Finance Minister Nicola Willis was told public service levels will be difficult to maintain under the current spending track. Photo / Mark Mitchell
Treasury officials have warned the Government that “significant reforms” or “reductions to public services” will be needed in the not-too-distant future if it sticks to its current, restricted spending track.
The Herald can reveal that even with this relatively tight spending, the Government will not post a surplus under the traditional Obegal measure until 2031, which will mark the longest period of Government deficits since the 1979-1994 deficits (which were measured quite differently).
Treasury officials also warned that the Government had planned so much capital investment – spending on items like schools, hospitals and roads – that it might have to cut spending earmarked for public services so it can fund the significant ongoing maintenance of those investments.
The warning came in a document that advised Finance Minister Nicola Willis on the details of Treasury’s long-range forecasts, which were put together for the Half-Year Fiscal and Economic Update (Hyefu) and Budget Policy Statement (BPS) in December. (The Treasury’s Budget Economic and Fiscal Update (Befu) is released annually on Budget Day).
The document on forecasts sets out the difficulty the Government will have in keeping to its restrictive level of spending so it can post a surplus and rebuild the Crown balance sheet while also maintaining public services at existing levels. The Government has maintained this is possible – but Treasury is now clearly warning it will come at the expense of public services in what it calls the “medium term”.
It paves the way for a 2026 election campaign which is likely to involve a battle on the issue of taxation and the role higher levels of tax might play in rebuilding the balance sheet without cutting services.
Usually, the longer-range forecasts, known as the Fiscal Strategy Model (FSM) are published with the Hyefu (another version of the FSM is always published with the Budget), but Willis chose not to publish them – going against the advice of Treasury. Part of the forecasts were released in a document released under the Official Information Act to the Labour Party.
Willis told the Herald she believed that the projections, which extend 15 years into the future, were “highly uncertain”.
“I considered there was limited value in including them as part of the BPS, which has a more immediate focus on the next Budget,” she said.
Willis also said that given the Government had not yet set its spending limits beyond Budget 2028, any “speculation about managing within assumed allowances” would be “premature”.
“It is clear as New Zealand looks to future decades we face significant challenges and opportunities. We need to make careful choices about how we invest, prioritise, and raise revenue so as to ensure people can get ahead. The Government is setting foundations now that will position us better for those choices,” she said.
Labour finance spokeswoman Barbara Edmonds saw things differently – noting in the forecasts something of a smoking gun: a concession from Treasury that, eventually, the Government’s tight spending limits would require a reduction in services.
“We already know Nicola is struggling to balance the books without making significant cuts. Treasury’s advice shows that this won’t be an issue just for this Budget, but for future Budgets to come,” Edmonds said.
“Treasury advises that significant reforms to policy settings and cuts to public services will likely be needed. Nicola has no plan for reform, so we are left to assume that more cuts to public services that Kiwis rely on are coming. These budget constraints won’t just result in cuts to public services. Nicola is also going to struggle to make the investments into infrastructure that we need,” she said.
Treasury revises its forecasts at least twice a year – once for the Budget in May and again at Hyefu in December. When it does these revisions, it puts together a Fiscal Strategy Model (FSM), which takes the form of a massive Excel spreadsheet detailing the state of the economy and the Government’s spending 14 or 15 years into the future.
The Government must publish the FSM at the Budget and it usually publishes it at Hyefu too – unless there is a good reason not to, like in 2023, when the fact the new Government had just been formed rendered the FSM slightly useless.
The way one reads these forecasts is important. Treasury can’t forecast with great certainty what the economy will look like in 2039. What the forecasts do quite successfully, however, is set out whether the Government’s current track is broadly sustainable.
Treasury uses economic and demographic forecasts to estimate things like the rate of GDP growth, the number of people on a benefit, the number of people receiving superannuation, the number of people working and the amount of tax they pay, and the inflation and wage growth rates, which helps determine the level of benefit and superannuation people receive.
Unlike the numbers for the near-term “forecast period”, these projections are not terribly sophisticated and often involve indicators returning to the long-term average.
Treasury then adds to those forecasts the political decisions made by the Finance Minister: the two main ones are the level of new operating and capital spending in each Budget. New operating spending is used to cover the rising cost of public services each year, and any new services the Government might want to provide. Capital spending is used to fund investment in new schools, hospitals and roads.
Combining these political choices with Treasury’s assumptions and estimates produces the FSM.
Treasury advised Willis on the settings she might want to use for the forecasts.
It recommended Willis set an operating allowance of $2.4 billion in the first projection year, 2029, and grow it by 2% a year thereafter to keep up with inflation. This would mean the smallest allowance in nominal terms since Steven Joyce’s 2017 Budget, although in real terms this hypothetical $2.4b allowance would be slightly smaller than Joyce’s.
This allowance features only new spending, however. Overall, these Budgets would still be relatively large because they inherit prior spending commitments.
Treasury warned this amount of new spending “in practice” would “likely require significant reforms to policy settings and/or reductions to public services in some areas to manage medium-term expenditure pressures”.
The paper said Treasury would provide “a stream of advice … to support [Willis] to deliver the fiscal strategy through medium-term budgeting across several Budgets”.
Treasury offered Willis another option, which it did not recommend: a $3b allowance in 2029, rising by 2% a year. This option would mean hitting surplus by about 2035 and net core Crown debt about 5.4 percentage points higher in 2039, although still below the Government’s target, which is to have net core Crown debt on a “downward trajectory” to 40% of GDP.
More spending and borrowing would run the risk that New Zealand would be less prepared for the next economic shock, which is likely to arrive before 2039.
Treasury also recommended Willis adopt a capital allowance of $7b in 2029, rising by 2% a year.
It said this maintains the current rate of investment in a way that still allows net debt to gradually fall, hitting the Government’s 40% of GDP target in 2023/34.
Officials raised one big problem, however. They said Treasury’s rule of thumb for capital investment is that each $3 of capital spending requires $1 of operating spending for maintenance and other matters. Officials said this meant investment in new infrastructure would put pressure on the money set aside to run services – pressure so large it would require cuts to that service funding.
It said the $7b allowance “implies reprioritisation of existing spending beyond what will be required to manage cost pressures and deliver new initiatives within $2.4b operating allowances”.
Treasury offered another option, which was a $3.625b allowance in 2029, rising by 2% a year, but it warned this would be less than what it had forecast capital investment to be – a signal to infrastructure providers the Government was stepping away. Officials warned the level of spending “may be inconsistent with the Government’s intention to lift capital investment”.
Thomas Coughlan is deputy political editor and covers politics from Parliament. He has worked for the Herald since 2021 and has worked in the press gallery since 2018.
Mike Hosking spoke to Prime Minister Christopher Luxon on the Mike Hosking Breakfast. Video / Newstalk ZB