Prime Minister Christopher Luxon and Finance Minister Nicola Willis. Photo / Mark Mitchell
Treasury officials delivered a stark warning to the new Government last year, saying there was a long-term shortfall in the amount of revenue the government takes in taxes and the amount of money it spends.
Officials said that the last Government’s spending plans were only just enough to meet current cost pressures. Cutting those spending plans further, as the new Government has said it would do, could mean cuts to services.
It warned that spending cuts combined with a capital gains tax might be needed to consolidate New Zealand’s public finances and deliver a surplus by 2026/27. Treasury advised addressing tax issues early in the term, as tax changes took time to bed in. The three parties of Government have been dead set against a Capital Gains tax, and NZ First stopped Labour from implementing one in its first term. There is almost zero likelihood of the Government taking up that recommendation.
There were other warnings too. It said New Zealand’s risk of annual losses for insurers was the second worst in the world, behind only Bangladesh, and worse than Japan. It means New Zealand businesses and households are likely to struggle with getting insurance and paying high premiums for cover.
The insights are included in a slide pack that accompanied Treasury’s Briefing to the Incoming Minister of Finance. They were uploaded after the main document.
There are some areas of good news. New Zealand’s wage growth has outpaced OECD peers in the last few decades, Treasury said, but it warned it may be difficult for the Government to continue this trend.
“Increasing productivity will be critical to drive future gains in living standards. While income is not the sole determinant of living standards, the ability to fund public services and institutions, invest in infrastructure and preserve the natural environment all depend on the economy performing well,” the agency said.
The document warned a number of challenges faced the incoming government in the short, medium and long term.
Citing a 2021 paper by Treasury, the briefing warned “New Zealand’s core Crown expenditure will significantly outpace revenue over coming decades” with the “most significant spending pressures come from a combination of healthcare and NZ Superannuation”.
By 2061, the briefing said, core Crown revenue will hover below 30 per cent of GDP, while expenses will be over 35 per cent of GDP, creating a large and unsustainable deficit.
Big changes in revenue and spending would be needed to address that shortfall.
The paper said that if the policy settings of the previous Government were unchanged, core Crown expenses would fall to 31 per cent of GDP by 2026/27, which is slightly above their long-run average. Tax revenue would rise to 30 per cent of GDP by the same year. Both of these figures will be altered by the new Government’s plan to both cut spending and taxes.
Treasury warned that currently, the Government was “currently running a structural OBEGAL [Operating Balance Before Gains and Losses] deficit of around 2 per cent of GDP”.
Every year the Government sets aside a portion of “new” money to fund the increasing cost of delivering new services as well as any new programmes it wants to create.
Labour increased these allowances significantly, before scaling them back just prior to the election.
The current operating allowances are $3.5 billion for Budget 2024, $3.25b for Budget 2025 and $3b for Budget 2026.
Treasury said these allowances should be “broadly sufficient to meet critical cost pressures that are not already funded”.
National’s pre-election fiscal plan pledged to cut these allowances by a cumulative $3.3b over the forecast period, which would put pressure on funding those critical cost pressures.
Treasury was not critical of this idea, and actually suggested that the Government may want to “reduce[...] allowances to encourage trade-offs, requiring agencies to re-prioritise within existing baselines”.
It criticised the former Government for making spending commitments outside of the Budget cycle and for repeatedly increasing spending allowances from where they had been set, worsening the fiscal position.
However, it balanced this by saying that most of the last Government’s increase to operating expenses was simply to “address cost pressures.
“Cost pressure spending as a percentage of Budget allowances ranged between 50 per cent and almost 90 per cent between Budgets 2018 and 2023,” the paper said.
Treasury urged the Government to stick to its promise of delivering a surplus in 2026/27, as set out in National and Act’s fiscal plans. NZ First wanted a surplus in the 2024/25 fiscal year.
Treasury proposed four fixes: decreasing current levels of spending by finding savings from existing programmes, constraining the growth of new spending, increasing tax revenue, and better management of the Crown’s balance sheet by ensuring capital flowed to the areas where it was needed most.
The Treasury paper proposed two tax ideas. The first was that problem created between the difference between the top personal income tax rate of 39 per cent and the company tax rate of 28 per cent.
Officials said this “limits the ability to efficiently raise revenue on individuals or reduce the company tax rate, as income can be sheltered in companies”.
The officials also said the “lack of a comprehensive capital gains tax restricts the ability to manage gaps between company rates and personal rates and increases costs of income taxation”.
The lack of comprehensive taxation of capital gains “has also contributed to higher house prices,” the officials said. Elsewhere the paper warned that restrictions on the development of residential land were also playing a role in driving up house prices.
The paper said that based on “principles such as sustainability, efficiency and fairness”, Treasury’s “first best advice is to address these two structural issues”
“Major tax changes take time to implement so there is a need to plan for these early,” they said.
The warning fell on deaf ears. One of the new Government’s first policy changes was to wind back the bright line test, a limited capital gains tax, from 10 years to two years.
Treasury said there were other options to raise revenue, but there was no “low-hanging fruit” left, and further revenue tools would require some tough decision-making.
The report also ventured into social policy, saying New Zealand’s high house prices and declining education system were dragging on the economy.
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.