Finance Minister On Eve Of Budget Policy Statement
Chen & Palmer Government & Business Series
Board Room, Level 6 NGC House
6.00pm Tuesday 7 March 2000
Hon Dr Michael
Minister of Finance
Minister of Revenue
Speech to Chen & Palmer Government & Business Seminar Series.
I am releasing the 2000 Budget Policy Statement tomorrow, and while I cannot give you any indication of the numbers it contains, it might be useful if I reflected on its role in the Budgetary scheme of things and sketched out the policy principles that have guided me in developing it.
The BPS is a reasonably new addition to our fiscal reporting armoury. It is sometimes seen as Ruth Richardson's parting gift to the nation. I am sure Ruth sees it that way. There are a wide range of views about its motivation and its usefulness.
At one end of the spectrum is the belief that it is an anti-democratic right-wing conspiracy. The argument holds that having lost the battle against MMP, the right enlisted the finance markets to frustrate the expression of popular democratic will: any attempt to extract money to meet levels of social support that the markets find uncomfortable will be met with countervailing retaliation in the form of higher interest rates or a reduction in the value of the currency.
Next along the spectrum is the view that sees the BPS as a rather pointless exercise. It has a focus on broad long-term fiscal goals and specific intentions over the next three years. Implicit in the BPS is some notion that it can bind future Parliaments, which of course it cannot. For example, the last government factored tax cuts into its medium term projection of revenue: this government reversed them. The so-called certainty is an illusion.
In the middle of the range, commentators see the BPS as a useful indicator of financial intentions: a top-down Budget that sets some general guidelines and imposes the financial constraints under which bottom-up bids for money will be evaluated.
Enthusiasts rate the BPS as the key element of sound public finances. Even here, though, there is some ambivalence about the audience. Does the BPS pacify financial markets and make the government's job of financing and re-financing its debt easier? Or is the audience an internal one: arming finance ministers with the wherewithal to fight back against any emerging collective Cabinet claims for too much money?
I tend to locate myself in the middle of the spectrum, with some qualifications about the way the BPS has been presented to date.
It is useful to set the financial parameters within which the government's policy programme will be conducted. This does act as a discipline on spending. There is value is having to define longer term goals. Budgeting is more efficient if the line by line bids for money have to be reconciled with a top-down financial allocation.
There have, however, been some weakness in the way the BPS has been presented and used in the past.
Firstly, I think that the BPS has had an excessively financial market orientation in terms of the way much of the information in it is presented. If we are going to get more of a public consensus around the exercise of democratic discretion inside framework of responsible fiscal management then there needs to be much more buy-in to the basic message that the BPS is sending. The BPS has to be interesting to and relevant to wider user groups than bond dealers.
Take the issue of public debt. Intuitively, New Zealanders don't like debt, so less debt is better than more debt. But logically they know that there are times when debt is good - like using a mortgage to buy a house and avoid a lifetime of paying rent.
When the BPS sets debt goals and debt reporting in terms of gross and net public debt as a percent of GDP it simply makes no connection with the public perception of what debt is necessary, sensible and affordable.
I have no great aversion to reporting on debt/GDP ratios. But I also want to be able to express debt in common sense terms.
How big is debt in relation to the government's income?
How much of our annual revenue is spent paying the interest on the debt?
How big is debt compared with levels at different periods of our recent past?
How do we compare with other countries like Australia, or smaller developed European countries that have similar economies to our own?
Do we have any foreign government debt ?
When does the debt mature and need refinancing? There was a time in the early 1980s when a big chunk of debt matured in one year - we were very exposed to prevailing interest rates at that time. Have things changed?
The financial analysts will scoff at this because all of that information is on the public record. But it is not in the public arena, and it is not easy to assemble and access. Financial reporting can be more relevant and (dare I say it) less elitist and more democratic.
My second concern is spurious degrees of precision.
