I was away last week so have been rather late in getting to the Budget Policy Statement and associated material released last Wednesday. It does not make for pleasant reading, at least if one cares at all about governments not borrowing to pay for the groceries.
Once upon a time – still not that long ago – New Zealand had a fairly enviable fiscal record. This chart, comparing New Zealand and the median advanced country, draws from data published in the IMF’s last World Economic Outlook
We used to have smaller deficits or larger surpluses than the typical other advanced countries (consistent with that our net public debt as a share of GDP was materially lower than the median advanced country). But no longer.
Using data from the same WEO (which, incidentally, was published before our election in October), on the IMF’s estimates we had one of the very largest structural fiscal deficits of any of the advanced countries.
Structural deficits – by definition – do not go away of their own accord as the cyclical position of the economy improves. They are removed only by conscious and deliberate choices by governments, and – by the same token – if they are left to linger that is a conscious and deliberate choice by a government.
There wasn’t even a hint of this starting position in any of the material released last week (although they did mention an international comparison of the increase in net debt over the Covid period). And consistent with that, there is very little about eliminating the structural deficit or getting back to operating balance/surplus. In her BPS the Minister outlines several priorities for the coming Budget, but none of them involves any priority or emphasis on getting the structural deficit down. The current government inherited the deficit, but if they choose to continue to run structural deficits – which aren’t about the cyclical state of the economy – the responsibility is on them, quite as much as it was on their predecessors when they chose to continue to run structural deficits once the heavy Covid spending was behind them. If it was pretty irresponsible then, it isn’t much better now.
Consistent with this overall approach, the Prime Minister has this morning released an “action plan” for the next three months, a period which includes the Budget. There is not even a vague suggestion in that list that closing the deficit is any sort of priority for the government.
Under the previous government the forecast date for a return to surplus kept getting pushed back. And this government now seems to be engaged in the same game – the fiscal version of the old line from St Augustine (“grant me chastity and continence but not yet”) – and whatever numbers finally emerge in the Budget projections should probably be accorded no more weight than when the Treasury produced (eventual) surplus forecasts under Labour. It might be nice to be back to surplus by whatever the next published horizon is but….don’t hold us to it. Much more important to keep funding the baubles that both Labour and National competed to offer last year.
Much of the Minister of Finance’s rhetoric in recent months has seem designed to convey a sense that structural deficits are things that just happen and that ministers can affect only at the margin. That wasn’t so under Labour – when Grant Robertson chose to run substantial structural deficits – and it is no more so under the current government. It is simply a policy choice, and a bad one, especially when there is no particular besetting crisis. She talks about the difficulty on the projections of getting back to surplus by a particular date, but the issue isn’t projections – especially when the economy operates fairly close to capacity – but choices, political choices. It might be particularly challenging for a government to take the budget from substantial deficit to balance in its first year, but over a two or three year horizon it really is pure choice. If we still run structural deficits by, say, 2025/26 that is purely a policy choice by the current government, for which responsibility will rest wholly on them.
The Minister appears to attempt to cover herself from this sort of critique using this line, which I saw twice in the documents she released: “International evidence is that reducing deficits is best done over the course of several years by focusing on structural reforms to expenditure and revenue settings”.
Which might sound good but (a) there are no footnotes or references to support this claim of “international evidence”, and (b) there isn’t anything much specific about these “structural reforms” (at present the focus of fiscal policy seems to be on finding enough spending savings to fund tax cuts and other giveaways, rather than on a actually reducing the deficit). I’m rather sceptical of the claim. It might have a little merit in an economy in a deep recession with monetary policy constrained by the effective lower bound on nominal interest rates, but…..that very much isn’t the world New Zealand fiscal authorities now face. Instead, the line just feels like an unsupported excuse for a few more years of deficits (“they had them so why shouldn’t we?”).
The Minister has also been making quite a play of a story that it has all gotten so much harder than she had envisaged because the economy has been deteriorating. At present, that seems a dramatically overblown story, designed to distract more than to enlighten.
Much is made of the revisions downwards late last year in the level of real GDP (and thus the level of labour productivity). But that is mostly distraction, because before those numbers came out Treasury and IRD already knew how much tax revenue the economy had been generating, all they didn’t know was the latest macroeconomic estimates of the size of GDP itself. That matters for, eg, nice charts of tax/GDP ratios but not very obviously for making sense of the fiscal situation and its challenges.
Some weeks ago I showed this graph on Twitter, showing the Reserve Bank’s latest nominal GDP forecasts against those the Bank produced in August last year (ie the last projections before the election).
