But on Monday evening I was sent some analysis of the fiscal outlook prepared by a group of former senior Treasury officials, who were keen that I should give it some coverage. They are keen to retain anonymity, but I know all those involved, and have a considerable regard for most of them. Most, in my observation, would also seem considerably more likely to vote for ACT than for, say, Labour or parties to its left. But what they sent me wasn’t particularly value-laden; it was an attempt at a technocratic assessment of some of the basic pressures on government finances over the next few years.
I’m not going to swamp you with numbers And trying to unpick and explain here the differences between core Crown and total Crown expense items, and which is relevant where, is sure to have your eyes glaze over, and (frankly) on a couple of points I couldn’t get clear answers myself.
But their main point is a simple one. Budget projections of government tax revenue, including the PREFU ones that both Labour and National are relying on, include the effects of forecast wage and price inflation, and forecasts of a rising population. On the other hand, most line items for government expenditure, as presented in the PREFU, do not do so.
But things governments purchase, and people governments employ, will become more expensive over time (that’s inflation). And a rising population will also, over time and all else equal, require more public employees – perhaps no more Treasury officials, but certainly more nurses and teachers, police and perhaps even Corrections officers. Given the outlook for inflation and population growth, those cost pressures are largely inescapable – at least without specific decisions to cut real per capita spending in some or other areas. (When I say “inescapable”, of course governments can change inflation and non-citizen immigration targets, but given the targets they choose, there are future – largely inevitable or inescapable – spending consequences.
In fact, the PREFU documents would be much more useful – as I noted a couple of weeks ago, picking up a comment on an earlier post – if they included some analytical tables showing expenditure numbers that adjusted for these all-but-inescapable inflation and population pressures. If political parties presented their alternative plans relative to that sort of baseline we would all be much better off.
Instead, at present, we are given a table like this (or its total Crown equivalent)
In this table, some specific line items show considerable increases over the four year period. In particular, where there is a statutory requirement to make expenditures in a particular way, explicit allowance is made in the PREFU line item numbers. New Zealand Superannuation expenditure for example – eligibility and formula in statute – is explicitly shown as increasing from $13043 million in 2016/17 to $16085 million in 2020/21 (included in the first line above).
But most government spending isn’t like that. It is simply subject to appropriations after each year’s budget, and each government agency must make an explicit bid for any new spending, even that which (in effect) simply results from inflation or population increases. So those – largely inescapable – prospective spending increases aren’t identified in specific line items in the table above. Instead, it is all lumped together in the line labelled “Forecast new operating spending”, which – in PREFU – captures the cumulative total of the annual “operating allowances” the current government has identified for the next few years (cumulative because the decision to spend $1000 million extra next year, and another $1000 million extra the following year means that in the second year, total spending would be $2000 million higher than what has been appropriated this year).
In other words, that new operating spending line can deceive. From a Treasury budget management perspective it is all new money available to spend – you don’t want government departments counting on what ministers and Parliament haven’t approved. From a bigger picture perspective though it is a mix of money available for genuinely new initiatives, and money that will end up having to be spent to keep up with wage and price inflation and population. Quite how much governments want to have available for genuinely new stuff is up to them – and political and market tolerance for debt and taxes. But in recent years, that proportion hasn’t been much. Government spending has been falling as a share of GDP. In fact, as I’ve noted previously, both parties tell us they expect to reduce government spending as a share of GDP further over the next few years.
Labour less so than National, but it is still a reduction.
And the other half of the point the former senior Treasury officials are making is that Labour seems to have promised to do quite a lot of new stuff over the next few years. Specifically, in 2020/21 – the final PREFU year, although not the last year of Labour’s plan – they have announced specific policy promises that, on their numbers, would have total spending $6058 million higher than under PREFU.
Of course, they are partly doing this through revenue measures – primarily not proceeding with National’s promised tax cuts. On their numbers – and the same economic assumptions – revenue will be $2341 million higher in 2020/21 than is provided for in the PREFU. Since the projected surplus in 2020/21 is almost identical to that in PREFU, they have precommitted a net additional $3700 million to fund the (net) new policy promises.
And how much as-yet-unallocated spending provision is there in PREFU for 2020/21? Well, we can see that number in the table above: $5495 million. But if around $3700 million is already committed to meet policy promises, that leaves only around $1800 million.
Again, the question the former senior Treasury officials are raising in whether that is enough to cover the inescapable cost pressures.
