5.6 Impact on the New Zealand fiscal position
5.6.1 Rising debt and pressure to change policy
The impact on debt under all three scenarios is severe (refer Figure 8). Even under our most modest (average OECD) scenario, where New Zealand experiences a single year decline in GDP of 2%, debt rises to 54% of GDP. In our more extreme scenarios (Spain and Ireland), debt grows rapidly and does not stabilise by the end of the projection period. In all cases, policy has been held constant and spending growth is based on the Government's fiscal strategy as of HYEFU.
- Figure 8: Gross sovereign issued debt under OECD growth scenarios (excluding changes in spending)
- Source: The Treasury, HYEFU 2010
To replicate the size of changes experienced in countries such as Ireland our figures need to also consider increased spending. However, this analysis is complicated as spending depends on the policy decisions of the government of the day. Nevertheless, for the purpose of illustration, we model a half percent reduction in productivity growth, which reduces trend growth under the Irish scenario by an equivalent amount. One-off increases in spending were also included to cover the cost of a banking crisis (13% of GDP[12] as laid out in Box 3) and the cost of recapitalising falling government asset values ($14 billion)[13].
The results indicate that, while tax still makes up the majority (58%) of the change in debt, the outcome of our scenarios could be up to 69 percentage points worse than Figure 8 if the policies laid out above are incorporated. This compares to the IMF’s study of sovereign debt (IMF, 2010) which suggested that average debt levels in developed countries are projected to increase by 39 percentage points. Of this increase over 19 percentage points (48%) will come from declining revenue. Despite common perceptions, only 3.2 percentage points (8%) are expected to come from financial sector support and 4.5 percentage points (11%) from fiscal stimulus measures[14]. New Zealand studies looking at tax volatility (Irwin and Parkyn, 2009) estimate that the impact of tax changes account for 52% of the past volatility in Crown net worth. However, given spending changes are contingent on future government decisions, we retain the usual modelling assumption used in the government’s long-term projections – that policy remains constant – for the remainder of the paper.
Notes
- [12]This % GDP is based on World Bank estimates (Honohan & Klingbiel, 2002).
- [13]Our assumption is that a small proportion of assets may require additional government funding following a decline in value. An obvious example would be ACC, where funding may fall well short of the organisation's liabilities. This allows us to discuss valuations changes in terms of the final impact on debt. The cost changes are based on a 1.5 standard deviation change in value of SOEs and Financial assets (Irwin and Parkyn, 2009).
- [14]This analysis predated the bailout of Ireland’s major financial institutions.
