That was a weird 24 hours or so. If you had told me a week ago that anything I was involved with would be the lead item on Morning Report and on the two TV channels’ evening news bulletins, I would not have believed you. Election campaigns are funny things.
I don’t want to say anything much more about the foreign buyers’ tax issue, although it did occur to me this morning that National’s stance – refusing to release any workings, or details of the Castalia review- was somewhat at odds with Willis’s recent statement that National now wants a state Policy Costings Unit established. In any such model, the full costings/modelling for any policy a party adopted would routinely be released. But in the end it is their choice, as it should be. And, as I noted yesterday, whatever political/reputational significance the (likely large) gap in the revenue estimates has, it simply isn’t macroeconomically significant, at about 0.1 per cent of GDP per annum.
The OBEGAL operating balance forecast for this fiscal year in the PREFU earlier this week was 2.7 per cent of GDP, and less than three months into the fiscal year I’m sure Treasury would tell us that even if there are no policy changes, that is a point estimate within a credible range easily 0.5 percentage points either side of 2.7 per cent.
In the run-up to last year’s Budget, the Minister of Finance released a new set of “fiscal rules” (these have tended to be something of a moveable feast to say the least, but the 2022 ones are still in place). Under those “rules” (to be a real rule it has to lead to changes in behaviour not just changes in the rule), the aim was not just to get back to surplus (OBEGAL) but to maintain a surplus in the range of 0 to 2 per cent of GDP. To simplify things, we’ll focus on a midpoint of 1 per cent of GDP, each year.
Back then – less than 18 months ago, the big Covid spend now well behind the government – a surplus was thought to be close. In fact, in the HYEFU in December 2021, Treasury had projected a surplus of 0.5 per cent of GDP for this current fiscal year 2023/24 (by Budget 2022 that forecast had already slipped to a deficit of 0.6 per cent of GDP). So back then, not long ago, getting to surplus wasn’t some “end of forecast period [4 years away]” idyll, per the Labour Party’s current “Our Pathway Forward” document released a couple of weeks ago.
Treasury forecasts that GDP for the 23/24 year will be $417 billion. If we take the difference between the forecast deficit of 2.7 per cent of GDP and the 1 per cent of GDP surplus target, we get a $15.4 billion fiscal gap this year. Expenditure not sufficiently funded by revenue to be consistent with the fiscal goal the government itself had set.
People will talk a lot about Covid spending having been necessary, and I’m sure much of it was. But that was then and this is now (23/24 and beyond). The only justifiable reason for the Covid spend to still be influencing spending today is the servicing costs of the resulting debt – which themselves are much higher than they would have been if only the Reserve Bank MPC, with the imprimatur of the Minister and the Treasury, had not engaged in a massive liability swap, buying back long-dated debt and issuing huge volumes of new floating rate liabilities, right near the trough of a decades-long trend decline in long-term interest rates. And part of the reason we should aim to run surpluses in more-normal times is to counterbalance the inevitable deficits when really bad things happen (be they the Canterbury earthquakes or Covid).
One could produce lots of other estimates of “the gap”. For example, the residual cash deficit (number 2 on the PREFU “fiscal strategy indicators” bit of the tables) is way larger again. Or – as I talked of in earlier posts – we could play around with inflation adjustment. But whichever way you look at it there is a really large fiscal gap, which wasn’t foreseen even at the end of 2021, let alone pre-Covid
In the 2019 HYEFU, just prior to Covid, the forward projections had had a surplus for this year (23/24) of 1.5 per cent of GDP. Tax revenue as a share of GDP for 23/24 is higher in the recent PREFU forecasts than it was back in December 2019 (not surprising given the fiscal drag from inflation), so the gap is entirely down to additional spending. That’s a choice, by this government.
