5  Simulation results

The Government spending share of GDP (G/Y) is plotted in Figure 5 for the five demographic projections. The patterns reflect those of the support ratios. Falling support ratios imply rising government spending due mainly to rising spending on NZS and health associated with higher old age dependency. The High Fertility scenario increases government spending to GDP by a maximum of 1.1% in 2035 and by 0.4% in 2060. The other demographic scenarios take longer to impact on GDP; indeed the effect is less than 0.2% of GDP up to 2035. After that the effect is greater. Zero Migration increases spending by the most, 1.7 % of GDP by 2060, compared with 1.2% under Low Mortality. High Migration reduces spending by 0.3% of GDP by 2060.

Figure 5 - Government spending (ratio to GDP)

Three tax smoothing regimes are compared with a balanced budget regime. See Figure 6.

Figure 6 - Tax to GDP ratios - Medium demographic projection

The first is a sustainable debt regime, where this is defined by NZ Treasury as a stable debt to GDP of 20% by 2060. This implies a tax to GDP ratio that starts at 30.9% in 2015 (compared with 30.5% under balanced budgets) and increases to 35.3% in 2060 (compared with 35.6% under balanced budgets). The sustainable debt tax path is very close to the balanced budget path. There is no more than 0.4% of GDP difference at any point over the projection period. Such a small increase in the balanced budget tax rate is all that is needed to reduce debt from the balanced budget level of 31.7% to 20% from 2015 to 2060. This is reflected in small/modest budget surpluses of between 1.3% and 0.6% of GDP over the projection period (see Figure 7 for budget surpluses).

Figure 7 - Budget balance (ratio to GDP) - Medium demographic projection

The third budget regime has debt to GDP stabilising at zero rather than 20% (see Figure 8 for the debt ratios in each regime). This requires higher initial budget surpluses of 2% of GDP declining to zero by 2060 (Figure 7). The fourth budget regime is even more extreme tax smoothing where the debt becomes negative and stabilises with net foreign asset of 20% of GDP. The budget surplus starts at 2.6% of GDP in 2015 and steadily declines to a stable budget deficit of 0.5% of GDP. Hence the three regimes represent progressive degrees of smoothing. A higher degree of smoothing implies greater transfer of the consumption cost of ageing to present generations and away from future generations, as discussed earlier.

Figure 8 - Net debt to GDP ratios under alternative fiscal regimes - Medium demographic projection

Sensitivity to the demographic projections is illustrated in Figure 9 which shows the tax to GDP ratios under the sustainable debt regime under the five demographic scenarios. It mirrors the pattern of government spending illustrated in Figure 5. The tax ratio is eventually highest under Zero Migration, being 1.6% above that under the Medium projection by 2060, although it takes at least 15 years (until 2030) for the tax ratio to rise above that of the Medium projection. Indeed that is the case for most of the alternative demographic projections - their fiscal implications are slow to take effect, the exception being the High Fertility scenario where the fiscal cost of higher dependents arises sooner.

Figure 9 - Tax to GDP ratios for sustainable debt (=20% GDP) - Various demographic scenarios

A key aim of the analysis is to determine whether households of different generations are better off or worse off under tax smoothing, and by how much. The method adopted here is to calculate the effect on lifetime income from the year of the policy shift which is 2015.[13] The policy shift is assumed to be unexpected, prior to which balanced budgets are the actual and expected policy.