Brian Gaynor: We're not ready for baby boomer blowout

Retirees cannot expect to maintain their standard of living unless changes are made. Photo / Supplied

This week's Budget Policy Statement is a timely reminder of the daunting challenges facing New Zealand as our society ages.

The post-World War II baby boomers will make enormous demands on the Crown's finances, particularly as far as superannuation and health expenditure are concerned, and if borrowings continue to escalate then interest costs will also add to projected budget deficits.

Finance Minister Bill English announced on Tuesday that the Crown's operating deficit before gains and losses (obegal) is now forecast to be $11.1 billion, or 5.5 per cent of gross domestic product, for the June 2011 year. This compares with the previous deficit forecast of $8.6 billion or 4.2 per cent of GDP.

The 5.5 per cent of GDP deficit compares with a similar deficit of 6.1 per cent for the 30 OECD countries but a number of points are worth noting:

New Zealand's projected deficit is not too far off the four "pigs", which are forecast to have the following budget deficits to GDP next year: Portugal 5.0 per cent, Ireland 9.5 per cent, Spain 6.3 per cent and Greece 7.6 per cent.

New Zealand had a great record throughout most of the 1990s and 2000s with 15 consecutive budget surpluses between 1993 and last year. Norway was the only OECD nation to have a better performance over the same period.

The Crown has to borrow to fund its deficits and this will lead to sharp increases in government debt and interest costs.

The Crown's fiscal position has deteriorated since 2008 because of a number of initiatives including KiwiSaver, Working for Families, the indexation of benefit and this year's income tax cuts.

There have also been a number of one-off items, including the Canterbury earthquake and the leaky homes scheme, while tax revenue growth has slowed because of the weaker economy.

The good news is that the deficit is forecast to decline to $6 billion in 2012, $4.4 billion in 2013, $1.5 billion in 2014 and to break even in the June 2015 year. According to this week's commentary, "the first surplus of note is projected for the June 2016 year".

However the optimistic forecasts for the 2012 to 2015 period are based on a significant increase in tax revenue while expenditure will be curtailed, particularly as far as health and education are concerned.

The debt outlook is bleak with the Crown's net debt forecast to increase from just $17.1 billion at the beginning of the June 2010 year to $70.5 billion at the end of the 2015 financial year.

The long-term fiscal picture is much bleaker based on the information contained in financial models compiled by the Treasury, which are available on its website.

The figures in the accompanying table are from the Treasury's bottom-up financial model, where existing programmes are assumed to continue in their present form. The projected figures for the 2025, 2035 and 2050 years are derived from this bottom-up model.

These are projections only, which can vary significantly if the assumptions are changed, but they do give us some indication of the financial demands of an ageing society.

The Treasury's long-term Crown revenue and expenditure figures are based on a number of assumptions, the most important of which are population demographics. Its main assumptions are:

The total number of individuals aged 65 and over will rise from 549,900 this year to 1.3483 million in 2050. As a percentage of the population, this age group will increase from 12.6 per cent to 24.5 per cent over the same period.

The number of individuals aged 90 and over will go from just 22,400 this year to 155,100 in 2050. This age group is expected to represent 2.8 per cent of the country's population in 2050 compared with 0.5 per cent at present.

The first expenditure line, which is New Zealand Superannuation, demonstrates the dramatic impact of the ageing population on Crown finances. NZ Superannuation is projected to cost $71.1 billion in 2050 compared with just $8.3 billion last year.

Most retirees claim that they are entitled to full Government superannuation because they paid taxes throughout their working lives but the big question is whether the country can afford this.

There will have to be a dramatic increase in the country's economic performance, and the Crown's taxation revenue, if the current superannuation scheme is to be maintained for all those aged 65 and over.

The next major expenditure item is health, which is projected to blow out from just $13.1 billion last year to a massive $95.1 billion in 2050.

A New Zealand Treasury Working Paper, dated September 2004, contained an analysis of the impact of an ageing society on health expenditure. The paper assessed that the annual per capita health expenditure for a male in the 35-39 age group was just $937, whereas individuals in the 65-69 age group required $3519 and those in the 90-94 group had annual average health expenditure of $15,573.

Burgeoning healthcare expenditure is going to be a major problem throughout the Western world but New Zealand faces a bigger problem than most other countries because our governments have had their heads in the sand over the issue.

In addition we have undeveloped capital markets and insufficient savings to create the businesses and job opportunities that will attract and keep the younger generation in New Zealand.

The basic problem is that total government expenditure on superannuation and health is projected to escalate from just $21.4 billion last year to $166.2 billion in 2050, yet the working age population - those in the 25 to 64 age group - will only increase from 2.268 million to a projected 2.612 million over the same period.

In other words, each working person will have to pay annual tax of $63,600 in 2050 just to pay for superannuation and health, compared with tax of only $9400 this year to pay for the same two items.

It is clear from these figures that the Crown cannot maintain its current level of superannuation and health services.

The next major expenditure item is education, which is projected to increase at a much lower rate as the the percentage of the population under the age of 25 is projected to fall from 35.1 per cent to 28.1 per cent between now and 2050.

Finally the projected interest costs of $112.1 billion in 2050 are based on the assumption that the Crown will run large annual deficits and net core government debt will go from $70.5 billion in June 2015 to an unbelievable $1979.9 billion by June 2050.

This is totally unrealistic and the Treasury's top-down model, which assumes a more prudent fiscal strategy until 2050, has much lower health, education and other expenditure each year. National superannuation is assumed to remain the same under the bottom-up and top-down scenarios because the formula for this is fixed.

Under the Treasury's top-down model, Crown interest costs are projected to be only $13.1 billion in 2050 because it doesn't run large annual deficits and the Government's net debt is much lower than under the bottom-up approach.

Our politicians gloss over the long-term implications of the country's ageing society and usually forecast a positive five-year budget outlook, as Finance Minister English did this week. However, this is a head-in-the-sand attitude and unless we start addressing the ageing issue immediately, retirees cannot expect to maintain their current standard of living, particularly as far as health is concerned.

* Brian Gaynor is an executive director of Milford Asset Management.

bgaynor@milfordasset.com