As the IMF, The Treasury, and every other serious analyst (including the ANZ just today) also recognise, the choice to widen out the prospective deficits a lot has also directly acted to work against the drive to lower inflation, putting more upward pressure on interest rates. (The Minister and RB Governor dispute this, but they must be considered motivated reasoners, and the Governor in particular has been slow walking the release of whatever (if any) analysis they might have to support his story. As one follower on Twitter noted, perhaps he and Willis have more in common than we had thought.) As I’ve documented, when we look across advanced countries, we now seem to have one of the larger deficits around. All this in a year in which the economy is expected to still be pretty much fully employed.
Ah, but the government would tell us, surpluses are coming. After all, Treasury said so. You only have to look at the PREFU tables and there in 2026/27 there is a very modest surplus.
But if we are talking about credibility of numbers, this really takes the prize for worst among the major political parties.
As I’ve pointed out previously, The Treasury has to do its forecasts on what the government tell them is its policies. There isn’t any real discretion. These are only Treasury’s best forecasts conditional on assuming the policies a government that is behind in the polls told them will be its policies in government for the next several years. You can’t really have Treasury doing unconditional forecasts, but PREFU numbers in particular for years beyond the current year really aren’t worth very much at all, because they can easily be, and have been, gamed.
Just before the numbers were finalised – no doubt knowing where they were heading – the government decided to indicate that future fiscal policy (almost entirely periods beyond the election) would be run materially tighter than they had previously indicated. This was a mix of cutting baselines for various departments, cancelling a few things immediately, and announcing that in out years the future budget operating allowances would be reduced. And, as if by magic, they took $4 billion out of total expected spending over the forecast period, without making even one specific commitment about things that wouldn’t be done etc in that future period. Going into a PREFU, the Minister of Finance can tell the Secretary any number he likes, and she has to use it. And this is not to suggest that the previously announced future operating allowances had been just fine either; after all, similar political imperatives had driven the government at Budget time, wanting to show a surplus (then) in 2025/26.
In the furore around National’s costings re the foreign buyer tax, we didn’t get to see any substance from the reviewers either. But being in government is a bit different. If Treasury had to do forecasts using what the government said was going to be its fiscal policy if it were to be re-elected, Treasury was free to provide its own interpretative or contextual comment. And it did.
We don’t have a very clear insight into just which cost pressures Treasury was referring to there. Some of it will be general inflation (prices and wages) from here, but some of it should presumably be stuff like the huge cut in real university funding that the government has imposed in the last couple of years, perhaps accidentally on account of inflation, but not remedied and probably not sustainable. Or the real wage cut they recently imposed on secondary teachers (even as private real wages are steady to rising) when recruitment and retention issues remain real, or a similar burden they seem to want to impose on senior doctors. Inflation can be a wonderful thing for government budgets in the short-term, but reality – market real wages, international competition etc – will eventually out. And as others have pointed out, none of these PREFU numbers capture things like the pressure for increased defence spending or the costs of big new projects like the new harbour crossing for Auckland that the government rushed out a few weeks ago.
On any fair assessment of the way this government operates, the current expenditure projections simply are not credible. And Treasury – the government’s professional advisers – know it (presumably some journalist will have thought to OIA any private fiscal analysis Treasury has given to the Minister in the last month or two). Cyclically-adjusted deficits do not heal themselves and nothing specific the current government has said or done has amounted to anything more in that direction than drawing a line on a graph and saying “that is our policy” (or would be if you were to re-elect us). What won’t be done, in such volume or quality or whatever. Ministers can’t or won’t tell us, and their own track record has actually been one of not delivering anything as low as the indicated future operating allowances.
These issues should swamp in substantive importance anything around one line item in National’s plan, which even if things are as bad as our model (and they could be worse if National did have to shift to a tax-residence base), is not much more than 0.1 per cent of GDP, slightly worsening a deficit that any new government will face of 2.7 per cent of GDP. It is the 2.7 per cent that really should be in focus.
