Thomas Coughlan has a column in the Herald this morning, under the heading “Nicola Willis is just the right amount of Tory”. To this centre-right voter it isn’t obvious Willis is (or sees herself) as any type of Tory, but what Coughlan seems to be suggesting is she is just right if the aim is to hold office, and never mind the large structural fiscal deficit the government inherited from Labour.

It isn’t an uninteresting column, and this post is just about one snippet where I don’t think the author is quite right. Here it is

The simple maths looks about right: $3.5 billion is 25 per cent higher than $2.8 billion and the CPI has increased by about 25 per cent since Budget 2018 (depends a little on your precise reference point). But that isn’t the right way to look at things: it misunderstands how the operating allowances work. And it doesn’t come even close to meaning that Willis is splashing the cash just like Grant Robertson was doing in his first Budget.

There are two things Coughlan seems to have overlooked. First, a big part of what the operating allowances cover is cost pressures on existing government spending programmes. Some increases, eg to welfare benefit rates, are done automatically by statute, and so don’t count against the operating allowance. But most other things do – new programmes of course, but also many of the spending implications of population growth (very rapid at present) and general inflation.

One way of looking at this is to compare the two operating allowances (2018 and 2023) with the total government (core Crown) operating expenses in the year just ending at the time of each Budget.

Grant Robertson gave himself an operating allowance of $2.8 billion in 2018 against an estimated final level of operating spending then for the year to June 2018 of $81.7 billion (3.5 per cent of that spending). Willis by contrast talks of an operating allowance of (probably just under) $3.5 billion against estimated (at HYEFU) spending in the year to June 2024 of $140.3 billion (or 2.5 per cent of that total). National was very vocal about the increases in spending under Robertson, but they went into the campaign not promising to get rid of many programmes (and needing most of their spending savings to finance promised tax cuts). The programmes still cost, inflation is still a thing, and the population keeps growing.

But this year’s story is even tighter than that simple comparison might suggest. Inflation is not something under control of the Minister of Finance – we have the autonomous Reserve Bank for that – and so from any one year’s Budget perspective inflation (as forecast by Treasury) is just one of those things the Minister of Finance is stuck with. In the early 2010s, one thing that made Bill English’s zero operating allowances less extreme than they might have seemed was that inflation was very very (and surprisingly) low. In the 2018 Budget – Robertson’s first – Treasury forecast CPI inflation for the year to June 2019 at a mere 1.5 per cent. By contrast, at least in the HYEFU the Treasury forecast for inflation in the year to June 2025 was 2.5 per cent (and in the BPS last week that forecast was still 2.2 per cent). Willis faces more cost pressures just from inflation than Robertson did in his first year, and that chews up not inconsiderable amounts of the operating allowance.

So it seems quite unlikely that the room she has given herself (all nominal) will do anything close to justifying Coughlan’s claim that this Budget will be “one of the more generous right wing Governments in New Zealand history”. Core Crown expenses as a share of GDP will almost certainly be dropping.

I’m no fan of this government’s fiscal policy – and the apparent indifference to the deficit, and the spooky scare stories about not being Ruth Richardson or Tony Abbott (both mentioned in the article) – but on the numbers the minister has given herself and the general inflation pressure Treasury is forecasting it hardly looks like being all that generous, even by National Party standards (one could make a case for not in effect being that much different than Steven Joyce’s Budget in 2017). That is neither surprising nor inappropriate coming off the back of six years of very large increases in government spending. And after all in 2018 (fairly or not) Robertson and Ardern were banging on about making up for “9 years of underfunding”, a very different narrative to Willis’s now. But the big difference from Steven Joyce in 2017 is that he was running surpluses, and Luxon/Willis apparently are content to keep running deficits.

But….there is the nagging question of what specifically are ministers deciding they don’t want to spend money on that Labour was spending it on (over and above the savings they are now exacting from departments, but on which the promised tax cuts have first claim). We don’t know. Do they?

I was away last week so have been rather late in getting to the Budget Policy Statement and associated material released last Wednesday. It does not make for pleasant reading, at least if one cares at all about governments not borrowing to pay for the groceries.

