Coming to terms with the hard realities of tackling the deficit

They say that denial is the first stage of grief and that overcoming it matters if you want anything to get better. There has been an awful lot of denial of the serious fiscal problem that the Government must start addressing in May’s Budget. From the left, every proposed reduction in spending is painted as a calamity. From the right, tax cuts are somehow still on the table. Both are serious forms of denial.

Tax revenue and government spending are both substantially higher than they were before 2020’s Covid lockdown – whether measured as dollars collected and spent, or as a fraction of overall economic activity.

Core tax revenue rose from just under 28% of gross domestic product (GDP) in 2019 to just over 29% of GDP forecast for 2024. But core government spending increased from 28% of GDP to 33.4% of GDP over the same period. The difference between the two is a problem.

Government spending increased by over six percentage points of GDP in 2020. Spending to deal with the worst parts of lockdowns and border closures mattered. But wage subsidies are now gone. Borders are open. And core government spending, as a proportion of GDP, is forecast to be only about a percentage point of GDP below its peak.

If you think the continued increase is because the Government has had to put more money toward healthcare, in the wake of Covid, and toward education, for dealing with the lingering effects of Covid in the school system, check the figures.

In 2019, education and health together were about $30 billion of a $100b government budget – 30% of the total. If education and health were pulling spending upward, they would now be a larger fraction of the larger budget. But Budget 2023 had education and health as about $44b of a $176b government budget – about 25%. Health and education are not what has driven the overall increase.

Compare growth in health and education spending with growth in other areas.

Spending at the Ministry for the Environment increased from $708 million to just under $3.5b over the same period. Transport’s budget also more than doubled – from just under $5b to just over $10b.

The Ministry for Social Development (MSD) went from $26b in 2019 to $41b in 2020 – understandable when the wage subsidy was in place and lockdowns blocked jobseeking. But MSD’s 2023 budget was $43b, despite relatively low unemployment rates.

Cyclical budget deficits resolve themselves: the reduced tax take and increased benefit spending during recessions should average out with higher tax revenues and reduced benefit spending during booms.

This problem is not going to go away all on its own. It would be there regardless of which party were in office. If we had a surprise economic upturn, it would still be there – though it could be eroded over time if spending held constant, or if the boom were big enough. The deficit is not cyclical. It is structural.

Whatever government is in office has to deal with it in the only way possible for dealing with a structural deficit: increase the amount the Government collects in taxes, reduce the amount the government spends, or both.

The last time New Zealand had a substantial structural deficit, the country was dealing with the global financial crisis and the Christchurch earthquakes. The structural deficit was at its worst in 2011 but recovered to surplus four years later through reasonable spending discipline combined with economic growth.

The current period’s deficit was at its worst in 2020 for obvious reasons. Three years later, Treasury’s briefing to the incoming minister estimated a current structural deficit equivalent to 2% of GDP. And the Government has been dampening expectations about any return to surplus, while still seeking to deliver tax cuts.

Pointing to low overall government debt as a potential way of avoiding spending reductions or tax increases is simply more denialism.

Debt is appropriate for handling cyclical deficits during recessions, not for dealing with structural deficits. And Treasury has warned that delaying getting the books in order means higher tax rates, lower spending, and a larger cumulative cost to the economy over time.

It gets worse. In 2011, the longterm fiscal challenges from an ageing population were still far in the distance. Those challenges are now much closer. Cost pressures will rise rather than fall, and the books need to be in order.

Basic maths lays out the options. Spend less, take more in taxes, or a bit of both. Anything else reeks of denial.

But surely a May Budget set by a National-led coalition Government ought to balk at setting a core spending path entrenching government spending as a larger share of the economy than finance minister Grant Robertson promised in 2019.

Dr Eric Crampton is chief economist with The New Zealand Initiative and a regular opinion contributor.

The NZ Initiative is a research group funded by a range of corporates and other organisations.