One of the purposes of the BPS is to give greater certainty about future tax rates. An image of certainty is created when revenue yields are projected out into the next three years down to the last million dollars. These are misleadingly precise. No government can forecast its revenue in three or four years time down to the last million dollars. So why pretend we can?
But more specifically, having created an illusion of precise management and of being in control, the practice has been to manage taxes with a great deal of instability and uncertainty.
Over the last five years, when surpluses appeared reasonably strong, the practice was to cut taxes. When the surpluses appeared weaker than forecast, the practice was to put up charges, or cut superannuation. This was fiscal policy by the rear view mirror - not certainty and stability. The challenge of the BPS is to look forward and make prudent decisions on the basis of reasonable expectations. We haven't had that, but have done a smoke and mirrors cover up of it by creating impressions of fiscal exactitude.
This leads on to an undesirable practice that has emerged with fiscal management. The practice of cutting taxes on the upswing of an economic cycle and cutting benefits on the downswing has been pro-cyclical. It has amplified the cyclical movement and is a contributory factor in our deterioration in the international rankings on measures of output variability.
I would like to be able to show less of a pro-cyclical stance in future BPSs, but at this stage I think it is too early to expect miracles. There are problems. One is the lag between when an economy grows (or slows) and when revenue and spending surge or abate. Obviously, company taxes adjust with a lag, but other elements of the revenue and spending mix have this delayed reaction as well. Employment and even consumer spending tend to follow rather than accompany changes in economic conditions.
This again comes back to presentation and clarification. If the government is going to lean against the cycle to smooth it out and avoid costly interventions and corrections, we will have to think about presenting the data in more transparent form and with more clarification about fiscal management intention. The present style is sterile, perhaps reflecting the disconnection between fiscal stance and economic performance. That was an inevitable result of a government philosophy that drew back from responsibility for wider economic activism.
It is one thing to talk about being less pro-cyclical; another to convert that into new targets through a BPS. Tick that off as a work in progress at this stage.
As a general principle, the government defines long term goals in broad terms and expresses medium term projections in precise terms. There are two parts to this equation that seem to be missing. The first is the lack of any link between medium term financial provisioning and longer term emerging liabilities. This is particularly acute as far as the impact of a changing demographic structure is concerned.
The second is a lack of any recognition of what I would call deferred maintenance.
Let me deal with each of them.
The demographic profile of the country is largely set. It can change with changing inward and outward migration. But that said, we have to face an increase in the costs of New Zealand superannuation as the proportion of over 65s rises. It is a known and emerging fiscal cost, not just a fiscal risk.
We can put our heads in the sand. The problem is that there are no viable options for dealing with the cost bulge if we simply wait until it happens.
I rule out an increase in the average tax rate sufficient to fund it. That will simply drive the economically mobile to seek a lower tax country to work in. I rule out cutting the level of NZS when there are more claimants. That is highly inequitable as between the generations. It also undermines confidence and personal security and can send perverse signals on saving to augment universal entitlements. I rule out economic growth as a solution. Growth usually means higher wages and because NZS is linked to the average wage it means higher NZS. Stronger per capita growth makes for more comfortable retirement, not a smaller number of retired New Zealanders.
The most practical solution is to save for a rainy day: to put some money away now, earning interest, to pay for the known increase in costs associated with an ageing population. I must stress that discussions with other political parties are at an early stage. No decisions have been taken. The form and level of any pre-funding arrangement is negotiable. I do want to signal, though, that by taking a longer than traditional view, the government signs up to a much more substantial commitment to sound public finances.
This level of realism cuts both ways. Providing for costs that are going to emerge in ten, twenty and thirty years is not so much an investment in the retirement of my age group as it is an investment in securing affordable tax burdens for my children's age group. But the flip side of that is that we must not run down the capital resources that the present working age population have at their disposal.
There has been underinvestment in public sector facilities across all fields of government activity. It is not possible to run a modern high tech economy on a creaking 1970s infrastructure. It is not possible to sustain high rates of growth of productivity unless private production interfaces with an effective infrastructural network.
