2.2 Measures and indicators of fiscal sustainability
Many governments around the world have begun to prepare projections of government finances over increasingly longer periods of time. This has been born out of concern that demographic changes in particular could have implications for the structure of government spending and revenue and the feasibility of sustaining the financing of the prevailing fiscal programme. Previous reporting on these issues had been somewhat ad hoc. The Public Finance Act (PFA) 1989 was amended in 2004 to require the Treasury to produce statements on the long-term fiscal position that look out at least 40 years into the future.
While traditional government financial statements provide information about past cash flows and assets and liabilities, they do not include information about the long-term financial implications of many government policies, including:
- revenue that is expected to be realised in the future, but that is not recognised as assets (for example, expected future tax revenue), and
- expected future obligations that are not recognised as liabilities (for example, expected future spending on entitlements, social services, infrastructure, etc.) (International Public Sector Accounting Standards Board, 2012).
Long-term fiscal information can therefore be used to complement the government's core financial statements to indicate whether government policies are sustainable over the long term, or whether governments will have to tax more or spend less to meet fiscal sustainability conditions.
In order to determine whether the current path of fiscal policy is sustainable, one needs to define the current path. This is often difficult as policy is rarely clearly defined over the long-term and future economic performance and demography are not known with certainty. As is common with most other long-term fiscal projection models, the Treasury Long-Term Fiscal Model (LTFM) converts information from the government's accounts into forward-looking projections based on assumptions about the economy, demographics, government spending, transfers, taxation, assets and liabilities. This information is also valued by private sector agencies whose decisions are influenced by their assessment of future taxes, expenditure and public debt (such as credit-rating agencies concerned with assessing sovereign risk).
Various measures can be used to assess the future sustainability of the government's fiscal position. Some measures are based on the projected trend in fiscal aggregates, such as the operating balance, primary balance, gross debt, net debt or net worth. Other methods condense one or more time series of fiscal aggregates into single indicators, such inter-temporal infinite horizon or finite horizon fiscal gaps.[4] For all of these indicators, uncertainty in the projections tends to increase as the projection horizon increases. Table 1 summarises how these measures are defined, what they best measure, as well as their limitations.[5]
Generational accounts can also be used to assess the effects on different generations of alternative ways of satisfying the government's inter-temporal budget constraint. Generational accounts calculate the net lifetime taxes faced by people born in different years.[6] A set of generational accounts was prepared for New Zealand in 1997 (Auerbach et al., 1997). However, generational accounts have not been widely used (Netherlands and Norway are the only countries now that prepare regular generational accounts) and the suitability for fiscal policy decisions is somewhat limited.[7]
| Measure | Definition | Best measures | Limitations |
|---|---|---|---|
| Operating balance | Core Crown operating balance: Projected core Crown revenues less projected core Crown expenses (plus projected surpluses from Crown entities). | Size and time profile of fiscal imbalances, including debt financing costs. | Underlying revenue and expenditure imbalance may be exaggerated by compounding financing costs. |
| Primary balance | Core Crown primary balance: Projected core Crown operating balance less projected net interest costs and unrealised valuation gains or losses on financial assets. | Size and time profile of fiscal imbalances, excluding debt financing costs and valuation gains or losses. | This measure does not capture financing costs of government borrowing, or changes in borrowing costs. |
| Gross debt | Core Crown gross debt: Projected core Crown debt issued by the sovereign less settlement cash held by the RBNZ. |
Sustainability of government gross borrowing over the long-term, if current policies are maintained.
|
Does not take into account financial assets that could be used to offset debt. |
| Net debt | Core Crown net debt: Projected core Crown gross debt less projected core Crown financial assets (excluding advances and the NZSF, which is held for policy purposes). |
Sustainability of government finances over the long-term, if current policies are maintained. Presents reduction as a % of GDP in the terminal year. |
This measure introduces an additional uncertainty over the future value of government financial assets.
|
| Net worth | Core Crown net worth: Projected core Crown net worth (assets and liabilities of the core Crown) based on Generally Accepted Accounting Principles (GAAP) | Sustainability of government finances over the long term, if current policies are maintained, based on a more comprehensive measure of government assets and liabilities. | This measure introduces more valuation requirements and further uncertainty over the future value of government assets and liabilities. |
| Inter-temporal infinite horizon fiscal gap | Inter-temporal infinite horizon fiscal gap: Projected permanent spending decrease or revenue increase necessary to pay off all government debt over an infinite time horizon. |
Shows the extent of adjustment required in a single indicator. This approach can be useful to indicate whether the fiscal gap is tending toward a sustainable position. |
Assumes it will be necessary to eventually wind-up all government assets and debt. Assumes all fiscal adjustment is undertaken upfront, rather than managed over time. This measure does not indicate the source of change in the fiscal gap. |
| Inter-temporal finite horizon fiscal gap[8] | Inter-temporal finite horizon fiscal gap: Projected permanent spending decrease or revenue increase necessary to meet a debt target at a particular point in time. |
Extent of adjustment required in a single indicator. Different adjustment scenarios (adjust now versus later) and extent of adjustment required across countries. |
Requires a debt target and time period to be specified. Assumes all fiscal adjustment is undertaken upfront, rather than managed over time. Different time horizons may generate different results. |
Notes
- [4]There are also econometric techniques that have been developed to test the sustainability of government debt and deficits. Bohn (2007), for example, provides a critique of standard stationarity and cointegration techniques that have been used, and suggests alternative approaches that could be taken. As far as we are aware, these sorts of approaches have not been applied in the New Zealand context.
- [5]The measures are defined on a core Crown basis, as they have been in previous Treasury Long-Term Fiscal Statements (see, for example, New Zealand Treasury, 2009). The fiscal gap measures are defined more generically in the table. The definitions of government debt are discussed further in Section 4.1 of this paper. Since net debt is a cash concept, it is ultimately driven by cash receipts and cash expenditures, including capital spending, whereas the operating balance is an accruals measure. In recent years, the Economic and Fiscal Updates published by the Treasury have included a table that reconciles the government operating balance to changes in net government debt (for example, see Table 2.2 on page 26 of the 2012 Budget Economic and Fiscal Update).
- [6]Net lifetime tax is the discounted present value of tax paid and transfers and other government expenditure received over an individual's lifetime.
- [7]The OECD (2009b) notes, for example, that generational accounts compare net lifetime taxes of future newborns, but not people already alive today.
- [8]See Janssen (2002) for a further discussion about the inter-temporal finite horizon budget gap indicator.
