The Government may pick up an extra $14.6 billion of debt over the next four years as the economic slowdown hits tax revenue

Economists at Westpac New Zealand estimate the Crown accounts will be $4 billion deeper in deficit next fiscal year, due to weaker tax revenue. 

On Monday, the bank’s research team released a note previewing the Pre-Election Economic and Fiscal Update (PREFU) which will be released on September 12. 

It said the outlook for nominal gross domestic product, which drives tax revenue, had deteriorated since the forecasts which were included in Budget 2023.

Those forecasts predicted a $7 billion operating deficit this fiscal year and $7.6 billion in the 2023/24 fiscal year.

However, corporate tax receipts for the current fiscal year were already $2 billion below expectations by the end of May. Likely due to higher interest rates slowing the economy. 

Nathan Penny and Darren Gibbs, senior economists at Westpac NZ, said this trend was likely to continue and these deficits could be revised up to $9.4 billion and $12 billion, respectively. 

“This reflects pressures on corporate profitability due to strong growth in wages and other costs of doing business, at a time when growth is slowing,” they wrote. 

Rose-tinted forecasts

Treasury was likely to lower its forecast for gross domestic product growth, which will translate into lower tax revenue as well. 

The forecasts provided alongside Budget 2023 took a more optimistic view of the economic outlook than many others, including those prepared by the Reserve Bank. 

For example, Treasury assumed the Official Cash Rate would peak at 5.25% and that it would be lowered in mid-2024. One week later the Reserve Bank lifted the rate to 5.50% and has signalled it will stay at that level until 2025. 

Penny and Gibbs said the strong labour market was providing some support to domestic demand and holding up income tax revenue. 

But these good news stories would be outweighed by slow economic growth among New Zealand’s most important trading partners, most notably China. 

“Amidst an increasingly disappointing recovery in the Chinese economy, export commodity prices have declined further since the Budget, led by a very sharp slump in dairy prices.”

Treasury had assumed in its forecasts that stronger growth in China would limit any declines in export prices — that no longer looks likely.

“This weakness will weigh on growth in nominal GDP and will lead to lower tax revenue from corporates and small businesses (with many dairy farms likely to be running at a loss this year, tax from this sector will be down sharply).” 

Second surplus delay

Westpac NZ expects Treasury’s updated PREFU forecasts will not show the Crown accounts returning to surplus until the 2026/27 fiscal year. That’s one year later than in Budget 2023. 

During those four years, an extra $14.6 billion of debt would be added to the Crown balance sheet if no policy changes were made. 

The National Party has expressed concerns about debt levels, but hasn’t made any commitment to getting back into surplus faster than Labour. 

It has only committed to cutting spending enough to cover the cost of an 11.5% income tax cut, which would leave the Crown accounts in the same shape as forecast. 

Labour’s Grant Robertson has reportedly asked the public service sector to search for cost savings and could plausibly announce spending cuts alongside PREFU to soften the losses.

Westpac’s Penny and Gibbs said Treasury would likely have to increase its bond issuance by roughly $15 billion across the next four years to cover the extra debt levels. 

Investors may have already priced some increase into the market but the extra supply would likely lead to a modest rise in bond yields, they said. 

This short-fall in tax revenue seems likely to be what NZ First’s Winston Peters and National’s Nicola Willis were alleging was a $20 billion “fiscal hole” some weeks ago.

At the time, Robertson said it was public knowledge that tax revenue was below forecasts but dismissed the $20 billion figure as speculation.

The Act Party had suggested the tax short-fall could be as much as $30 billion, which does not seem to be very likely.

An earlier version of this story miscalculated the total amount of extra debt accrued.