Finance Minister Nicola Willis committed to 'challenging' future spending limits in order to deliver the full tax cuts as promised on the campaign trail

The big takeaway from Budget 2024 was future spending levels would be seriously constrained and most new policies would have to be funded through reprioritization.

What newly-released documents show is Finance Minister Nicola Willis restricted future budgets even more than Treasury officials advised, in order to deliver on her tax plan while still getting the Crown accounts into a comfortable surplus by June 2028.

The process to build Willis’ first budget began three days after the Coalition Government was sworn into office in late November 2023. A late election and protracted negotiations meant work was three-months behind schedule before it even started.

Documents show it was Treasury officials that advised the new finance minister to deliver the budget as late as possible in May and encouraged her to delay critical decisions for flexibility.

For example, the Budget Policy Statement (BPS) released in March 2024 was highly unconventional in that it didn’t outline the Crown’s operating allowances for future years. 

An email summary of a meeting between Willis and Treasury said the Finance Minister initially wanted to set allowances in the BPS and then plan spending within those limits.

But Treasury officials “persuaded” her not to do so. They warned economic forecasts were shifting and there was a risk those allowances would have to be reset just a few months later.

“MOF listened and took this onboard, she’s acutely aware reducing allowances constrains her room to manoeuver and puts her commitments at risk,” the email said. 

“She brought up the credibility of allowances point and is conscious of backward engineering allowances to deliver an outcome, something she said she’d commented on her predecessor doing.” 

Here Willis was referring to the idea that governments can set small operating allowances to show a path to surplus, but not marry it to a spending plan which stayed within those limits.

Labour’s annual budgets generally included larger operating allowances than had been signaled in previous fiscal forecasts. Willis wanted to avoid making the same mistake. 

This created a dilemma. The Finance Minister wanted operating allowances to be as small as possible but not so tiny that she would have to backtrack and increase them in the future.

To do this, she needed to take a “bottom up” approach in which the allowances were set around cost pressures and spending priorities, rather than the other way around.

Willis’ determination to stick to her operating allowances gets mentioned several times in emails summarizing Treasury meetings with the Finance Minister.

She ultimately asked her Cabinet colleagues to approve a 2024 operating allowance of up to $3.5 billion, which was what Labour had planned, and defer the decision on future years.

Trouble with tax 

Here Willis faced another dilemma. The National Party had campaigned on cutting taxes, as well as getting the books back into surplus — two policy goals running in opposite directions.

Treasury initially advised the Minister to target a return to surplus in June 2027, but later recommended 2028 as the economic outlook deteriorated. The next two operating allowances would have to be set at $1.65 billion and $1.4 billion to hit that first target.

“The speed and scale of a rebalancing to deliver an earlier surplus carries risk that it is not achievable or sustainable and may undermine broader objectives, including living standards and economic prospects,” they said.

Officials said it wasn’t “realistic” to reduce operating allowances below $3 billion unless the Government was willing to scale back both its tax commitments and other policy priorities. 

However, updated economic and fiscal forecasts in April showed that the Crown accounts may still be in deficit even in 2028 and Treasury began to advise further cuts. 

Future operating allowances should be reduced by $250 million to $300 million and the Budget 2024 package should be reduced “as much as possible” but by at least $500 million.

This would need to include scaling back the tax package and taking the “upper bounds” of other policy decisions that had not yet been finalized. 

If Willis wasn’t willing to cut Budget 2024, future allowances could be reduced by up to $500 million instead — as long as Cabinet approved an ongoing cost reduction plan.

Cut tax cuts

Treasury said it broadly supported correcting brackets for fiscal drag but “given the continually delayed return to surplus and the related rise in debt levels” recommended a rethink.

Officials drew up a range of options to reduce the cost of the package by between $1.3 billion and $1.7 billion across the forecast, either by phasing it in more slowly or downsizing the bracket adjustments.

At this point, Willis was still working with a $3.5 billion operating allowance for Budget 2024 but hadn’t yet confirmed the full package would fall within that limit. 

Unwilling to scale back the tax package, budget ministers agreed to a $3.2 billion package a week later and asked the Treasury for advice on how to still deliver a surplus in 2028. 

It suggested reducing future operating allowances by $2.5 billion but said it would be possible to cut another $100 million to increase the certainty of a surplus. 

“We do not recommend this option at this time as it increases the relative risk that allowances would need to be increased in future,” officials advised.

Willis’ determination to never increase allowances made this a more consequential decision than it might have otherwise been, and she opted for the $2.4 billion allowance.

In essence, this decision means the Government committed to making deeper cuts to spending in the future so that it could preserve room for the income tax cuts in 2024.

Treasury officials said Budget 2024 had already required the Government to not fully fund some cost pressures, leave out some policies, and reprioritise money from existing programs. That approach will now have to be replicated in the next three budgets with increasing difficulty.

“While you don’t have a single commitment as large as the tax package to fit into new spending at future budgets, Ministers will need to reprioritise to fund new initiatives far more than their departments are used to,” they warned.

“The savings exercise including baseline reductions undertaken for Budget 2024 has reduced much of the ‘low hanging fruit’ and easy savings options.”

Already off-track? 

To make matters worse, roughly $1.5 billion of Budget 2025 had already been pre-committed and the Government has since pre-spent another $150 million for cancer drugs.

Making funding decisions between budgets was something Treasury told the Finance Minister to avoid if she wanted to manage within the smallest possible operating allowances. 

The budget process pits competing bids against one another and allows Cabinet to select those with the best value for money. Funding decisions made out-of-cycle do not face this kind of competition and can end up taking the place of a better policy.

Treasury also said all Cabinet Ministers would have to share Willis’ commitment to sticking to operating allowances for this fiscal strategy to work. This rule has also been broken, with Foreign Minister Winston Peters negotiating to exclude his portfolio from spending cuts. 

In a letter addressed to Prime Minister Christopher Luxon, Peters offered up options for the $98 million annual budget cut that had been requested.

“Please understand these ideas are offered as an absolute last resort for how to move forward … if you and the Minister of Finance insist on proceeding with applying a savings target to the Ministry of Foreign Affairs," he wrote.

The most substantial proposed cuts were redacted from publicly released documents but likely involved closing some embassies and cutting foreign aid budgets. 

Peters described these as being “seriously unwise”, knowing his letter would eventually be publicly released, and ultimately only $15 million of back-office cuts were accepted.

Documents show Willis was interested in using substantial cuts from the Foreign Affairs Budget to informally offset a budget boost in the Defence Portfolio. She appears to have been overruled.

The Finance Minister ought to hope her colleagues don’t take inspiration from Peters’ exceptionalism and also start asking to be spared cost cuts in the next three budgets.

She already has a Herculean task on her hands.