Once upon a time – still not that long ago – New Zealand had a fairly enviable fiscal record. This chart, comparing New Zealand and the median advanced country, draws from data published in the IMF’s last World Economic Outlook

We used to have smaller deficits or larger surpluses than the typical other advanced countries (consistent with that our net public debt as a share of GDP was materially lower than the median advanced country). But no longer.

Using data from the same WEO (which, incidentally, was published before our election in October), on the IMF’s estimates we had one of the very largest structural fiscal deficits of any of the advanced countries.

Structural deficits – by definition – do not go away of their own accord as the cyclical position of the economy improves. They are removed only by conscious and deliberate choices by governments, and – by the same token – if they are left to linger that is a conscious and deliberate choice by a government.

There wasn’t even a hint of this starting position in any of the material released last week (although they did mention an international comparison of the increase in net debt over the Covid period). And consistent with that, there is very little about eliminating the structural deficit or getting back to operating balance/surplus. In her BPS the Minister outlines several priorities for the coming Budget, but none of them involves any priority or emphasis on getting the structural deficit down. The current government inherited the deficit, but if they choose to continue to run structural deficits – which aren’t about the cyclical state of the economy – the responsibility is on them, quite as much as it was on their predecessors when they chose to continue to run structural deficits once the heavy Covid spending was behind them. If it was pretty irresponsible then, it isn’t much better now.

Consistent with this overall approach, the Prime Minister has this morning released an “action plan” for the next three months, a period which includes the Budget. There is not even a vague suggestion in that list that closing the deficit is any sort of priority for the government.

Under the previous government the forecast date for a return to surplus kept getting pushed back. And this government now seems to be engaged in the same game – the fiscal version of the old line from St Augustine (“grant me chastity and continence but not yet”) – and whatever numbers finally emerge in the Budget projections should probably be accorded no more weight than when the Treasury produced (eventual) surplus forecasts under Labour. It might be nice to be back to surplus by whatever the next published horizon is but….don’t hold us to it. Much more important to keep funding the baubles that both Labour and National competed to offer last year.

Much of the Minister of Finance’s rhetoric in recent months has seem designed to convey a sense that structural deficits are things that just happen and that ministers can affect only at the margin. That wasn’t so under Labour – when Grant Robertson chose to run substantial structural deficits – and it is no more so under the current government. It is simply a policy choice, and a bad one, especially when there is no particular besetting crisis. She talks about the difficulty on the projections of getting back to surplus by a particular date, but the issue isn’t projections – especially when the economy operates fairly close to capacity – but choices, political choices. It might be particularly challenging for a government to take the budget from substantial deficit to balance in its first year, but over a two or three year horizon it really is pure choice. If we still run structural deficits by, say, 2025/26 that is purely a policy choice by the current government, for which responsibility will rest wholly on them.

The Minister appears to attempt to cover herself from this sort of critique using this line, which I saw twice in the documents she released: “International evidence is that reducing deficits is best done over the course of several years by focusing on structural reforms to expenditure and revenue settings”.

Which might sound good but (a) there are no footnotes or references to support this claim of “international evidence”, and (b) there isn’t anything much specific about these “structural reforms” (at present the focus of fiscal policy seems to be on finding enough spending savings to fund tax cuts and other giveaways, rather than on a actually reducing the deficit). I’m rather sceptical of the claim. It might have a little merit in an economy in a deep recession with monetary policy constrained by the effective lower bound on nominal interest rates, but…..that very much isn’t the world New Zealand fiscal authorities now face. Instead, the line just feels like an unsupported excuse for a few more years of deficits (“they had them so why shouldn’t we?”).

The Minister has also been making quite a play of a story that it has all gotten so much harder than she had envisaged because the economy has been deteriorating. At present, that seems a dramatically overblown story, designed to distract more than to enlighten.

Much is made of the revisions downwards late last year in the level of real GDP (and thus the level of labour productivity). But that is mostly distraction, because before those numbers came out Treasury and IRD already knew how much tax revenue the economy had been generating, all they didn’t know was the latest macroeconomic estimates of the size of GDP itself. That matters for, eg, nice charts of tax/GDP ratios but not very obviously for making sense of the fiscal situation and its challenges.

Some weeks ago I showed this graph on Twitter, showing the Reserve Bank’s latest nominal GDP forecasts against those the Bank produced in August last year (ie the last projections before the election).

