With inflation the elephant in the room, this Budget spend will be small fry compared with next year’s likely splurge

Treasury thinks the Government would have to deliver one of the biggest ever Budget spends next year just to stand still with inflation pressures likely to cost $3.5b next year.

In its Budget BEFU forecasts published yesterday, Treasury took the unusual decision of warning the Government it may have to raise taxes or cut services just to meet these costs.

Budget day isn’t just about the Government looking at who gets what — it’s about the Treasury publishing forecasts about what is happening in the economy and the risks it sees around the corner.

Unsurprisingly the big risk identified by Treasury is inflation. Next year, inflation is expected to be 5.2 per cent, the year after 3.6 per cent, and the year after 2.9 per cent. It will take until 2026 for inflation to get to 2.2 per cent. Those figures are about a percentage point higher each year than the Government was forecasting in December.

Inflation isn’t just a problem for households, it’ll hit the Government too.

Treasury said that in recent times, with inflation hovering around two per cent, funding “cost pressures” — the amount of money needed to maintain existing service levels — was about $2.2b a year.

Now it reckons higher inflation means the Government would need $3.5b for next year’s Budget just “to maintain the existing level of services”.

That is a large sum of money. Prior to this year’s Budget, the largest operating allowance in a modern Budget was $3.8b, which was the level of new spending in the 2021 and 2019 Budgets.

Next year’s Budget has $4.5b of new spending allocated to it — meaning it will be the second largest Budget delivered by this Government, second only to this year’s. New accounting rules mean $2b of that $4.5b has already been spent on funding cost pressures in areas like health, justice and natural resources sectors. That leaves $2.5b to manage cost pressures across the rest of the Budget. It’s worth remembering that agencies often complain of cost pressures, and ministers tend to push back on them.

Treasury warned it “may be challenging to meet these costs from the funding remaining”, and suggested the Government had “choices” if “a situation arises where additional funding may be required to manage the fiscal impact of Budget 2023 decisions”.

It presented three options the Government might want to consider. These included “reprioritising existing services” — essentially cutting spending somewhere to increase it somewhere else; “increasing tax revenue” or “finding savings” or “increasing the amount of the Budget operating allowance”.

Tax changes are probably off the menu, given Labour has committed to no taxes this term not already in its manifesto. Inflation also means the Government is taking in extra tax revenue, as people’s incomes rise.

Cost pressures were everywhere in this year’s Budget, with more than

30 new initiatives tagged as having something to do with maintaining the increased cost of service delivery.

One area shaping up to be a political battlefield has quite a lot to do with cost pressures.

Finance Minister Grant Robertson has been a frequent critic of the way the Government funds its services. Essentially, every ministry must come to him cap in hand each year for its regular funding. This means there is little long-term planning.

This year, he changed that in the areas of health, justice and natural resources. Those ministries were given multi-year funding, which will be counted against future Budgets.

In dollar terms, these new rules mean $2b of next year’s $4.5b budget has already been spent (mostly on health).

National argued that this essentially raids the kitty. Labour argues this allows sensible long-term funding.

Next year, we’ll be in a better position to say who is right. With health funding now consolidated under Health NZ it probably does make sense to give the agency the ability to plan funding long-term.

At the same time, ministers will have to make sure that multi-year funding isn’t abused. The system won’t work if Health NZ is allowed a top up each year if it blows its multiyear funding — this would essentially repeat the DHB deficit chaos the current Government wants to solve.

Treasury has forecast a mixed picture for housing. House prices will fall from their unsustainable highs by 2.5 per cent this coming year, remain level next year, and grow at just 1.7 per cent and 1.9 per cent in 2025 and 2026.

Treasury reckons residential investment — money going into building new houses — will roar ahead from just over $4b a year now to $5b next year. This is expected to pull back to about $4.5b a year as a “cooling housing market weights on residential investment intentions”. This means investment levels in new housing will remain above historic averages, but they will not increase year on year.

Treasury also put together interesting unemployment scenarios. In its pessimistic scenario, Treasury fretted the invasion of Ukraine would create more inflation, leading to the Reserve Bank having to hike interest rates even higher.

This would mean house prices experiencing a “deeper fall”, which would flow through to weak demand, triggering a recession in 2024 and unemployment of 6.5 per cent — higher than during the pandemic.

The weakening employment overall sees the Government forecasting tens of thousands more people will be on a benefit than it was expecting in December.

December’s HYEFU forecast reckoned 176,000 people would be receiving jobseeker next year, 169,000 in 2024, and 171,000 in 2025.

Those figures have been revised upwards to 178,000 next year, 180,000 in 2024, and 190,000 in 2025.

This is largely a function of the unemployment rate rising. It’s currently at a record low of 3.2 per cent, but is expected to rise to 3.3 per cent next year, 4.4 per cent the year after that, and 4.8 per cent in 2025.

Despite the high unemployment rate, wages are expected to roar ahead by six per cent in 2023, and 6.1 per cent in 2024, and 5.4 per cent in 2025.