Executive Summary
New Zealand, like many other countries, is experiencing a changing demographic age structure which has the potential to increase the costs of state-funded, age-related government expenditure programmes such as public health care and superannuation. The Treasury's Long-Term Fiscal Model converts information from the government accounts, demographic and economic growth projections and current fiscal policy settings into forward projections of the governments operating balance and level of public debt. Projections using Treasury's LTFM suggest that population ageing and rising health costs will impact on the long-term sustainability of the government's current fiscal programme.
Fiscal sustainability refers to whether a government can maintain its settings for welfare, health, pension and other fiscal policies without major adjustments in the future, or whether its policies would lead to excessive accumulation of public debt unless the government takes action to change its policies. Although there are alternative fiscal anchors, the Public Finance Act 1989 requires that government maintains its total debt at "prudent" levels. A debt anchor has the advantage that it does not take a view on the optimal size and role of government, although for this reason it has also been criticised for providing weak a discipline on the levels of government spending and taxation. This has prompted suggestions for supplementary fiscal anchors, which are discussed in the paper.
In recent years New Zealand governments have managed to keep the level of public debt well within prudent levels. Although New Zealand's level of public debt is currently relatively low compared with many other developed countries, under current policy settings public debt is projected to increase from the late 2020s onward as the effects of population ageing and rising health costs lead to increasing operating deficits and rising public debt. This paper discusses the modelling assumptions underlying these projections and the effects of the timing of fiscal adjustment on the size of the operating surplus required to maintain a prudent level of public debt.
The paper also discusses why fiscal sustainability is important to economic wellbeing. The sustainability of the government's fiscal position can influence a government's ability to issue debt, and it can influence the cost of issuing debt. For these reasons, fiscal sustainability can also enable a government to respond to adverse economic and other shocks to wellbeing, and to smooth tax rates over time. It can also influence the likelihood of a higher country risk premium being added to the cost of borrowing faced by private borrowers. Fiscal sustainability also has distribution effects. From an inter-generational perspective, increasing public debt can be seen as an obligation passed from one generation of tax payers to the next. The paper also discusses how, through the effects on government spending and taxes, population ageing can have other distributional effects.
Governments require an appropriate decision-making framework to weigh-up fiscal policy options. This is because population ageing and fiscal adjustments required have economic, distribution and other implications for living standards, and because there is uncertainty surrounding the effects of population on fiscal projections. One such approach is the Treasury Living Standards Framework. The paper concludes by discussing how this approach can be adapted to the challenges of population ageing and used to weigh-up policy options to achieve fiscal sustainability.
