Brian Fallow: Wait-and-see approach required with forecasts

How come the Government cannot see its way clear to spending more or cutting taxes when we are, Michael Cullen tells us, on track for a Budget surplus of $4 billion this year?

Next year's surplus is forecast to be only slightly smaller, $3.8 billion.

The Government says it wants to boost tax credits for families and overhaul the benefit system to make it easier to move from welfare to work. But not until next year's Budget, finances permitting.

What is it waiting for?

Part of the reason is that there is a now-you-see-it, now-you-don't element to forecast surpluses.

We are coming out of a period of exceptionally strong economic growth and heading into a period of below-average growth. Tax flows will reflect that slowdown.

Dr Cullen's problem is that he can't be sure where the durable, sustainable, structural part of the surplus - available for ongoing spending increases or tax relief - ends and the temporary, cyclical part begins. It should be clearer this time next year.

The other things is that the Budget surplus (the operating balance before revaluations and accounting changes) does not reflect all of the Government's spending.

It includes teachers' pay, but not student loans. It includes an allowance for wear and tear on physical assets like roads or schools, but not money spent building new ones.

It includes the New Zealand Superannuation paid to existing pensioners, but not the money being set aside to partially prefund future pensions.

When these capital spending items are added, this year's $4 billion operating surplus shrinks to a cash surplus of less than $400 million. Next year, the Treasury expects a cash shortfall of $2.1 billion, which will have to be borrowed.

The constraint that bites on the Government's total spending, operational and capital, is its debt target.

It has committed itself to keeping its gross debt level below 30 per cent of GDP (a measure of the size of the economy). It will have fallen to 27.3 per cent by June and is forecast to fall to 23 per cent in four years.

These are respectable ratios by international standards. But they still require upwards of $2 billion a year in interest costs, nearly twice the defence budget.

The Government is required by law to say what its debt target is and in principle it can set it where it likes. But not in practice.

It has to bear in mind what New Zealand as a whole looks like to the international financial markets.

When the private sector is included we are up to our chins in debt to the rest of the world, by a net $100 billion.

We probably already pay a price for that in higher interest rates.

The risk is that price could get a lot higher if the picture included a spendthrift Government instead of a frugal one.

No one knows for sure what level of Government debt would make the markets go off us in a big way, but as the Asian crisis showed that can be ugly when it happens.

Dr Cullen told the Herald this week that he needs a Budget surplus approaching 2.5 per cent of GDP ($3.3 billion in today's dollars) to feed the New Zealand Superannuation fund and to keep the debt ratios looking good.

At this stage the Treasury forecasts there will be about $500 million above that on the table in next year's Budget round.

Whether it is still there this time next year we will have to wait and see.