Over the three years (from the current Budget numbers for 2017/18) to 2020/21, those “inescapable” pressures include projected:
- Population growth of 4.6 per cent
- Cumulative increases in the CPI of 6.2 per cent, and
- Cumulative wage increases (QES measure) of 8.5 per cent.
Across core Crown agencies and Crown entities (the latter includes schools and DHBs) the government expects to spend $20142 million this year on “personnel expenses”. Using those cost pressures:
- forecast wage inflation alone would lift annual spending by around $1700 million by 2020/21, and
- if the number of public employees kept pace with population growth that alone would add another $900 million to the wage and salary bill.
- for an overall increase (the new workers will also get the higher salaries) of around $2700 million
But there was only about $1800 million left after the specific policy promises Labour has made.
Another item we could look at is Other Operating Expenses. These are around $39000 million this year (2017/18 Budget). Assume that the cost of whatever the government is purchasing increases at the rate of CPI inflation, and that the volume of purchases will increase with the forecast increase in population, and that would raise government spending on this item (simply to deliver the same volume of real services per capita) by about $4200 million by 2020/21.
Across just those two (large) items, the “inescapable” cost pressures would add $6900 million by 2020/21 to annual spending. And yet, the government’s operating allowance – passed to Treasury as current policy to use in PREFU – is for only $5495 million more spending by 2020/21.
We know the policy promises the Labour Party has made: they’ve committed about $3700 million to meet specific policy promises. We don’t have any decent estimate (that I’m aware of) of the cost of the National Party’s promises, although they seem almost certain to be less – for now anyway – than those the Labour Party has put out.
But the bottom line is that, on the macroeconomic assumptions both parties are using, the existing operating allowances (and revenue projections) are not sufficient to cover even what former senior Treasury officials would regard as “inescapable” cost pressures on the Budget over the next few years. (In the spreadsheets they sent me, they didn’t explicitly allow for the population growth, but in my subsequent exchanges with their representative, they accepted that the population pressures on spending are just as real as the inflation ones.) The gap – hole if you like – appears likely to be materially larger for Labour than for National, but it is there for both sides of the political divide.
Of course, there are ways through that. A government led by either main party could decide to make material cuts to services or other spending. Labour seems to have talked of the Defence budget and perhaps Corrections. National – probably faced with a smaller gap – has given us no clues. And none of those possible cuts – from either party – has been outlined in any detail and debated in this election campaign. Perhaps public service salaries could be held below general wage inflation. Perhaps no more teachers or nurses could be hired even as the population increased? Perhaps some extraneous (but mostly rather small) government agencies could be closed?
Then again, perhaps the spending as a share of GDP tracks just aren’t very credible, probably for either party (but probably more so for Labour). As I’ve said before, it is a little hard to understand how, for example, a party can campaign on the idea of years of underfunding of core services, and yet suggest that government spending will fall as a share of GDP over the next few years if they are elected.
And when (properly measured) net core Crown debt is about 9 per cent of GDP, and the macro outlook suggests rising surpluses from here, it isn’t entirely clear why it would be sensible to do so, given the stuff that a left-wing party says that it wants to deliver.
The future is uncertain. We could have a recession in the next few years, or a period of really strong growth. But if we take the Treasury PREFU macro outlook as given, it is hard not to conclude that under whichever party we elect there will be more total spending (than in either PREFU or the Labour plan) as a share of GDP and somewhat higher public debt. And before anyone starts hyperventilating about higher interest rates, a reminder of the Orr/Conway results I linked to on Monday: on those estimates, even a 10 percentage point increase in net debt to GDP might be worth about 6.5 basis points on long-term bond yields. Realistic differences over the next three years would not be worth anything like an additional 10 percentage points on the debt to GDP ratio.
And finally, my suggestion – indeed plea – to The Treasury, and to possible new Fiscal Council (which Labour is proposing if elected) – is that for the next PREFU we should have analytical tables that take explicit identifiable account of the likely – largely “inescapable” (in the words of the senior Treasury officials) cost pressures resulting from inflation and population growth. There are real debates to be had on what level of real per capita services/spending governments should provide – that is the stuff of politics – but for these sorts of purposes a much more sensible baseline – and a more enlightening one for voters – is one that explicitly takes account of those pressures, and thus more clearly identifies how much is “left over” for genuinely new initiatives. Anything beyond that amount has to be funded by either cuts in other spending, or lower surpluses. But inflation means things cost more, and more people means more government spending (all else equal), and it doesn’t help to bury those pressures, as current practice – led by Treasury, which decides what to publish – tends to do.