‘The Pre-election Economic and Fiscal Update’ (PREFU) tells us something about the future of the Public Sector but it requires careful analysis to assess how it is going.
The 2020 PREFU is the most important economic statement during any election campaign. Unfortunately the commentariat tends to treat it briefly and then move on – often to trivia.
Like BEFU (at the time of the budget) and HEFU (the half yearly report in December), PREFU is the Treasury’s assessment of the state of the economy and the government accounts. It is not the Minister of Finance’s. The Secretary of the Treasury signs it is the Treasury’s independent assessment. It has to be for there could be a new minister after the election. Moreover, the document is used by both local and international economists who would quickly identify political compromising which would undermine the Treasury’s reputation for independence.
A big document of 177 A4 pages, PREFU is based on all cabinet decisions up to 7 September, so that any Labour Party campaign promises (such as raising income taxes or spending more) are not covered (nor, of course, are National’s or any other party’s).
Treasury forecasts tend to be much in the middle of what professional economists think, but they are much more detailed and with more explanation, especially about current government spending plans. To repeat, they do not include any party’s election promises; in any case, most are too vague to call them ‘plans’ – try ‘pigs in a poke’.
The main caveat is that the Treasury forecasts will be wrong. They always are, as the PREFU indicates when it compares the current Treasury ones with the May 2020 BEFU ones. (The honesty of the Treasury’s assessment of its past forecasting performance contrasts with slacker standards of many commentators.)
Critically, PREFU provides an economic framework of how to think about the future. That is why serious economists spend a lot of time going through the tedious detail. There is only space to discuss a couple of issues.
Current Public Spending and Revenue
There has been a surge in public spending (including transfers) across the Covid Crisis. That has been understandable but the concern has been that mixed in with the emergency spending have been significant increases in structural spending which will not unwind with the ending of the crisis.
PREFU reports that nominal Core Crown Expenses in the June Year Ending 2024 (by which time they think the Covid Crisis will be over) are expected to be 33.6 percent higher than five years earlier (JYE 2019). On the other hand nominal GDP is expected to rise 20.0 percent.
So relative to GDP, the government expects to be spending about $7.3billion more in 2024 compared to 2019. The big percentage increases are Social Security and Welfare (38.8%), Housing and Community Development (56.6%) and Environmental Protection (33.2%). Among the smallest are Core Government Services (3.9%) and Heritage, Culture and Recreation (6.1%).*
Finance costs are down, despite increasing debt, because of falling interest rates. You’ll be surprised to hear that Health spending is projected to increase by only 17.6 percent and Education 19.0 percent. But there is an allowance of $11.0 billion for new operating expenditure in 2024; Health and Education will get the lion’s share.
Before your eyes glaze over, let’s go on past a lot more detail and report that Crown Tax Revenue is projected to rise 14.0 percent – less than the GDP rise. (That is without the promised – outside PREFU – Labour income tax increases, or National’s promised tax cuts.) Had it risen in line with GDP, there would have been an extra $5.1b of revenue in 2024.
Both personal income tax and GST rise in line with GDP. The deficit arises in a miscellany of taxes including lower company tax and from the impact of lower interest rates.
Net Government Debt
Given strong spending and weak revenue, the government deficit goes up. So government debt is rising (and its ‘net worth’ is falling), not only from the Covid Crisis.
I focus on Net Core Crown Debt, which is projected to rise from 19.0 percent of GDP in June 2019 to 56.9 percent in June 2024, because that is the figure the public rhetoric focuses on.
Before we descend into hysteria, I repeat my assessment in past columns.
Prior to the Covid Crisis I supported a net public debt ratio in the 20 to 30 percent of GDP range. To simplify, I observed that the midrange for OECD countries was 50 to 60 percent, and I thought it prudent that we should run a bit lower because of our high overseas private debt (which could turn into high overseas public debt if things went even more awry than they did during the GFC),
So I saw our medium-term public debt strategy as about a prudent reserve for coping with a big shock. I had not expected such a shock from a pandemic but the Covid Crisis has shown the wisdom of the target range.
The New Zealand ratio is now in what was the OECD middle range. But that, too, has risen because everyone else has been borrowing to get through the pandemic shock.
(A wonkish paragraph but I warn against various accounting tricks to reduce the visible ratio which do not change the underlying situation. Where we might make some progress is a serious discussion on how to evaluate the government balance sheet. By focusing solely on Net Core Crown Debt the commentariat dumb down the issue of a quality balance sheet.)
Should we be aiming to get the ratio down? It is too soon to tell. I worry that we may be caught out badly if there is another big shock soon. On the other hand, I do not see a case for screwing up the economy to meet any arbitrary debt target. We deliberately increased debt to cushion the effect of the pandemic. Suddenly removing the cushion will cause the contraction we have been trying to avoid. Even so, my sense is that we are going to have to raise taxes or cut spending in the longer run. I would be happier about making any decision if I knew who in the private sector was (indirectly) holding the public debt.
My cautious approach is not to do too much in the immediate future to change the PREFU trajectory. Let us prepare for a serious debate after the HEFU in December when we have better idea of the track of the Covid Crisis and have got past the ephemera of the election. rhetoric. For while the PREFU may be an important election document, sadly the political parties are paying little attention to it.
* Having a particular interest in heritage, culture and recreation I wonder why it does not have stronger advocates in cabinet.