Current rates of public sector capital investment are too low. The present, as well as the future, must be provided for.
I am not going to comment on the specific details of the 2000 Budget. The BPS sets out the framework, it does not fill in the detail. Most of the detail work has yet to be done.
I do, though, want to comment on one aspect of what might be called policy detail that goes beyond merely sketching out the financial parameters of the next Budget. I need to do this to correct a misapprehension about government attitudes.
In the latest Quarterly Economic Forecasts put out by the National Bank, the editors state that "Rhetoric from the Beehive that the current account and poor savings record is a private sector problem is pure bunkum". I am not sure what is being referred to here, but let me make it quite clear that nothing coming out of suite 7.4 in the Beehive can in any way imply that the government does not see the external imbalance as anything but a top priority national problem requiring urgent and sustained government attention.
The 'deficit is a private sector problem" outlook is pure market ideological extremism. It was associated with some previous occupants of the Beehive, not the current occupants.
I do not want to open up the issue of options for dealing with the current account deficit, but readily accept that it is a topic on which I need to stimulate debate. I hope to do so soon.
For the purpose of this presentation let me make two points. The government does accept that in the absence of sustainable levels of savings in the private sector, the government should not reduce its own level of saving. However, merely running surpluses, or indeed raising surpluses, is not a sufficient response to the external imbalance. A wider range of initiatives, focussed on the tradeable part of the economy, and on private sector savings and investment, is also needed.
This leads me in to the sorts of economic results that our economy, as currently structured, is generating. The BPS contains economic forecasts that the Treasury produces. These underpin the forecasts of revenue and such like. Those forecasts are simply Treasury's best guess about how internal and external influences will impact on the economy as currently configured.
The forecasts are not government goals. They do not reflect any government comfort with a particular pattern of economic development. Indeed, I have made it clear that I do not think the general alignment of the economy will deliver the sorts of results that we can regard as suitable.
So there is an irony in the BPS. I will release economic forecasts that I will immediately seek to subvert! - in the most benign way, you will understand.
Tomorrow's BPS is unique. The Fiscal Responsibility Act came into effect in June 1994. All BPSs produced so far have been produced under conditions where government policies, and the fiscal implications of those policies, were "settled".
Even in 1997, the BPS could work off agreed tax and spending change sequences and limits that were formally agreed as part of the 1996 Coalition Agreement.
Under these circumstances, the statements could work off agreed changes to "baseline" fiscal projections. Such changes were usually limited in number and reasonably easy to measure in fiscal terms.
The 2000 BPS is the first to be produced under circumstances where the set of government policies, priorities and programmes has yet to be finalised.
The BPS focusses more on the constraints under which those programmes will operate than on projecting the costs of each element in those programmes.
In some important areas, like the provision for meeting the costs of an ageing population, and on capital spending requirements, policy has not been finalised. Because of that the forecasts have had to use technical provisions.
This means that the BPS will have to be analysed with fresh eyes and fresh attitudes if its import is to be distilled accurately.
I have said repeatedly that the government will operate in a financially prudent and responsible way. It will not build into baseline programmes revenues that are flowing out of a temporary upswing in the business cycle. But equally it does not have a doctrinaire view that smaller - or for that matter bigger - government is always better.
We need a government of the size that meets reasonable public expectations of service and support and one that we can afford, and a revenue base that pays for it in a sustainable way without putting unacceptable pressure on current or future taxpayers. The quality of spending is as important as the quantity. The style of government - its responsiveness, and its commitment to values of service - is a part of overall quality.
Only some of this is reflected in a Budget Policy Statement. So don't expect the BPS to deliver the final word on the course this government intends to take, but do expect it to put some pretty significant signposts in the ground.
After all, this is where I came in. When it comes to the BPS, I am in the middle of the spectrum on what it should be expected to deliver!