But that is true as much for National as for Labour. And at the moment the signs are not encouraging. We are told to be a little patient and that the party’s “fiscal plan” will be released sometime before the first of us cast our ballots (little more than two weeks away). But nothing we have heard so far gives us much confidence that the party is any more serious about deficit reduction than Labour is.
The Back Pocket Boost package was their big tax and spending announcement. Luxon has been explicit that PREFU will change nothing about that package, so what else (material) is there? Perhaps this is unduly pessimistic but I wonder if we won’t see something a lot like Labour’s policy – vapourware commitments to surpluses years ahead, but nothing specific. In one sense National could be worse than Labour: not only is there the probable gap from the foreign buyers’ tax revenue, but National has already assumed a lot of whatever public sector fat can readily be cut is used to finance the promised tax cuts. That fat can’t be used again to cut the deficit. On the other hand, of course, National (and ACT more so) does seem genuinely exercised about bloat and excess in recent years, and you’d have to think they would be a bit better positioned (even just psychologically) to make the needed cuts, and personnel changes, than a bunch of ministers who delivered the spend-up in the first place. But those two influences probably largely net out and we are left with a big fiscal gap – that $15 billion one – and two parties neither of whom seem to have any real idea as to what they would do, sustainably, to actually deliver surpluses. Perhaps neither really cares very much. Which should go to their credibility with voters…..but probably won’t.
To end, just another chart for those – from whichever side – going “but Covid”. The chart is a variant of one I’ve shown before, but this time I’ve indexed net debt to a common starting point in 2019 for the median OECD country and for New Zealand (the latter using PREFU numbers for 23/24). (The scale here is percentage points of GDP: so an increase from 100 to 110 is an increase of 10 percentage points to net debt as a percentage of GDP.)
You can see the impact of Covid. In both the OECD grouping and in New Zealand the spending associated with the first big lockdowns made a big difference, boosting debt materially. Probably few argue with that very much. But what has happened since then? Net debt for the median OECD country (as a share of GDP) is now a bit lower than it was in 2019, reflecting some mix of inflation (unexpected inflation cuts nastily into the real value of nominal debt) and a prompt return to something near a balanced budget (not every country of course, but this is the median country).
But not in New Zealand where the government has made a conscious choice to increase core spending a lot further (even in the gamed PREFU core Crown spending as a share of GDP is now expected to be a bit higher than was projected for 24/25 even at Budget time), consciously choosing to run large deficits, which it now has no real idea how to close.
(Note that as I’ve shown previously the absolute level of NZ government net debt (share of GDP) is still below the OECD median- the chart above is about relative changes over that specific period – but that gap has been closing fast.)
One interviewer yesterday asked me to sum up the gap in National’s foreign buyers’ tax revenue estimates in one word. I could only manage three: “a bad gap”. That gap matters on its own terms, but the really bad gap – the one that should be getting a lot more attention from the media, and a lot more engagement from our political parties, is the $15 billion one that none of them seem interested in engaging honestly on how they really plan to close it. It is a huge gap. Having brought it about reflects very poorly on Labour (or should) but the apparent indifference to the grim outlook for the next few years reflects very poorly on the credibility of both our main parties, notably he who is now Minister of Finance, and she who would take the job just a few weeks from now.
I should perhaps add that while Matthew Hooton’s column today makes some useful points in a similar vein, his prophecies of impending doom, parallels with 1990 etc, really don’t stack up exposed to any very much scrutiny. Our situation now is grim but much less dramatic. More perhaps on a par with the resigned in difference of both parties to house prices (is anyone talking getting them durably lower?) or productivity (does either party have any serious ideas that might drive productivity growth sustainably much higher?). Does either party really care?
Fiscal credibility was once a thing in New Zealand. Both main parties seemed proud of it, even if at times the constraints tied their hands. These days, the two parties – led by Labour, now apparently followed by National – seem to have together shredded what was left of it.
My wife and I are heading off tomorrow for a spring holiday so most likely there will be no more posts here until the middle of the week after next.
