Treasury asks itself why its forecasts are wrong, with sanctions on the table for poor forecast decisions

Treasury is looking at its forecasting abilities. Photo / 123rf

• Treasury’s economic forecasts have varied considerably with the actual results.
• Revenue implications of Labour’s Smokefree policies were acidentally left out of the 2023 Budget.
• Treasury has reviewed its revenue forecasting for the first time since 2005.

It’s been a tough few years for economic forecasters, particularly Treasury, the Government’s main economic forecaster.

Treasury was excessively pessimistic during the pandemic. Its monthly accounts often reported billions more revenue flowing into government coffers than Treasury’s gloomy Budget forecasts.

But in 2023, things went from being unexpectedly good to being unexpectedly bad.

In April last year, Treasury revised its economic forecasts, concluding that the post-Covid economic recovery was much softer than it had previously thought. In urgent briefings to the then Government, it warned spending would need to be trimmed to cover $9 billion worth of revenue that had essentially disappeared from the Government’s forecasts. The imbroglio eventually made it into the public domain when rumours of a $20b “hole” in the Government’s books broke in a press release from NZ First.

Things only got worse this year, with forecast revisions at the 2024 Budget trimming revenue assumptions back by $28b, mainly as a result of soft economic growth.

This creates something of a nightmare for a Government trying to decide how much money it should spend in a Budget.

Finance Minister Nicola Willis supported Treasury's self-assessment. Photo / Mark Mitchell

Treasury thinks so too, and last year the agency commissioned a review into its revenue forecasting. It was the first review of Treasury’s forecasting since 2005. The review and its 21 key recommendations was delivered to Treasury this year. It has been published and papers associated with it have been released to the Herald under the Official Information Act.

Treasury found that overall, the Government tends to place a lot of emphasis on ensuring that its spending forecasts are accurate, but pays comparatively less attention to its revenue forecasts. It also found that forecasting was getting more complicated, thanks to changes in the economy.

The straw that appears to have broken the camel’s back was the apparently accidental omission of Labour’s Smokefree Aotearoa policy from the Budget 2023 forecasts. That policy, since repealed, would have reduced smoking rates, which would have in turn hurt the Government’s books by reducing the amount of money collected from tobacco excise. However, this was not included in the Budget 2023 forecasts – a fairly serious omission.

The review found the “inadvertent omission of the Smokefree Plan” from the forecasts “was not the result of a single point of failure, but it arose from multiple missed opportunities across government”.,

“The current system is not well equipped to capture revenue implications in costings,” the review concluded.

The challenge is that government can be siloed, with poor information flows from one agency to another, particularly when dealing with a Budget’s confidential information, which agencies tend to hold quite tightly. Another problem is that the ministries developing individual policies were not necessarily talking to the people at Treasury who put together the Government’s revenue forecasts. Even within Treasury there was a problem, with the teams developing policy not necessarily telling the forecasting teams about the revenue assumptions.

“The Treasury necessarily operates with strict internal information security protocols, meaning that the details of policies under development are often restricted to the relevant Policy and Budget teams,” the review said.

“This gives rise to a natural tension, since knowledge of policies under development may be required for the production of relevant economic and revenue forecasts.”

The review recommended Treasury engage chief executives from across government to ensure they were across the revenue implications of any policies. It recommend the standard Regulatory Impact Statement template be updated to include any revenue implications from any policy on the front page. The review also recommended a “sanctions regime” for ministries that ”miss tax revenue implications” from their policy work. These sanctions would be similar to those that are given to agencies that go over their annual budgets.

At a slightly higher level, the review recommended Treasury get more up-to-date information from the Inland Revenue Department (IRD) to inform forecasting decisions and hold itself to account more when it gets things wrong.

Treasury and the IRD already swap notes to aid forecasting. The IRD is particularly helpful because it can see whether regularly-updated tax receipts are tracking to forecast, which helps to give some indication of whether the Government’s thinking is overly optimistic or pessimistic.

The review wants more of this, although it didn’t specify what.

“One option would be for Inland Revenue to provide Treasury a summary of their intelligence arising from recent outturn or other high-frequency data early in each forecast cycle. This summary should focus on corporate taxation, other persons taxation and any other information that may not be immediately available to the Treasury,” the review said.

It also recommended that each Economic and Fiscal Update (known as an “EFU”), Treasury should publish its most recent forecast errors for one year ahead, and “provide some brief analysis regarding the main contributors to the deviations”.

“Publishing forecast errors in every EFU would add to Treasury’s ongoing incentives to continue to improve its forecast accuracy,” the review said.

Finance Minister Nicola Willis was supportive of the review, which began under the last Government.

“I think is important that Treasury continuously make sure it’s implementing best practice in the way it does its forecasting, it takes its reputation there very seriously. Its forecasting function sits independently of politicians, I think that is appropriate. They should always be doing what they can to tune it up and make sure it’s as close to what actually happens as possible,” Willis said.

Finance Minister Nicola Willis was supportive of the review, which began under the last Government.he Herald since 2021 and has worked in the press gallery since 2018.