6 Summary and conclusions
Designing government fiscal programmes to ensure they are sustainable has important economic benefits. In acknowledgement of these benefits, New Zealand has adopted a legislative framework that requires government to keep its total debt at "prudent levels". Consistent with this, successive New Zealand governments have steadily reduced the level of New Zealand's government debt since the mid-1980s. Nevertheless, New Zealand, like many other countries, is experiencing a changing demographic profile which will have implications for society and the economy, including the government's fiscal position in the future and potentially the sustainability of its spending programmes. This was the message highlighted by the Treasury's first two Long Term Fiscal Statements published in 2006 and in 2009, and it is a fiscal theme that applies to many other developed countries that are experiencing a structural shift in their demographic profile.
Although the success of the past 25 years in reducing the level of government debt suggests that New Zealand governments have a good history of reducing fiscal vulnerability and managing to a prudent debt level, the underlying forces impacting on government expenditure in the future will be different and therefore the economic and political tradeoffs and challenges will be different.
While there is considerable uncertainty over future interest rates and economic growth, it would seem that because of the implications of population ageing (as well as the income and technology effects on demand for health care) governments are likely to be faced with a significant fiscal challenge in the future. Projections using the Treasury LTF Model suggest that under the scenario that the current fiscal programme being implemented during this term of government (which involves government expenditure as a percentage of GDP being reduced by over 1% between 2012 and 2014), net government debt gradually increases from around 25% of GDP in 2012 and by the 2060s reaches levels well beyond what is currently regarded as prudent.
The Treasury's Long-Term Fiscal Statements do not recommend a long-term government debt target, as this will change over time in light of some of the considerations discussed in this paper. However, for modelling purposes scenarios are examined that constrain net government debt to 20% of GDP on average over time and can show the sensitivity of the projections to different debt targets, eg, 0%, 10% and 30% net debt. The projections show that in order to stabilise net debt at 20% of GDP the government would probably need run an operating surplus of 1 to 1.5% of GDP over the long run. Stabilising net debt at 20% of GDP requires the government to manage the "wedge" that arises between the cost pressure and sustainable debt scenarios, for example, by changing tax settings or expenditure. A significant portion of the gap represents the difference in debt financing costs between the two scenarios, and so if governments begin adjusting earlier, they avoid some of those costs eventuating.
Although there is uncertainty around these fiscal projections, it is difficult to avoid the conclusion that there are considerable economic risks associated with policy inertia, particularly if projections underestimate future increases in life-expectancy. There are also economic and political costs associated with delays in making the adjustments required to ensure that public debt remains within a prudent range. Although Long-Term Fiscal Statements have analysed these issues and provided illustrative adjustment scenarios, we suggest a stronger focus needs to be given to assessing the options and trade-offs associated with fiscal adjustments to government expenditure programmes, to taxation revenue-raising options, and to the timing of policy adjustments.
This paper has summarised the issues relevant to assessing the government long-term fiscal situation. This includes having a clear understanding of how population ageing and other factors such as rising incomes will impact on the future fiscal situation, forming a view on prudent levels of public debt and understanding the degree of uncertainty surrounding fiscal projections. Also relevant is how uncertainty and the political and economic costs of adjustment now and at a future date should influence decisions about the timing of fiscal adjustment. Developing a set of transparent criteria for weighing up fiscal reform options (such as Treasury's Living Standards Framework), is important to communicate how policy options impact on policy objectives such as achieving economic efficiency and growth, sustainability, managing risk, and understanding the distribution of benefits and costs of reform options.
It is beyond the scope of this paper to delve into these options and tradeoffs in any detail. But greater attention needs to be placed on these issues to ensure a more informed public debate and more informed policy choices.
