Peter Lyons: More cuts loom to reach surplus holy grail

A government budget has an enormous impact, both socially and economically. Photo / Mark Mitchell

We are unlikely to achieve the much vaunted government budget surplus this year. While this is a huge disappointment for those who have eagerly awaited this accounting milestone, it is important we do not allow this to ruin our festive season.

The projected surplus is now a possible deficit of half a billion dollars. We may need to postpone the street parades for another year or so. More fiscal tightening and austerity may be necessary to reach this target. This may necessitate more pruning of regional health budgets and more school closures in Christchurch. It may require the sale of state houses to private developers leaving charities to cope with the mess. It may require tightening of benefit eligibilities and perhaps cuts in mental health care. It will require more cuts in pay rates for nurses, teachers, police and other public servants.

With inflation running at 1 per cent this is likely to mean nil pay rises for most public servants, except for those few who are fortunate enough to have their pay determined by the Remuneration Commission. As Finance Minister Bill English has pointed out, lower inflation makes people's pay rises more meaningful. This is provided they get one. Most public servants will continue to sit on the sidelines of our rock star economy.

When we finally reach the promised government budget surplus we can all breathe a huge sigh of relief. Prime Minister John Key has hinted he may then give us a tax cut.

"A government is like a household. It is important that it manages its budget carefully to ensure it doesn't live beyond its means." This apparent truism is one of the most controversial statements in economics. The operation of a government budget is quite different from that of an individual household. The budget of an individual household has little impact on the wider economy. A government budget has an enormous impact, both socially and economically.

The New Zealand economy is still fragile. Growth has largely been based on the Christchurch rebuild, dairy prices and housing inflation. Over the past few years this Government has used the goal of achieving a budget surplus in 2014 as a holy grail of prudent economic management. Mr Key's statement that he might use a surplus for tax cuts suggests this target was largely ideologically driven. The large budget deficits of recent years, were partially the result of tax cuts in 2010 and finance company bailouts. Trumpeting the goal of achieving a budget surplus has been used as a mantra to justify shrinking government services.

Cuts in government services generally impact most on the vulnerable in our society. From a broader economic perspective, cuts in real government spending reduce total demand and incomes in the economy.

From an accounting point of view a government may achieve a surplus by increasing taxes or cutting spending but this sucks demand and incomes out of the broader economy.

Running a budget surplus makes good sense when the economy is at full employment. With unemployment still hovering around 6 per cent and dairy prices plummeting, an obsession with attaining a budget surplus is likely to drive the economy further from full employment. A government budget surplus means little if it results in a society that is fraying at the edges.

An argument used to justify the obsession with attaining a budget surplus is the crowding out effect. This states that government borrowing to finance a deficit pushes up interest rates. This makes it more expensive for households and firms to borrow. Yet there has been little evidence in recent years that government borrowing has had a major impact on domestic interest rates.

An obsession with achieving a budget surplus may not be the prudent economic management it appears. This is not to deny that a government should be prudent in its spending to ensure value for money for taxpayers but it needs to take into account the different stages in an economic cycle.

It is also important to recognise cuts in real government spending in social welfare, state housing, education and health care impact mainly on the most vulnerable. Any budget surplus will also be the result of pay cuts for most public servants over the past few years.

When we eventually achieve the budget surplus we need to recognise it has been paid for by many of those who had the least to start with. Let's hope the failure to achieve an accounting surplus this year doesn't lead to further slashing and burning.

Peter Lyons teaches Economics at St Peter's College in Epsom and has written several Economics textbooks.