While the country’s financial outlook is slightly better than forecast with tax the main contributor of an improved fiscal outlook, a litany of risks puts New Zealand’s recovery in a delicate position, Treasury says.
“All headline fiscal indicators are now stronger, largely due to an improved tax forecast and the flow-on effects to interest costs from the reduction in the Government’s borrowing requirements,” according to the pre-election economic and fiscal update (PREFU), released by Treasury on Tuesday.
PREFU shows what the Treasury, the Government’s lead economic and financial adviser, is observing in the current economic and fiscal climate before a general election. It also includes future projections and potential risks over the forecast period.
This comes as Treasury said Operating Balance Gains Before Gains and Losses excluding Accident Compensation Corporation (ACC) had improved by $11.5 billion over the comparable forecast period. This was an average of $2.9 billion per annum with Treasury saying the improvement was weighted towards the early years of the forecast.
The Operating Balance Before Gains and Losses (OBEGAL) is a key fiscal indicator used by the Government. Finance Minister Nicola Willis introduced OBEGALx, which excludes the ACC.
“The OBEGALx position in 2028/2029, the year in which the Government intends to return to surplus, has improved by $1.4 billion from a surplus of $2.6 billion at the Budget Update to a surplus of $4.0 billion."
OBEGALx is now expected to return to surplus in 2027/2028 – one year earlier than in this year's Budget.
Tax the primary driver of an improved fiscal outlook
“Higher tax revenue is the primary driver of the improved fiscal outlook,” Treasury’s document said, with Core Crown tax revenue revised up by $11.4 billion over the four comparable years of the forecast period.
The tax-to-GDP (gross domestic product) ratio showed the average tax take for each dollar of GDP lifts from a cycle low of 27.6% in 2025/2026 to reach 29.1% in 2030/31.
This was due to the operating surplus of firms growing at a faster rate than nominal GDP – lifting business income tax. As growth in nominal incomes lifts the average tax rate paid by individuals (fiscal drag) means more tax is paid for every dollar of income, and multiple policies contributing over the forecast period to extra tax revenue forecasts that reflect the latest tax data.
The higher tax revenue was partly offset by the decision to defer the increases to fuel excise duty and road-user charges, which PREFU said would have reduced tax revenue by $1.4 billion over the forecast period.
“The stronger revenue outlook reduces government borrowing, resulting in net finance costs being revised down by $1.7 billion despite increased market interest rates.”
Treasury said the improved tax revenue forecast was primarily the result of higher than previously forecast tax returns in 2025/2026 combined with a stronger nominal GDP growth forecast.
“In part, the stronger fiscal outlook reflects the asymmetry between the impact of inflation on revenue and expenditure,” the PREFU document said.
“Higher prices lift tax revenue by increasing nominal incomes, spending and profits, while many areas of government expenditure are determined through fixed Budget allowances and therefore do not automatically rise with inflation.”
PREFU said this generally resulted in a net fiscal gain in the forecast period.
“However, higher inflation can also make it more difficult for agencies to operate within existing funding baselines and allowances, increasing pressure on future Budgets.”
Economic outlook
In terms of the economic outlook, Treasury said it was characterised by three themes: restrained domestic demand, resilient global demand supporting exports and ongoing geopolitical risks.
“Household spending, business investment and employment growth are expected to remain subdued in the near term, before improving as inflationary pressures ease and real incomes recover," Treasury said.
“At the same time, resilient global activity continue to support demand for New Zealand’s exports, helping offset weak domestic conditions and supporting an improvement in the terms of trade over the forecast period. However, geopolitical risks, particularly for those associated with the conflict and oil price volatility, remain a key source of uncertainty for both growth and inflation.”
The risks
PREFU said risks remained skewed towards weaker growth and higher inflation.
“While the forecasts show the fiscal position recovering steadily over the forecast period, there is considerable uncertainty around that outlook.”
Treasury pointed to cyclical risks affecting near-term growth and inflation, unexpected events like natural disasters, financial market volatility and geopolitical conflicts, and structural factors affecting the economy’s long-run growth potential as risks to New Zealand’s outlook.
Alongside this, Treasury said: “Fiscal pressures, including demographic and other cost drivers could also place pressure on future Budgets and the fiscal outlook. On balance, these risks are assessed to be weighted to the downside.”
When it comes to the near term, Treasury said the persistence of the oil price shock due to conflict in the Middle East was the main uncertainty.
“If energy prices remain elevated for longer than assumed, inflation could prove more persistent, requiring higher interest rates for longer and resulting in weaker economic activity.”
Over the medium to long term, the PREFU document said structural risks related to productivity growth, migration and the terms of trade, could affect economic performance and the fiscal outlook.
In terms of house prices, Treasury forecasts they'll fall 0.4% this year, rise 0.6% next year, with price growth continuing to increase through 2028 to 2031 from 2.4%, to 3.7%, 4.1% and 4.8% in 2031. It sees unemployment falling from 5.6% this year to 5.2% next year, and continuing to drop over the forecast period to 4.3% in both 2030 and 2031.
Treasury's forecasting annual consumers price index (CPI) inflation dropping from 4.1% this year to 1.9% this year, and staying around 2% through the balance of its PREFU forecast period.
Tax take
Finance Minister Nicola Willis said the numbers gave “real grounds for optimism."
Tax revenue, particularly from businesses, has been higher than expected.
“It’s not because of new or larger taxes, but because New Zealand businesses have been doing better than anticipated. This is what we all want to see,” Willis said.
“Many of these positive effects, including higher business tax and boosted revenue, are expected to flow into future years as well.
She said the update showed the operating balance deficit shrinking from the $11.4 billion forecast at the Budget to $6.8 billion this financial year, and to less than $1 billion next year.
Willis said she would not play the rule in, rule out game when it came to income tax change promises, “because today is about opening the books and demonstrating to New Zealanders that our plan is working”.
The PREFU replaces the Half Year Economic and Fiscal Update (HYEFU), which is normally published annually every December except in years that have a general election.
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