5.3 Timing of fiscal adjustment

When undertaking fiscal adjustment the timing and pace of fiscal adjustment is an important consideration. On the one hand delaying fiscal consolidation may increase the amount of adjustment required at a later period. However, in an environment of uncertainty, there may also be benefits of waiting for further information before making decisions. The decision whether to make fiscal adjustments now or whether to wait will depend on the degree of uncertainty associated with population ageing, expected behavioural responses to the consequences of population ageing, including expected impacts on government spending programmes and revenue. It will also depend on the time preference of society; that is, the willingness of society to put up with more "pain" today in return for less "pain" later. Also relevant is how society values the well-being of current versus future generations.

But the economic and social costs of making fiscal adjustments early versus delaying adjustment may not be symmetric. For example, the costs of reducing the track of government spending today in anticipation of growth in the proportion of older people which ultimately proves to be overstated, may not be as serious as delaying fiscal adjustment where the growth in proportion of older people turns out to be understated. This asymmetry could be accentuated if the decision to act early is easily reversible while the decision to delay leads to change being politically difficult and economically disruptive to implement. The situation that some countries are now facing in the aftermath of the GFC perhaps illustrates this type of risk.

Projections using the Treasury Long-Term Fiscal Model show that in order to stabilise net government debt at 20% of GDP, the government needs to run small budget surpluses on average over time. If the government delayed making adjustments then it will accumulate debt, which will require larger fiscal adjustments in the future. Projections using the LTF Model show that:

1. If fiscal adjustment starts in 2015/16 (continuing on from the current programme of fiscal consolidation) then governments would need to run budget surpluses of 2.3% of GDP for six years to pay down debt to 20% of GDP by 2020 (the current government goal).
2. Delaying adjustment until 2020/21 would require average surpluses of 2.6% of GDP to be run to reach the debt target within the same adjustment period of six years; and
3. Delaying adjustment until 2030/31 would require average surpluses of 3.5% of GDP to be run to reach the debt target within the same adjustment period of six years.[25]

To put these figures in context, during the decade from 1997-2006 when there was strong revenue growth, governments ran average budget surpluses of 2% of GDP. Delaying fiscal adjustment, in addition to requiring a greater degree of fiscal adjustment, also places greater risk that the government is not well placed to respond to an adverse shock to the economy and to government finances.

Sutherland et. al. (2012) estimates that for New Zealand a two year delay in fiscal adjustment increases the fiscal gap by more than one-third of a percentage point of GDP. Delaying adjustment in certain areas may make reform more difficult from a political-economy point-of-view. For example, it may be more difficult to reform retirement income policy as the age of the median voter increases. Adjustment sooner allows for more gradual adjustment and greater tax and expenditure smoothing over time and also helps to build a buffer more quickly to respond to future shocks. Reducing debt servicing costs also provides more flexibility for expenditure increases or tax reductions in the future as governments will be spending less tax revenue on debt servicing costs. However, from a political perspective, implementing fiscal reform may be easier to bring about when the challenge of fiscal sustainability becomes more acute.

The current National-led government has a target of bringing net government debt down to no higher than 20% of GDP by 2020. Therefore the timing of fiscal adjustment may occur in at least two stages: adjustment over the medium-term to reach the 2020 debt target, and then adjustment required to stabilise debt beyond that point in time.

Ongoing expenditure control and/or revenue increases will be necessary for the government to reach the target of 20% net government debt to GDP by 2020. The government's fiscal strategy involves government expenditure as a percentage of GDP being reduced from just under 34% of GDP in 2011 (which includes approximately 0.75% GDP Canterbury earthquake related costs) to 30% of GDP in 2016.

While the second phase of adjustment may seem a long time away, many of the policy changes that governments may consider in the second phase of adjustment, such as changes to NZS, could benefit from reasonable phase-in periods. The Retirement Commission (for example, in its 2010 report) recommend increasing the age of eligibility for NZS from 65 to 67 years, starting in 2020 and increasing the age of eligibility by two months each year. This would mean that the increase in the age of eligibility for NZS to 67 years would not be fully implemented until 2033 (Retirement Commission, 2010). However, when the age of eligibility for NZS was increased most recently in New Zealand from 60 to 65 years, the change was implemented over a shorter time horizon (on average about 6 months a year 1992-2001). Nevertheless, there are generational equity implications of delaying adjustment and then making a quick adjustment subsequently.