Scanning the Far Horizon: Treasury's Fiscal Outlook

Last month the Treasury released a report on New Zealand’s long-term fiscal position, looking out to around the middle of this century.

This is the first such four-yearly report required under the Public Finance Act 2004. Australia and numerous other countries have attempted similar long-term fiscal assessments.

As predictions these would be heroic enterprises. Much of what will happen in the future is unknowable. The mechanistic projections in Treasury’s charts suggest relatively smooth trends. Reality may be quite different, as the economy is impacted by unexpected events and policy changes. This calls attention to the need for prudent planning and economic flexibility.

Nevertheless, the Treasury does a professional job of projecting plausible trends in major spending categories and taxes, based on assumptions about the size and structure of the population and the economy and government policy settings.

Its demographic assumptions are for population ageing with increasing life expectancy and lower fertility rates.

These are largely beneficial trends, and not a crisis. Moreover, attempts to engineer population changes, for example through immigration, would have limited impact.

Interestingly, Treasury implicitly casts doubt on the widespread notion of a marked ‘browning’ of the New Zealand population in the future. It notes that “convergence between Maori and Pakeha is continuing in many aspects of life”. This is likely to include fertility in due course.

The document suggests that with population ageing, spending on New Zealand Superannuation (NZS) and health is likely to rise relative to GDP, particularly from the 2030s. Spending on welfare and education is likely to fall, but not by as much.

So fiscal pressures will increase, but slowly and against a background of a fiscal position which is strong by both historical and international standards.

And Treasury emphasises that the largest single driver of the fiscal position is the policy choices governments make. Even relatively minor changes in such things as the indexation of superannuation benefits can have large cumulative effects.

What may be under-emphasised by the Treasury is the influence of economic performance and productivity on the fiscal choices governments will face and on living standards generally.

Treasury assumes that trend labour productivity growth will be 1.5% a year, which means that real incomes will have more than doubled by mid-century.

This should mean less need for state welfare support by then, just as the much higher average incomes today should mean less need for welfare than when it was expanded in the 1930s.

But such modest labour productivity growth also means per capita income growth in New Zealand is unlikely to be consistent with the government’s stated goal of getting New Zealand back into the high income league. Indeed, given that Australia and many other countries are likely to grow faster, New Zealand could fall further in the rankings.

This prompts two final reflections.

First, the report discusses New Zealand largely in isolation from possible developments in the rest of the world, yet these could have very marked implications.

For example, if an increasing income gap between New Zealand and Australia (and other countries) materialised, it is not implausible to suggest that New Zealand could experience a net outflow of population, as Ireland did for many decades. Many developed countries will be seeking skilled and enterprising workers as their populations age.

Secondly, it is perhaps unfortunate in a document aimed at advancing public understanding and debate that Treasury did not say more about the proper role of government.

In respect of the government’s role in retirement income, it rightly noted that a greater focus on NZS as a safety net and increases in the eligibility age could go far to reduce future fiscal costs. However, a similar discussion of the government’s role in health would raise issues such as the case for greater resort to user charges to discover the value placed on health services, the role of private insurance, and the potential for more efficient provision by the private sector.

It is likely that people will want to spend relatively more on health care as incomes rise, but it doesn’t follow that this should all be done by the government.

Debates on issues such as the mediocre growth outlook and the proper role of the government in the funding and provision of services are better held sooner rather than later if New Zealand is to realise its potential.

Ends

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