • new fiscal base.

Bridging from the 2006 model to the 2009 version involves applying the changes in a stepwise manner. The impact of each change, shown in Figures 2.5 and 2.6, depends on the order in which the changes are imposed. However, the total difference, as depicted in Figure 2.4, remains the same no matter how the various impacts are calculated.

Figure 2.4 - Net debt, 2006 and 2009 projections
Figure 2.4 - Net debt, 2006 and 2009 projections.
Source: The Treasury
Figure 2.5 - Net debt, 2006 projections and the first four changes
Figure 2.5 - Net debt, 2006 projections and the first four changes.
Source: The Treasury

2.6.1  The change to IFRS data and simplification of the LTFM

In 2007, the New Zealand Government changed its set of accounting standards for fiscal reporting. The new standards are New Zealand equivalents of the IFRS. Both the old and new standards conform to Generally Accepted Accounting Principles (GAAP), and, when they were introduced in 2007, they were often differentiated by the terms old GAAP and new GAAP. The 2006 Statement used modelling from an old GAAP-based model.

The switch to IFRS data affected most fiscal variables used in the model, meaning it had to be rebuilt. The decision was made to take the opportunity, as part of this rebuilding project, to simplify the model. Over the years, the model had been developed and had components added, and so a complete reconstruction gave the opportunity to remove any modelling whose size and complexity did not justify the value it added to the modelling. Most of the simplifications involved non-core Crown material associated with Crown Entities and State-Owned Enterprises.

The change to IFRS data had no impact on the economic data used in the model. Furthermore, simplifying the model did not alter the manner in which any economic variables were projected.

To quantify the impact of these changes, the data used in the original model were converted to IFRS equivalents and run through the new simplified model. The change in the core Crown net debt indicator, from the original 2006 model's projection, produced by these changes is shown in Figure 2.5 as Step 1: Use of IFRS data & simplifying model. This shows that these changes did not substantially change the projections of net debt.

2.6.2  Modelling changes, other than those related to tax

These modelling changes reflect changes in the way key variables were projected relative to how they were modelled in the 2006 Statement. Because tax revenue is such a vital component of the fiscal projections, changes to tax projections are treated separately.

The most significant-non-tax changes to the modelling were in the way non-social welfare expenditure types, such as health and education, were projected. The details of these changes are covered in Sections 6 and 7. Less significant changes, in terms of their impact on key fiscal indicators such as net debt, occurred in the modelling of some asset classes.

The change in the core Crown net debt indicator produced by these modelling changes, from the projection that resulted from the switch to IFRS data and simplification of the model, is shown in Figure 2.5, as the line labelled Step 2: Non-tax modelling changes.

2.6.3  Tax revenue modelling changes

The 2009 Statement modelled tax revenue in a number of different ways to the 2006 Statement. The biggest change occurred in source deductions (largely PAYE tax on wages and salaries), where fiscal drag was modelled for a period. The approach used in the tax projections in the 2009 Statement is covered in more detail in Section 5. However, two significant points to mention here are:

  • the 2006 Statement simply assumed that all tax types remained at their end-of-forecast ratios to nominal GDP throughout the projection period, and
  • a fiscal drag elasticity is applied to source deductions in the 2009 Statement's modelling for the first decade of projections, after which source deductions are returned to a long-run ratio to GDP and stay at that ratio for the remaining years. This implies that tax thresholds and/or rates are then adjusted regularly to prevent the impact of fiscal drag.

The importance of tax revenue, and in particular how it is projected, is illustrated by the line labelled Step 3: Tax modelling changes in Figure 2.5. Applying the 2009 Statement tax projection approach to the 2006 Statement data actually reduces net debt to zero around 2020. It remains there for nearly a decade before lifting again.

However, across the period 2006 to 2050, the average core Crown tax revenue to nominal GDP ratio is actually slightly lower in the 2009 approach (31.1%) than it is in the original 2006 modelling (31.5%).

As with many other factors in the long-term projections, timing matters more than totals. With fiscal drag lifting the overall tax-to-GDP ratio in the early years of projections, more revenue is received in this period than under the 2006 approach. This, in turn, reduces debt in this earlier period and so keeps debt financing costs down. Post-2023, when fiscal drag is removed and the overall tax-to-GDP is reduced below that assumed in the 2006 modelling, debt starts to rise again. However, it rises from a lower base than at the same time in the original 2006 modelling, and so has to cover a smaller expenditure total because debt financing costs are significantly less.

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