The choice will come, and it will be simple; raise taxes or cut spending or do a bit of both.
Sooner or later, a future New Zealand Government will have to decide how to pay the bill for Covid. .
That bill and options on how it might be paid have been set out in a detailed Treasury document, He Tirohanga Mokopuna 2021 (Long Term Fiscal Statement) presented to the Government 10 days ago.
Treasury Secretary Caralee McLiesh will not say how much time the Government (or its successors) have, but the implication within the document is clear; the sooner they start, the less the adjustment will have to be. She told POLITIK it was time to look at the options.
“The trajectory is steep and will require action,” she said.
“But we’re not saying that it’s at one point or a later point in the future.
“We think that these are issues that need to be considered now. “
Simply, the cause of the problem is the extra amount that has been borrowed over the past 18 months to fund the Government’s various COVID initiatives, such as the wage subsidy.
An ageing population and the costs of climate change either through adverse weather events or mitigation add to the fiscal burden facing future Governments.
Delaying too long could pitch a future Government back into the fiscal panic mode that the National Government got into in 1990-91 and which led to the infamous “Mother of All Budgets”.\
The language in the document is stark.
“While we do not know exactly how large a policy adjustment will be necessary for stable, prudent debt in the long term, the scale of the long term fiscal challenges will make a significant adjustment necessary,” it says.
“New Zealand needs to start thinking about these changes now. Small and gradual changes in the nearer term would help to minimize the cost of fiscal pressures across generations, preventing higher debt and a larger adjustment in the future.”
The scale of the challenge is easily seen when it is remembered that the 2019 Budget forecast net debt as a percentage of GDP to be 18.7 per cent in 2023 but that now, as a consequence of the COVID borrowing, that will have nearly tripled to 48 per cent.
To put that in perspective, net debt, as reported in Treasury’s Briefing to the Incoming Government in 1990, was at 51.7 per cent.
That led directly to the December 1990 mini-Budget with its benefit cuts, prescription charges and income-related rents for state housing.
So acting now or very soon might avoid a repeat of 1990.
“When we look at debt, changing demographics, climate change, rising service expectations, future shocks, then we think the trajectory of debt is unsustainable,” McLiesh said.
“And so that’s really what the report is trying to point out – that distinction between the level and the trajectory; to change the trajectory of debt.
“There are a range of different options for Government to consider.
“There’s no one single strategy that will reduce expenditure growth to sustainable levels.
“And so there are a range of choices that Governments could make.
“We do point out that smaller and more gradual changes may be beneficial to avoid large scale shocks further down the track.
“But the key point here really is that there are choices and tradeoffs, and no one single strategy can be followed.”
However, all of the options presented in the report will present political challenges to one side of politics or the other.
Raising income tax by one per cent by 2025 and not adjusting for fiscal drag would generate enough tax to keep the Budget in surplus up till 2035.
To achieve the same effect but to raise GST rather than income tax would require a 1.5 per cent increase in the rate, or as another alternative, company tax would need to rise by six per cent to equal a one per cent income tax rise.
Otherwise, the Government could introduce new taxes such as capital gains or wealth tax.
ROBERTSON’S NUMBERS VERSUS TREASURY’S NUMBERS
The other big option is to start cutting spending, and here the Long Term Fiscal Statement (LTFS) reveals an intriguing difference between the Statement and this year’s Budget Economic and Fiscal Update, which points to the political difference between the Minister of Finance and the Treasury.
The Budget is the Minister’s document.
The Budget projections show net debt falling steadily to reach 28 per cent of GDP in 15 years (2036), while the LTFS shows the debt peaking then at between 48 and 49 per cent of GDP.
Treasury’s projections are based on historical trends. The Budget projections are based on what the Minister projects his Government’s policies to produce.
And what he is assuming is that the Government will be able to restrain expenditure.
“The Budget projections assume that the majority of government expenditure will be constrained by an annual allowance,” the Statement says.
“In the Budget projections, only New Zealand Superannuation and indexed welfare expenditure is assumed to grow as the economy and population grow over time, and interest costs grow as a function of debt levels and interest rates.
“All other growth in operating expenditure – including health, education, and most other government services – is assumed to be met from within an operating allowance which begins at $2.0 billion in Budget 2025 in the central projection, growing at 2 per cent per annum thereafter,” it says.
In other words, Finance Minister Grant Robertson has assumed that future government expenditure will have a real growth rate of zero, assuming that we have an annual inflation rate of two per cent.
