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Sludge Report #194 - Bill's Magic Deficit Elimination Budget

Sludge Report #194

Now You See It - Now You Don't!
Bill English's Magic Deficit Elimination Budget

Scoop Audio + Photos
Budget Lockup Report - 2011 NZ Government Budget

By Alastair Thompson

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Finance Minister Bill English presents his 3rd Budget to a Beehive lockup of media and analysts See more images below

Now You See It - Now You Don't!

This year (the year ending next month) the NZ Government will borrow a cool net $20 billion. But next year it plans to borrow a net $5.9 billion (albeit a gross $13.5 billion the majority of which will be used to re-finance existing debt).

This seems on its face remarkable, and is certainly news to warm the hearts of the hard nosed credit ratings gnomes upon whose judgment we will collectively wait following this year's budget. (At the time of publishing the demand for NZ bonds had increased as a result of the budget and Standard and Poors had announced no change to NZ's rating.)

To use the figure which Dr Brash (and formerly Bill English) is so fond of referring to - and which we will no doubt hear a great deal over coming days - the borrowing requirements of the Government are forecast to fall from $380 million a week to just $113 million a week.

Next year the fiscal deficit is expected to fall from close to 9% of GDP to under 5%.

And in a year in which we are expecting relatively modest growth of just 1.8%.

So where will this remarkable turnaround in our economic fortunes and borrowing needs come from?

It turns out not everything is precisely as it seems.

A 2% Tax Rise With No Fiscal Impact

Ironically the biggest single change in this year's budget - the change to employer and employee contributions to Kiwisaver - will have no impact on the fiscal position at all, though it will have a big impact on personal and business incomes.

When Kiwisaver was first introduced by Labour in 2007 it was intended that employer contributions would gradually rise to 4% by 2011, increasing at 1% a year. In 2009 when the rate had reached 2% that increase was stalled as the Government cut its contributions back from 4% to 2%. While not everybody noticed at the same time they also cut the minimum employee contribution back to 2%.

Now in 2011 both employer and employee minium contribution rates are being increased by 1% to 3%.

Practically speaking this means a 2% increase in the deductions from gross employee earnings for a large part of the workforce - albeit with 1% coming on the employer side.

In gross dollar terms the numbers involved are very large in comparison with most other initiatives in this budget and collectively amount to a $2.6 billion rise in payments from the private sector to Kiwisaver of the four year period.

And Borrowing Which Is Not (Strictly) Required

The borrowing which is not strictly required in the 2011 fiscal year (the one we are in now with the huge deficit) is of two sorts.

Firstly there is the borrowing to fund the Christchurch rebuild. The government has elected to borrow all the funds for this up front and to set up a $5.5 billion fund with this money. It has chosen to do so and effectively take the full fiscal hit on Christchurch in the current financial year as borrowing conditions for New Zealand sovereign debt are currently very favourable. I.E. people are queuing up to buy Kiwi bonds now at nice low yields.

The second set of borrowing which is not strictly required is pre-funding. This means that the Debt Management Office has been getting ahead of itself in general. Borrowing money in advance of when it is needed. From the look of things roughly $3 billion will be borrowed this financial year in advance of when it is needed. Again this is happening because of favourable borrowing conditions.

Together the pre-funding of future deficits and full funding for the Christchurch rebuild amount to around $7-8 billion of this years borrowing - a little over a third.

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This Is Not A Black Budget

The headline writers for this budget were expecting a black budget - albeit one for an election year - which would inevitably soften any sharp edges significantly.

In fact today's budget is far from black budget, at most it is a fairly light shade of grey.

Core crown expenses are not being cut and are in fact forecast to rise from $72.8 billion to $73 billion in the coming year. According to the forecast spending will then fall back to $72.6 billion in 2013 before rising again in 2014.

The changes which have been widely flagged to Working for Families and Student Loans and Kiwisaver have all turned out in fiscal terms to be fairly trivial (though the Kiwisaver ones are significant in $ terms in relation to personal savings levels).

Consequently changes to household incomes as a result of these policy changes will be relatively modest - especially when considered against the impact on other things which are affecting kiwi battler financial well-being like food inflation, rent rises and transport costs.

Changes to interest free student loans are mainly around eligibility - notably there is no interest element being added.

Kiwisaver changes net the government the biggest fiscal positive with a reduction of close to half a billion in the next financial year.

Working for Families is being cut - but only mildly - and it is also being rebalanced in favour of the more needy. Three quarters of recipients will get more and a very small number will find themselves ineligible. The overall savings from the changes rise fairly slowly to $200 million a year over the forecast period.

The main change to WFF is being made by way of an increase to the abatement rate from 20% to 25% which will have the effect of lessening the incentive to earn more - i.e. rising the effective marginal tax rate for recipients to 58%.

Public Service Gets A Year's Reprieve

So what of the expected public service razor gangs?

In substance Wellington's public servants have been given a stay of execution for another year. The razor gangs are being let loose, but only to have a jolly good think about how to cut budgets dramatically for the next financial year - beginning 1 July 2012. From then on life can be expected to again get very tough for public servants in Wellington.

As we have become accustomed to - there is a fairly large amount of "re-prioritisation" in the coming year - but less actual cuts than many expected.

But come budget 2012 the axe will be poised to fall and departments are going to be expected to do a very efficient job of cutting their own cloth.

This year in terms of social services health and education expenditure will actually grow more than they grew over the past year.