The Reserve Bank reckoned in February that if anything nominal GDP would be a little higher than they’d thought just prior to the election. And while nominal GDP tends not to be a big point of focus for the RB in putting together its forecasts, the Secretary to the Treasury (or her senior delegate) does actually sit on the MPC.

What about real GDP? Well, as we know, there were some downward revisions to the historical data, so in this chart we will focus on forecast real GDP growth, using as the base date the March quarter of last year (the latest actual data the RB had when it did its last pre-election projections)

Those are pretty tiny differences. And, after all, the Reserve Bank had been telling everyone – including the then Opposition – that the economy was going through a tough patch as part of getting inflation back down.

Among the material released last week was a four page Treasury note on the economic and tax outlook. It contains some preliminary high level forecasts, but can’t be directly lined up against the Reserve Bank numbers because there is no quarterly track for nominal GDP (the best proxy for the tax base). It appears from Treasury’s annual forecasts that they are running with a lower nominal GDP track than the Reserve Bank has (perhaps by around 2 per cent), although it isn’t clear quite why (and although the documents note a revision downwards in inflation forecasts, the Treasury inflation forecasts for the first year or so still seem higher than those of the Reserve Bank).

In terms of spinning a story around the deficit this is perhaps the paragraph the Minister will have been most keen to have readers pay attention to.

You are meant to take away from this that it is going to be so much harder than the current government had thought last year when they were in Opposition, to get back to balance by 2026/27 (recall, a date already pushed out under Labour). But there are a few crucial words in that excerpt: “all else equal”.

And they aren’t (of course). When the size of the nominal economy is smaller than previously expected – but still operating at around capacity (and the Treasury preliminary forecasts have unemployment by 2025/26 and beyond around their estimate of the NAIRU) – it isn’t just revenue projections that need to change. So will many spending obligations – both statutory things like indexed benefits (remember, Treasury has revised down its inflation forecasts since late last year) but also expected wage inflation (in the private sector but also in the public sector). Economies with a dreadful productivity growth record – and the productivity assumptions in these forecasts seem likely to be very weak indeed – tend not to support large wage increases. Of course, there are other items in government spending where there are no semi-automatic savings, but the weak productivity story doesn’t seem to be just a New Zealand phenomenon at present. (More generally, of course, all medium-term economic forecasts – RB, Treasury, IMF, or whoever – are subject to huge margins of error, and not worth a lot more than the paper they are printed on.

Being in surplus two to three years hence (or not) is purely a political policy choice. Not to be is a bad choice. (Of course, in the meantime some really bad event could hit – earthquakes, deep global recessions or whatever – but since no one can or does pick the timing of those we can worry about them when and if they hit. At the moment, planning proceeds on the basis of an economy developing fairly routinely (if underwhelmingly).

I’m old enough to remember when a National government and Minister of Finance first got New Zealand back to operating surplus in the mid 1990s. I’ve told stories about what seemed to have been bipartisan commitment to get back to surplus fairly promptly when occasional nasty shocks happened (although in truth it was really tested only once). It is disheartening now to see little sign that National (and their coalition government) is any more bothered about deficits – borrowing to pay for the groceries – than their Labour predecessors were. (The new debt target enunciated in the BPS is no more encouraging, with the new government seemingly willing to settle for higher levels of (net) debt than New Zealand has averaged over the last 25 years, with no evidence of strong potential productivity growth that might compellingly justify such debt.)

UPDATE: Incidentally, I saw in the weekend papers (page 3 of Saturday’s Post) one academic economist defending the government’s fiscal approach as classic supply-side economics. I don’t find that claim at all persuasive. There are certainly elements in the fiscal grab-bag that might fit that bill (one could think of restoring interest deductibility to rental property owners, on the same basis as any other business in New Zealand). In the abstract, lower income tax rates might, were it not for the fact the starting position is one of a deficit. Savings from cuts to spending can be used to cut the deficit or for tax cuts, but tax cuts today with a structural deficit – all else equal – just mean either further cuts to spending or higher taxes in the future. And some of National’s policies are distinctly retrograde even with a supply-side focus in mind – one could think, for example, of the policy both they and Labour campaigned on, the elimination of depreciation for tax purposes in respect of commercial buildings (office, factories, warehouses). Simply a freshly distortionary revenue grab. And meanwhile we run one of the highest company tax rates in the OECD with not even a suggestion the government is interested in addressing that.

