New Zealand has a post-pandemic hangover and needs to take its economic medicine in Budget 2024, according to Finance Minister Nicola Willis at least.
Speaking to the Employers and Manufacturers Association last week, she said the “post Covid-19 party” had become a distant memory, replaced by a “difficult economic downturn”.
“Now that the laws of economic gravity have reasserted themselves, New Zealanders are faced with the cost of cleaning up. This is the hangover after the wild party. And, as everyone knows, the wilder the party, the longer and messier the hangover,” she said.
While it is not fair to say the Labour Government spent the past three years partying, it did drink too much from a punchbowl of unsustainable economic growth.
The enormous, and largely necessary, fiscal response to the pandemic was mixed in with some nice-to-have policies and a permanent expansion in public sector employees.
When the economic tide went back out—thanks in part to the Reserve Bank—the Government discovered it had become too big to float in shallower water.
Grant Robertson began the process of jettisoning surplus cargo but was turfed out of office in the election and Willis won herself the job of reducing Crown spending.
Take an aspirin
The new Finance Minister said on Monday she had found 240 individual savings to be included in the Budget, either by reducing funding or stopping the activity altogether.
“We have uncovered a layer cake of government initiatives, many of which we had never heard of before, which were absorbing tens of millions, if not hundreds of millions of dollars”.
She also said asking public sector departments to cut their budgets by up to 7.5% had resulted in 2250 employees being laid off and 1150 vacancies not being filled.
Willis also said an additional 500 employees were losing their jobs due other savings initiatives. That puts the total count at just under 4000 jobs cut, largely in Wellington.
The Public Service Association, the country’s largest trade union, has described this approach as being “heartless and chaotic” and warned it will lower the quality of public services.
But the Taxpayers’ Union, a small government pressure group, says these cuts are only a fraction of the 18,000 jobs added between 2017 and 2023. They want much deeper cuts to clear the path for income tax brackets to be adjusted for all inflation that has occurred since 2011, a policy which would cost almost $5 billion a year.
Willis and the National Party campaigned on a much smaller promise. They would move the brackets by about 11.5%, or about $2 billion, which only compensates for inflation since 2022.
The Coalition Government has promised to deliver a version of this tax policy with some adjustments. NZ First killed a revenue source and the Act Party asked for a flatter system to be considered.
Cutting tax cuts
It is plausible the final policy offers even less than the 11.5% campaigned on. National took its tax calculator offline this week, making it hard for voters to compare it to the Budget.
Analysis by Interest.co.nz suggested the Government was about $1.6 billion short on money required to make the cuts fiscally neutral, and Willis has more-or-less ruled out new taxes.
There may be unannounced spending cuts that fill the gap but if not, she’ll have to downsize the tax cuts or phase them in more slowly.
Mark Smith, an economist at ASB, said the income tax cuts would likely be smaller than in the package originally announced, due to the revenue shortfall.
National’s tax package was designed to be isolated from the fiscal strategy and economic context. This was always a fiction, but has become harder to justify as deficits deepen.
Smith said Treasury’s economic forecasts were likely to confirm a downgrade in nominal GDP which will mean the gap between government spending and revenue will widen.
“Incorporating tax cuts will dent Crown revenues even if we do expect the size of the package to be scaled back,” he said.
Doug Steel, an economist at BNZ, said he doubted whether “any meaningful surplus” could be achieved in the forecast horizon — which runs out to 2028.
“A structural deficit and cyclical pressures, that we have long pointed out, make for an awkward backdrop for a budget,” he said.
Income tax cuts were a non-negotiable promise to voters which the Government cannot walk away from now, particularly since they have already cut property-related taxes.
Long walk to surplus
The real test for Willis will be whether she can chart a credible path back to surplus within the forecast without destroying the public services New Zealanders rely on.
Miles Workman, an economist at ANZ, said whatever new policy mix was described on Thursday would be less important than the ongoing fiscal consolidation.
Willis would need to adopt a $3.2 billion operating allowance this year and then stay below $3 billion in each subsequent year to achieve a “wafer thin” surplus in 2028.
She has given herself permission to match Labour’s operating allowance, at $3.5 billion, in this budget while also warning she couldn’t make a habit of it.
“If we were to continue with the spending allowances set by the previous government, the operating balance would not get back to surplus until the year 2030/2031,” she told the EMA.
Prior to the election, National said it would spend $3.2 billion, $2.85 billion, and $2.7 billion in each of the next three budgets, compared to Labour’s $3.5 billion, $3.25 billion, and $3 billion.
The Treasury warned, in its pre-election update, that future governments would have a difficult time sticking to even the higher spending track.
Budget cuts which have shocked the public sector this year will likely just be the first round, many chief executives will already be thinking about what to cut next year and the one after.
And at the end of it all, there will have been another three years of inflation and Willis will be wanting to take another swing at income tax brackets.
Love it or hate it, Budget 2024 is only the beginning.
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