Vote Health is actually forecast to rise $483 million vs a $115 million decline this past year. And Education funding while still very tight will rise $248 million next year vs $178 million this year.

And when you net all this out the Government is actually planning to increase its spending by $396 million in the coming financial year. The overall new expenditure announced in the budget of $1096 million actually compares very favourably with new initiative spending in previous years.

Which begs the question where is the dramatic turnaround in our fiscal fortunes going to come from?

The answer is five sources.

As already mentioned a large chunk of the massive deficit we are incurring this year is prefunding (borrowing in advance of the funds being needed), assuming there are no more earthquakes this will be a one off.

The remainder is coming from reduced public service spending, asset sales and most important of all a forecast strongly increasing tax take (driven by projected growth).

Jam Today, Bread and Water Tomorrow

While the current budget is not full of cuts - if this Government is re-elected then future budgets will be. This is being very clearly signaled in this budget.

From 1 July 2012 Government departments will be forced to fund their pension requirements internally (something which the budget says will save $650 million a year).

In addition they will be expected to find another $330 million in efficiency savings over four years presumably from things like not printing so many copies of the budget and hiring fewer HR and PR consultants.

Come tomorrow all new prospective public servants should expect to find the generosity of any pension scheme offers they receive to be dramatically reduced.

We can expect some considerable industrial unrest to be generated by this change - and when it comes to balancing the budget in the funding streams for Judge, MP and Ministerial salaries we can expect a fair bit of hair pulling in high places. Gold plated schemes such as these will take some paying for.

And as the axe falls over the coming 12 months public service support industries like printing, IT consultancies, PR and HR firms and such like can expect the pain they have already been experiencing to deepen.

And overall the Public Service bread and water for the next four years prescription (albeit delayed by a year in its introduction) will be responsible roughly half of the $10 billion in borrowing that the Government is no longer expecting to have to do.

State Asset Sales

The second big contributor to the turning around of the books will come from the sale of stakes in the four baby SOE electricity companies, and from a sell down in Air New Zealand.

This is expected to raise $5-7 billion over five years and like the public service funding cuts - will be conditional on this Government winning the coming election and having support parties willing to go along with its plan.

At this stage both the ACT party and the Maori Party have indicated some willingness to do so.

When describing the asset sales plan to the budget lockup Finance Minister Bill English stressed that he expected Kiwisaver funds, the NZSF (the Cullen Fund) and other Government pension funds would all be key investors in the assets as well as Kiwi mums and dads.

Tax Outcomes Expected To Improve

Finally - and arguably most important of all - we have forecasts of a steadily increasing tax take which pave the fiscal position's road back into the black.

The positive projected fiscal outcomes (net Govt. debt peaking at just under 30% of GDP) are strongly dependent on this annualised compounding growth of close to 10% per annum in tax take occurring.

For it to do so we will need the economic malaise we have been in since 2008 to end. Arguably there are signs that this is happening - and the Government continues to talk up the part it expects to be played by the Rugby World Cup and the $16 billion Christchurch rebuild.

While the substantially worse than forecast economic performance over the past five months has seen tax take forecasts fall since December - the drops are not as dramatic as we might have expected.

The total tax take for the current year is now forecast to be $51.2 billion (down $1.3 billion on forecast in December).

In the coming financial year Treasury expects this to grow to $55.2 billion, rising further to $59.9 billion in 2013 and $64 billion in 2014.

All things being equal the Government is therefore counting on the economy returning to a growth path by the end of calendar 2011 and continuing to grow through the forecast period.

Plus of course no more earthquakes (touch wood).

A Budget For The Electorate To Digest

In summary then we have a budget which paints a far rosier picture of NZ's future than we had been primed to expect.

Doomy and gloomy this budget is not. It has some credibility issues in places but it is clearly intended to be electorally palatable and that is where it will be judged.

While all governments tend to write election year budgets with the intention of getting themselves elected this government has written one with the intention of getting a mandate.

The prescription in the out years starting from 1 July 2012 is pretty harsh. Three years of spending cuts plus asset sales the proceeds of which will be largely used to fund road building.

The obvious fiscal alternative which might be offered by the opposition will be to suggest funding either or both of the $5 billion holes via tax rises for corporate and high income earners. It is unlikely that all $10 billion could be found via this source however.

Alternately the opposition might suggest a longer period of deficits than is currently envisaged accompanied by a tax increase.

Either way the decision on whether to implement most of this budget will not be taken by the current Parliament.

We therefore have some thinking time.

And during that period of thinking we would be well advised to collectively consider the role to be played by restoring the economy to a growth footing. Without this all the fiscal forecasts in this relatively rosy budget will get busted to pieces.

The budget documentation contains some fairly detailed economic analysis suggesting that we lost our way financially in 2004. This bears some deeper analysis and consideration. However that will have to wait till next week.

  • Scoop Image:More images from today's budget lockup

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Finance Minister Bill English

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Finance Minister Bill English, Treasury Secretary John Whitehead, Telecommunications and Transport Minister Steven Joyce and Justice Minister Simon Power

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Finance Minister Bill English

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TVNZ Political Editor Guyon Espiner

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NZ Herald's Fran O'Sullivan

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Kiwiblog's David Farrar

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BusinessDesk's Jonathan Underhill, Pattrick Smellie and Paul McBeth

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Finance Minister Bill English faces the cameras

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Analysts and media pour over the budget documents



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