[NB: I wrote a few quick paragraphs here before fully appreciating that nothing of the government’s own policies were being allowed for in the numbers (which itself seems unsatisfactory). Nonetheless I am leaving the post up because (a) I don’t want to pretend it wasn’t written, and b) the Treasury’s own comment (see below) that, to a first approximation, government plans to date do not seem likely to improve the outlook, and c) the fact that the Minister’s statements give no particular reason to think actual policy will be better than what is allowed for in these numbers. Fiscal policy has been badly mishandled in recent years and we should not be looking at deficits for the next few years.]

As I wrote prior to the election, both in the PREFU (reflecting Labour’s plans, some plucked from the ether just in time for Treasury to do the numbers) and in National’s Fiscal Plan, there was a strong element of either wishful thinking or vague “trust us, we’ll do it” about the numbers. Both parties talked up getting the operating balance (OBEGAL) back to surplus by 2026/27, but neither gave us any specifics as to quite how the substantial structural deficit was going to be closed. There were lines on a graph, and that was about it. In its pre-election plan National indicated that by 2026/27 it would deliver a slightly large surplus than Labour (in PREFU) had foreshadowed.

That was then. In their pre-election fiscal plan, National’s numbers were for an OBEGAL surplus in 2026/27 of $2.9 billion. In the first EFU of the new government, incorporating the new government’s fiscal plans [UPDATE: the government’s plans are not included, but - see note below - Treasury’s best guess so far is that for things foreshadowed or announced they would make little difference], that surplus has been revised down to $140 million, basically zero (Treasury shows it as 0.0% of GDP). Recall that under the previous government, the date for a return to surplus was always just somewhere over the (rolling forward) horizon. Is it any different now? And the revisions aren’t just to that one year: for 2025/26, the Fiscal Plan foreshadowed a deficit of $1.0 billion, but the HYEFU numbers now show a deficit that year of $3.5 billion.

Core Crown spending was, unambitiously, supposed to fall to 31.0 per cent of GDP by 2027/28 (the only year for which the Fiscal Plan gave us numbers), but HYEFU has spending that year of 31.4 per cent of GDP. Perhaps unsurprisingly, net debt by 2027/28 is also a couple of billion higher in 2027/28 than National’s plan had portrayed.

In the grand scheme of things, these dates are quite a long way away, and the changes are, in isolation, perhaps of only middling significance. But from a starting point of (a) years of structural deficits (when one, just possibly two, years of deficits might have been warranted by Covid), and (b) repeated revisions which pushed further into the future the return to surplus, it is hardly an encouraging sign from the new government and its Minister of Finance (whose comments on the HYEFU bottom lines seems to take them for granted, rather than foreshadowing something materially less bad).

And all this in a “mini-Budget” (perhaps itself an ill-advised pre-election promise, which put the Minister against very tight deadlines) that seems to offer nothing any more specific about how the government proposes to return to surpluses, and what (at scale) it proposes to spend materially less on.

It was all rather underwhelming, and the slippage relative even to what National was promising just over two months ago is disappointing. It is though perhaps consistent with the pre-election rhetoric from National that seemed very little bothered by the size and duration of the run of fiscal deficits Labour had run, and proposed to carry on running.  Sure, they have to deal now with coalition partners, but when the first fiscal numbers have a worsened outlook it hardly speaks of a strong and demonstrated commitment to “getting New Zealand back on track”. On these numbers, we’ll have had eight years in a row without an OBEGAL surplus…..and even those numbers rely on high-level wishful plans rather than concrete specifics.

On the economic numbers, much will have been superseded by the surprises in the GDP numbers last week. But it is perhaps worth noting that - working with much the same information the Reserve Bank had for its MPS late last month – the Treasury reckoned that the economy was still runnjng excess demand to a greater degree than the Reserve Bank (a positive output gap on average for the year to June 2024), but that the Treasury also envisaged earlier room for OCR cuts (having the OCR at 4.9 per cent by June 2025, while the Reserve Bank was projecting 5.4 per cent), with a weaker exchange rate too.

UPDATE

From the HYEFU document.

