Inflation pushes up the cost of Government, putting pressure on Grant Robertson

Finance Minister Grant Robertson has tough choices ahead in 2023. Photo / Mark Mitchell

The Government has “just” enough money to fund the increasing cost of new services in the next Budget, but has very little left over to fund new, potentially election-winning policies, according to a Treasury analysis.

Inflation-fuelled cost pressures are hitting the Government hard, and Treasury warned if those cost pressures come in even bigger than expected, ministers will need to choose between reprioritising funds within their portfolios, cutting services, adding extra borrowing-financed spending, or hiking taxes.

Finance Minister Grant Robertson, unveiling the figures on Wednesday, said ministers would be asked to reallocate funding from elsewhere in their portfolios if they were looking to fund a new project in the next Budget. A reallocation drive happens in each budget, but it appears a special emphasis has been put on it this year, given how tight the finances are looking.

“Ministers are well aware of the fact that we used our balance sheet to get New Zealanders through Covid - it was the right thing to do… I try to act in a way that is responsible to the time that we live in. We are in a period now where there is a need for some fiscal contraction,” Robertson said.

Treasury published its Half-Year Economic and Fiscal Update this week, setting out what it thinks will happen to the Government’s books and the wider economy in the next year, the analysis was included in those figures.

One concern flagged by Treasury is just how much inflation is costing the Government, which has to find money to fund the increased costs of delivering existing services - all of this comes before the Government can even think about putting up funding for new policies.

At the 2020 election, Labour campaigned on an operating allowance - the public finance term for new day-to-day spending in a budget - of $2.625 billion for the 2023 Budget. This was increased to $4b and then eventually $4.5b at the 2022 Budget.

Of that $4.5b, Treasury reckons the Government will need to spend $3.7b just to stand still next year - such are the increased cost and wage pressures on the public service (that figure has increased by $200m since it was last forecast in May).

The analysis said there was still enough money “within the signalled funding set aside in the Budget 2023 operating allowance” to fund those cost pressures, without increasing the allowance, however there was little money left for much else.

The Government has already decided where $2b of its $4.5b of new spending will go. As part of a new, multi-year Budget approach, the Government gave multiple years of funding to some areas, like Health, in the last Budget. This funding gives those portfolios certainty over multiple years, rather than forcing ministers to come cap-in-hand to the finance minister to fund cost increases in each Budget.

Health Minister Andrew Little said on Thursday that Health was operating within its multi-year funding envelope.

“We were pretty careful when we were doing the two-year budget to think very hard about population growth and challenges on the system now, but I think in 2024 when we are due to prepare a three-year budget is going to be challenging, but that’s the system we’ve agreed to adopt,” Little said.

“I’ve had no advice that we are radically short of what we expected to be,” Little said.

The HYEFU also revealed the Government had allocated a further $700m in spending since the budget, although it has not announced what that money will be spent on.

This means that despite having an operating allowance of $4.5b - the second largest Robertson has ever delivered - just $1.8b is left unallocated as of December.

Treasury warned that more money might be needed next year, either by increasing the operating allowance or by freeing up money by spending cuts elsewhere. This could be particularly difficult if inflation was higher than expected next year.

“The possibility of higher-than-normal cost pressures expected in the 2023/24 years, could make it challenging to meet these costs from the funding remaining in the Budget 2023 operating allowance.”

Robertson acknowledged this in his HYEFU speech saying the allowance, though large in historical terms, was “an allowance that is going to have to deal with significant cost pressures across every part of the government’s expenditure.

“It is not an allowance that I would describe as allowing for much more than meeting cost pressures on a small number of new initiatives as we return ourselves to a more conventional fiscal position,” he said.

Treasury also warned this wasn’t just an issue for next year’s budget. Future Budgets would also be under pressure, given current forecasts are for inflation to remain high for some time. Future Budgets are currently expected to have a $3b operating allowance.

The analysis said “increased baselines could be expected to continue into future Budgets with signalled allowances just sufficient to cover increasing cost pressures”.

National finance spokeswoman Nicola Willis said the increased cost of services meant the Government needed to be “very careful in its prioritisation.

“There is no room for spending on things that are not core,” Willis said.

“It is critical to cut out expenditure that is not delivering outcomes,” she said, adding that non-core projects “like the TVNZ and RNZ merger should not be happening”.

Willis said the Crown still had room for her party’s tax reduction policy, which was estimated to cost $1.9b to the 2024 Budget, the first year they could be implemented following the election.

She said the Crown must also “meet its commitment to core frontline services”.

Act leader David Seymour noted that inflation was also helping the Government in the form of much higher tax receipts thanks to inflation pushing up people’s incomes.

“I agree that it’s not obvious if inflation is helping or hindering the government by increasing taxation as a percentage of nominal GDP,” Seymour said.

“I’m glad the Government is feeling that pressure because households and businesses have been feeling that for a long time,” he said.

He said the focus should be on tax reduction paired with larger spending cuts. This would have the effect of pruning back the state, returning a greater share of income to people, and running a deflationary fiscal policy.

The warning was included in a mixed set of forecasts. On the one hand, debt is low and tracking downwards over the forecast period, and the increasing revenue means the government is expected to return to surplus in 2025.

On the other, however, expenses are growing - and growing fast, thanks to inflation adding costs.