Treasury warns NZ net public debt track still unsustainable by 2050 despite better economic outlook

Treasury has redone its projections for government debt out to 2050 and has repeated its warning that New Zealand's net public debt will surpass 100% of GDP without changes to policies on pensions or improvements to New Zealand's economic performance.

Treasury again suggested a public debate over retirement ages, means testing of pensions, cutting public pensions, raising labour force participation for the elderly, increased migration rates and increased labour productivity, particularly in government.

Treasury released its long term fiscal outlook in 2009 in the depths of the Global Financial Crisis, but since then the New Zealand budget deficit outlook has improved and the global growth outlook has improved. The government also announced major taxation reforms.

Treasury Deputy Chief Executive Gabs Makhlouf told the Retirement Income Policy and Intergenerational Equity conference in Wellington that were Treasury to redo its projections based on the May 2010 budget then net public debt would be expected to rise from around 20% now to over 100% by 2050. This is better than the 223% projected in 2009, but is still close to the net debt currently causing problems for Greece, he said.

"The underlying reality is that the Crown’s finances are not sustainable into the long-term on the basis of projecting forward historic trends in spending," Makhlouf said in the speech, which is available here.

"It isn’t the end of the world – but it is a warning signal for us to prepare for action," he said.

"New Zealanders need to do some significant things differently in the years ahead from what they have become accustomed to. Some serious trade-offs will be required to maintain the Crown’s finances in order."

New Zealand was transitioning from a high fertility/high mortality state to a low fertility/low mortality state. By 2060 New Zealand was expected to have four people aged 65 years and over for every 10 New Zealanders of working age between 15 and 64. That is up from a ratio of two to 10 today.

In the next 50 years the combined pre-working age population and population over 65 would be around 7 for ever 10 of working age, up from 5 for every 10 now. Makhlouf said this was likely to reduce the labour force participation rate from around 68% to 63% by 2060. He noted this also took into account the likelihood of more older New Zealanders working for longer.

"If we assume, perhaps optimistically, that those older workers undertake paid employment at around the same number of hours as the average of the current workforce, that still won’t be enough to prevent New Zealand’s trend real economic growth rate from easing back from an average of 3% per annum over the next three years, to a bit under 2% from the mid-2020s," he said.

"The rise in the ratio of elderly to the working age population will act as a drag on the economy’s potential growth rate. Over time, our economy will be constrained by a lower “non-inflationary” speed limit than we are currently constrained by and this will coincide with a period when the call on the Crown’s resources to fund social services and entitlements will be rising because the ratio of dependents will be rising relative to those of working age," he said.

"Today, around 25% of the government’s annual operating spending goes on social services, including health and New Zealand Superannuation, to the 13% of the population aged 65 and over. Those ratios are projected to rise dramatically by mid-century, reaching as high as 40% of the central government’s annual operating spending for a group that, by 2050, will constitute around 25% of the population," he said.

"Those are significant figures and they raise important questions, including about intergenerational equity."

Some other OECD governments, with more precarious public finances now, were raising their pension entitlement ages and reducing public service pensions.

"But New Zealand’s relatively benign starting position is just that, a benign starting position," Makhlouf said.

Better, but still trending up

Treasury's projections showed spending would quickly overwhelm income and New Zealand's benign starting position.

"Our problem in the long term is the same as other countries’ and that is that our government’s debt curve is projected to be on an upward trend at the end of the projection period, when what we require is for a levelling off or a decline," he said.

Treasury wanted to foster public debate about the choices the public would have to make, including likely tax changes if no changes were made to spending.

The latest projection update suggested the tax to GDP ratio would have to rise by a little over 2%, by possibly either a 3.5 percentage point rise in personal tax or a 4.2 percentage point rise in the GST rate. However, this would reduce the long term growth rate, he said.

"More attractive solutions lie in enhancing our economic growth, which in turn will provide higher living standards to all New Zealanders. With higher incomes, people will be better positioned to cover some of the costs of services they currently receive from the public purse. They will also be able to afford to pay more tax to ensure that those unable to participate in the workforce are still adequately cared for by the State."

Other options to improve the growth rate included enhanced labour productivity, improved labour force participation for over 65s or increased migration, he said.

"But, as we also said in 2009, higher economic growth is not the sole solution to addressing our future fiscal pressures. While lifting economic growth, we also need to slow our spending growth to ensure we live within our means and do not burden future generations of New Zealanders with higher levels of debt they need to finance.

"New Zealanders are in the same boat as every other developed economy on the questions that need to be addressed in the context of the long-term finances of government. The hard questions confronting us are the same ones in front of all developed societies: how best to adjust to put government finances onto a sustainable footing over the long term.

"A projection for net debt of around 100% of GDP may be a less unnerving headline than a projection for over 200% of GDP, but what matters is not individual numbers but the direction of the Crown’s debt position. If the direction is upwards and deficits are set to continue, then it is only a matter of time until a 100% net debt position spirals out to a 200% ratio to GDP.

"The Treasury’s work in this area since 2006 consistently informs us that, if you project historic trends in spending into the future, then the projections for the Crown’s debt curve is headed upwards, meaning that growing debt financing costs ensures that net debt will continue to grow at an accelerating rate."

Reform options

Some options for reform included:

* changing the indexation of the taxpayer-funded pension;

* means testing of New Zealand Superannuation;

* more KiwiSaver-like products in providing retirement income.

"Governments have the capacity to manage the fiscal position over time. It will involve change and choices. The principles we advocated last year still apply: make early change, keep debt under control, focus on outcomes and growth, encourage workforce participation, keep spending under control and focus on public sector productivity."

Here is the full speech attached.

Here is the full Powerpoint display with the speech.