UPDATE:

Notwithstanding the Treasury headline, the highlighted sentence is probably more pertinent. With a higher than previously forecast population, potential output has still been revised down, so mediocre is the NZ productivity story. Treasury should probably have been more careful earlier about believing that somehow productivity growth had accelerated in the wake of Covid, something for which there was never any a priori reason to expect/believe.

In my post yesterday on the new OECD Economic Outlook fiscal numbers I included this chart

Even if you leave off the last two observations (OECD projections based on current – Labour government – fiscal policy) recent trends have hardly been something to take any comfort in. But at least we were still a bit less indebted than the median OECD country. But as I also noted in passing, the big OECD countries mostly were a lot more indebted than most of the rest.

I was talking this morning to my son – yes, a geeky economist-in-waiting- about the German constitutional “debt brake”. The great and the good in much of the rest of the world have been critical of this provision since it was put in place in 2009 – for the FT editorial view recently see here – and just recently a constitutional court ruling has created tensions that apparently may threaten to bring the government down. The rule stops German governments running material structural fiscal deficits, except in an emergency (Covid was, appropriately, treated as one), which I’ve long thought should be the benchmark fiscal rule our government should work to (yes, formally operationalising it is a challenge, given uncertainties about output gaps etc, but in principle a rule of that sort is a useful discipline).

The cynic in me has sometimes wondered whether other people disapproved of the rule because it showed up their own countries’ fiscal fecklessness. Here is a chart showing net general government liabilities for the group of large OECD countries.

Germany’s public debt is not extraordinarily low in absolute terms – just a bit higher than New Zealand’s at present – but it is this only one of the large OECD countries to have kept the level of public debt (a) fairly low, and b) stable this century. Were I a German voter I would look favourably on that sort of record. Remember that such “brakes” do not stop governments choosing to spend more, they just require them to front up to the voters with additional tax demands now.

The group of large OECD countries is different. Here is another chart with the OECD countries for which there is data (not the Latin American ones,Turkey or Iceland) grouped as large (as above), medium, and small (population of about 10 million or less), and compared to New Zealand (also in the “small” grouping).

A couple of things caught my eye. First, when the comprehensive data start (1995) our debt was a bit higher than the medians for any of these groupings. 1995 isn’t really that long ago. Second, that group of large countries really is different. It isn’t that there aren’t other highly indebted countries – Greece is in the “small” grouping – but the small and mid-sized countries have typically run much lower (and more stable) public debt ratios than the large countries. And that isn’t because of some threat to the ability to borrow: both Japan and Switzerland are big net external surplus countries, and Japan has very large debt (and deficits) and Switzerland has net general government financial assets. it is, by and large, simply a series of political choices.

Third, all the debt ratios rose in 2020, through some combination of GDP taking a hit (lockdowns etc) and more spending being judged necessary appropriate. What makes New Zealand unusual is that our debt ratio has kept on rising even after the economy had recovered, Covid spending had ended, (and surprise inflation has reduced somewhat the ratio of debt to (inflating) nominal GDP).

And finally, of course, the convergence at the end of the chart. We used to run lower debt than the typical OECD small and medium-sized country – although we were never (not even in 2008, when 10 OECD countries had lower net debt) anywhere near the least indebted-country. But now we look pretty much like the typical OECD country, once one leaves out the feckless few (the big countries minus Germany plus Greece). If your inclinations are more leftist than mine you might think that is just fine – where I think it is regrettable – but in a country where much political and economic coverage is still focused on the US and the UK – it is a reminder that there isn’t now vast unexploited capacity to borrow, just to make us like some “normal” advanced country, rather than one characterised by Cullen/English alleged “underborrowing”.

And if in some senses we are just another small (underperforming) advanced economy, we are also one more exposed to natural disasters and the associated fiscal risks than most (Iceland is another, but not in this particular dataset).

I did a couple of media interviews this morning on the fiscal challenges facing the new government if, as seems likely from other reports, the foreign buyers tax promised by National can’t be got across the line when the agreements with ACT and New Zealand First are reached. Preparing for those prompted me to refresh my memory of a few of the relevant numbers.