The Long Term Fiscal Statement suggests this may not be realistic because the big government expenditure item, health, faces pressures that go beyond inflation. For a start, as a society, we are getting older.
CUTTING HEALTH SPENDING
“There’s no doubt that the underlying drivers of health expenditure growth, the demographics, the rising expectations, wages, those are going to continue to be real challenges for the health system in any form to manage,” said McLiesh.
“Thehealth reforms will encourage greater accountability around funding and performance, and over time that should alleviate some of the pressures in the system.”
But by themselves, they won’t be enough.
“I think with health, and indeed with all aspects of expenditure that we’re looking at in the report, it’s less about making dramatic cuts and more about managing the trajectory of growth,” she said.
Health expenditure New Zealand is no exception.
“Around the world, certainly in advanced economies, health expenditure is facing really large pressures from that aging and growing population, from a rising expectations of care.
“As we become richer, we tend to expect better services and also from new technologies, which can sometimes reduce costs, but very often increase them and again, lead to higher demand.
“So they’re just growing pressures on health expenditure, and it’s a question about how to reduce that growth rather than make significant cuts.
“The LTFS does point to a range of strategies that can help to bend that cost curve.
“There are several strategies that are being pursued through the current health reforms; the various measures to improve efficiency, looking at different types of centralisation of health services.
“That’s very much part of the current reforms; better coordination of consistency and care; better balance between prevention and acute care, or primary and acute care.
“So there are a range of strategies; that’s not to say that it’s easy, but there are certainly options and choices for governments to make.”
CUTTING NZ SUPER — INCREASE THE AGE OR DECREASE THE PAYOUT
But ageing does not only affect health; superannuation becomes a bigger cost as the average of the population grows increasingly older over the next 30 years.
New Zealand Superannuation (NZS) expenditure is projected to grow from 5.0 per cent of GDP in 2020/21 to 7.7 per cent of GDP by 2060/61 as a result of demographic change. The LTFS says the NZ Super Fund smooths this increase but does not fully fund it.
Therefore Treasury presents two options to try to control the expenditure rise. Under one scenario, the age of eligibility could rise by six months every year from 2025 until it got to 67 by 2030. That would cut the cost of super by 0.7 per cent of GDP.
The other more brutal option would be to increase it by only the rate of inflation every year rather than the rise in average wages. Currently, super is 66 per cent of the average wage, but under this scenario, it would fall to less than 50 per cent in the 2050s. But it would cut the share of GDP by a substantial 2.3 per cent.
Ironically, older people are already getting wealthier, not just from New Zealand Super but also the rise in house prices.
Between 2001 and 2018, total wealth increased, and older people gained relatively more than younger people.
In particular, the number of people aged 65 and older in the top wealth quintile has increased from around 30 per cent to about 50 per cent.
The LTFS says this will have had multiple causes, including changing aspects of the housing market over time (including house prices and interest rates) and capital gains accruing to certain cohorts.
And also ironically, COVID may have exacerbated that trend.
MONETARY POLICY OR FISCAL POLICY?
In March 2020, the Reserve Bank dropped the official Cash Rate from 1.0 per cent to point 2.5 per cent and began the “printing” of $53 billion to fund bank bonds in a bid to stave off a COVID-induced recession.
The lower mortgage interest rates this induced saw residential mortgage lending shoot up from $5.4 billion a month in August 2019 to $8.2 billion last August. That house buying boom has seen median prices rise by 25.5 per cent between August 2020 and August 2021, according to Real Estate Institute of New Zealand statistics.
But, interestingly, McLiesh believes it was the Government’s $12.1 billion of additional fiscal spending which had the greater effect in avoiding a COVID recession.
“One of the big lessons is really just about how effective fiscal policy can be in a short term response,” McLiesh said.
“Very often, economists will say that monetary policy has a key role in short term stabilisation, and fiscal policy should really look through to the longer term and focus on longer-term growth and productivity and that automatic stabilizers help to manage through economic cycles.
“What we’ve seen is that through measures like the wage subsidy and the resurgence support payment, that very swift and targeted support can play a critical role in short term stabilisation in the face of large, large shocks.
“So I think COVID has really reinforced that lesson on the effectiveness of fiscal policy.”
But, of course, a fiscal response has to be paid for, one way or another, by taxpayers.
And that is where the political debate will move when the immediate crisis is over.