The Reserve Bank reckoned in February that if anything nominal GDP would be a little higher than they’d thought just prior to the election. And while nominal GDP tends not to be a big point of focus for the RB in putting together its forecasts, the Secretary to the Treasury (or her senior delegate) does actually sit on the MPC.
What about real GDP? Well, as we know, there were some downward revisions to the historical data, so in this chart we will focus on forecast real GDP growth, using as the base date the March quarter of last year (the latest actual data the RB had when it did its last pre-election projections)
Those are pretty tiny differences. And, after all, the Reserve Bank had been telling everyone – including the then Opposition – that the economy was going through a tough patch as part of getting inflation back down.
Among the material released last week was a four page Treasury note on the economic and tax outlook. It contains some preliminary high level forecasts, but can’t be directly lined up against the Reserve Bank numbers because there is no quarterly track for nominal GDP (the best proxy for the tax base). It appears from Treasury’s annual forecasts that they are running with a lower nominal GDP track than the Reserve Bank has (perhaps by around 2 per cent), although it isn’t clear quite why (and although the documents note a revision downwards in inflation forecasts, the Treasury inflation forecasts for the first year or so still seem higher than those of the Reserve Bank).
In terms of spinning a story around the deficit this is perhaps the paragraph the Minister will have been most keen to have readers pay attention to.
You are meant to take away from this that it is going to be so much harder than the current government had thought last year when they were in Opposition, to get back to balance by 2026/27 (recall, a date already pushed out under Labour). But there are a few crucial words in that excerpt: “all else equal”.
And they aren’t (of course). When the size of the nominal economy is smaller than previously expected – but still operating at around capacity (and the Treasury preliminary forecasts have unemployment by 2025/26 and beyond around their estimate of the NAIRU) – it isn’t just revenue projections that need to change. So will many spending obligations – both statutory things like indexed benefits (remember, Treasury has revised down its inflation forecasts since late last year) but also expected wage inflation (in the private sector but also in the public sector). Economies with a dreadful productivity growth record – and the productivity assumptions in these forecasts seem likely to be very weak indeed – tend not to support large wage increases. Of course, there are other items in government spending where there are no semi-automatic savings, but the weak productivity story doesn’t seem to be just a New Zealand phenomenon at present. (More generally, of course, all medium-term economic forecasts – RB, Treasury, IMF, or whoever – are subject to huge margins of error, and not worth a lot more than the paper they are printed on.
Being in surplus two to three years hence (or not) is purely a political policy choice. Not to be is a bad choice. (Of course, in the meantime some really bad event could hit – earthquakes, deep global recessions or whatever – but since no one can or does pick the timing of those we can worry about them when and if they hit. At the moment, planning proceeds on the basis of an economy developing fairly routinely (if underwhelmingly).
I’m old enough to remember when a National government and Minister of Finance first got New Zealand back to operating surplus in the mid 1990s. I’ve told stories about what seemed to have been bipartisan commitment to get back to surplus fairly promptly when occasional nasty shocks happened (although in truth it was really tested only once). It is disheartening now to see little sign that National (and their coalition government) is any more bothered about deficits – borrowing to pay for the groceries – than their Labour predecessors were. (The new debt target enunciated in the BPS is no more encouraging, with the new government seemingly willing to settle for higher levels of (net) debt than New Zealand has averaged over the last 25 years, with no evidence of strong potential productivity growth that might compellingly justify such debt.)
UPDATE: Incidentally, I saw in the weekend papers (page 3 of Saturday’s Post) one academic economist defending the government’s fiscal approach as classic supply-side economics. I don’t find that claim at all persuasive. There are certainly elements in the fiscal grab-bag that might fit that bill (one could think of restoring interest deductibility to rental property owners, on the same basis as any other business in New Zealand). In the abstract, lower income tax rates might, were it not for the fact the starting position is one of a deficit. Savings from cuts to spending can be used to cut the deficit or for tax cuts, but tax cuts today with a structural deficit – all else equal – just mean either further cuts to spending or higher taxes in the future. And some of National’s policies are distinctly retrograde even with a supply-side focus in mind – one could think, for example, of the policy both they and Labour campaigned on, the elimination of depreciation for tax purposes in respect of commercial buildings (office, factories, warehouses). Simply a freshly distortionary revenue grab. And meanwhile we run one of the highest company tax rates in the OECD with not even a suggestion the government is interested in addressing that.