There are several relevant points:

• if the work I was part of before the election was roughly right (and we may never know if the tax is indeed stillborn), the fiscal challenges with the tax would not have been a lot less than they will be without it.    National’s costings assumed revenue of about $735m a year, and our work (and the experiences in places like Vancouver) suggested that something not much above $200m was more likely.
• since total government revenue this year is forecast to be $134bn and GDP to be $417bn, the estimated annual revenue from the foreign buyers tax (on National’s own numbers) was always fairly modest in macroeconomic terms (under 0.2 per cent of GDP, when the fiscal deficit this year is forecast by The Treasury to be 2.7 per cent of GDP).
• National, like Labour, has suggested it will deliver operating balance surpluses from 2026/27, without being at all specific as to how they would get from here to there (structural deficits do not simply fix themselves), and was inclined during the campaign to play down the severity of the deficit, in favour of an emphasis (like Labour’s) on new shiny baubles to lure in the voters.  These two charts (using the recent IMF numbers for comparison) were from a post the day before the election.

All of which is to say that there were pressing fiscal challenges whether or not the foreign buyers tax went ahead, and the scale of those challenges isn’t much changed if it can’t be proceeded with. There might be a larger political challenge – remember the emphasis National put on everything being fully-costed and funded – but then again in MMP any pre-election programme is to some extent only an opening bid in post-election government-formation discussions.

This is the summary table from National’s fiscal plan document.

You’ll see that in the first full year (24/25) the plan envisaged being modestly net positive fiscally (that $537m in the bottom line), mostly because the promised interest deductibility changes would be phased in.

So the new government – or National more specifically- could just argue that for the first year anyway the loss of the foreign buyers tax still left their numbers for that year – the next year’s Budget – looking okay (lose $700m, but they already have a margin of $500m). And if they wanted to change tack and accept that argument I and others had made that the foreign buyers tax revenue wasn’t going to be disinflationary (since it was mostly coming from people outside the economy, so wasn’t reducing domestic private spending) they could even argue that scrapping it wouldn’t materially complicate the fight against inflation.

Or they could delay/rephase any of a number of the other specific items in that table. Delay the income tax cuts by a quarter and you save $500m in the first year, and push back the interest deductibility changes and childcare subsidies by a year and you save another $500m in the first year (perhaps a little more to the extent interest rates are a bit higher now than was allowed for in the costings). Rejigging the first year on the table – 24/25 – really isn’t a particular problem (at least if the foreign buyers tax were the only material change to National’s plan).

But it would further increase the challenges – which will already be severe – on both the 2024 and 2025 Budgets, which will mainly determine whether there is a serious chance that in election year 2026 the Minister of Finance will be able to produce a budget that year with a credible prospect of an operating surplus for 2026/27. It isn’t impossible that the extent of the increased pressure might be small – there are several more rounds of Treasury fiscal and economic forecasts to come (including one next month) and the outlook could be a little less unfavourable than it has been (although things could go the other way too) – but it wouldn’t be a promising start after the last few years of fiscal incontinence.

One way of covering any gap over time is, of course, fiscal drag. Recall that National was very non-committal on future adjustments to tax brackets for inflation.

The more government formation locks in fiscal pressures now the less likely any future band adjustments become.

My bottom line in all this is that on its own the loss of the foreign buyers tax isn’t critical or determinative, but it should simply sharpen the focus on the key questions that were there all along even just on National’s own programme: are they willing and able to make hard choices across successive budgets to get the government accounts back to surplus, and can they do it (as they promised, with all the options they ruled out) without cutting into programmes, or taking some of their own promises off the table. I’m somewhat sceptical – and there are some easy, low-value, programmes they should not have committed to keep (eg fees-free, winter energy payments, Kiwisaver subsidies) – but at present we really don’t have a lot to go on (eg all the attention has been on a possible NZ First win around the foreign buyers tax, and not at all on what ACT might succeed in securing). But National might have been on stronger ground had it spent more time in the campaign highlighting the fiscal mess Labour was leaving and less on shiny new baubles it was offering.

2.5 months ago, when National’s Back Pocket Boost plan was released I made a quick comment on Twitter that promising tax cuts in the current climate was almost a definition of fiscal irresponsibility. The deficits they’ve inherited aren’t National’s fault but they will very shortly be its responsibility (shared with partners, but National is the biggest party and Willis is to be the Minister of Finance), and the focus should have been first on closing those structural deficits, not on upfront tax cuts and vapourware commitments to surplus one day, but not yet.