Fiscal policy is getting harder, according to the Minister of Finance

Is she hinting that the Coalition Government will have to back down on key promises it made in Opposition?

• Brian Easton writes –

The Minister of Finance, Nicola Willis, is telling an evolving story about her fiscal challenges. In Opposition she was confident that she could deliver her promised income tax cuts. Appointed minister, she reported the (Treasury) ‘books’ were in a worse state than she expected, although this seems to be more from her advisers not reading the Treasury’s Pre-election Forecast and Update carefully enough. It’s a good trope because it blames the outgoing government, but it’s hardly the analytic foundation to plan the 31 May budget.

More recently, she has been arguing that the economic outlook is tougher. The Treasury September 2023 PREFU, and just about everyone else, had forecast a stronger economy for 2024 than now looks likely.

We won’t have the detailed Treasury macroeconomic forecast until the end of May, but the Reserve Bank’s Monetary Policy Statement has one although, alas, not as detailed nor as structural as Treasury’s so that it is harder to analyse.

Even so, we can get some insight into the deterioration by comparing the RBNZ February 2024 forecast with the November 2023 one. It would appear that it is now expecting the economy to track about 1 percent lower than was expected three months earlier.

The commentariat has just announced the economy was in recession in the last 6 months of 2023; a more detailed analysis suggests the economy has been stagnating since the middle of 2022. The forecasts do not expect the economy to really pick up before the end of this year. That means per capita output has been falling and will continue to fall through the year. Next year might be better – it might not.

The fall appears to be from lower than expected private consumption and possibly in exports – although the RBNZ now expects export prices to be better – and public expenditure (neither of which it reports). Business investment has hardly been changed.

You may not think these changes are large but lower GDP translates into lower tax revenues, compounding the fiscal problem Minister Willis faces. It appears that some of the Opposition’s estimates of the additional revenue from tax changes were markedly optimistic.

Probably – we shall need to wait until May to find out – the gains from cutting some public expenditures, such as on investment projects and social security benefits, have been spent already (e.g. on reinstating for landlords the income tax deductability of interest rates).

In Opposition, the minister said her plans depended on cutting government spending in many areas by 6.5 percent and more, without being aware that previous Minister Robertson had already ordered 2 percent cuts. They are proving difficult to attain.

The public sector is not being curmudgeonly. Rather, the government is reluctant to cut programs. Instead, it is requiring substantial productivity increases, which are much harder to get in service industries. (Another possibility is there will have to be cuts in the remuneration of public servants – they will not be compensated by the promised income tax cuts.)

Oppositions tend to be more optimistic, thinking the economy will grow faster under their benign influence. I do not think the prolongation of the current stagnation is anything to do with the new coalition government; business is not expected to revise its investment plans in either direction. On the other hand, there is no evidence the new government has caused the economy to grow faster (sustainably – it can always be boosted for a few quarters).

The National Opposition’s optimism was evident in some of its estimates of tax revenue from others of its policies, with some revenue-raising initiatives even having to be abandoned. So the additional revenues side of their policies is looking weaker too.

There are claims (notably by Winston Peters) that the government faces a huge fiscal deficit if it implements its policy promises. I don’t know whether this is from access to inside information. I’ll wait until the Treasury bean-counters’ figures are revealed.

All this makes the promised income tax cuts difficult to finance without additional borrowing. Minister Willis has already announced she will be borrowing more, with the return to zero net borrowing delayed by one year.

It is all about squaring the circle, isn’t it? So easy to promise in the fantasy of opposition, so hard to attain when you are in the reality of government. It is not just that oppositions tend to be optimistic about themselves. They do not always have the technical capacity to analyse the deeper issues. (One National Opposition spokesperson on finance appeared to be innumerate – as the Labour government gleefully exploited.) We are likely to see similar challenges in the current Labour Opposition.

In opposition, Willis said she would resign if she does not deliver on her promised income tax cuts. Other politicians have made similar promises and reneged on them. That is not an easy course, requiring both courage and political skill. But ultimately it is better for the economy and the nation to live in the reality of government than the fantasy of opposition.

In government, Willis, while denying any fiscal shortfall of the size Peters claims, says she won’t guarantee the promised tax cuts will arrive in July until the policy has been discussed by Cabinet. Perhaps her shift on the state of the economy is preparing the public for moderating or delaying the cuts. If the fiscal situation is proving as difficult as one fears, I hope so.

You will find this columnist criticising the government when politics dominates economic commonsense and approving it when it makes good economic decisions. That does not mean I agree with the values which frame its decisions (any more than I did with previous governments).*

In a sense I am like a Treasury official. They accept the political direction of their minister – even when they personally disagree with it – and do their best to design policies to implement their minister’s desires. But the desires are limited by reality; the hard numbers in their accounts and forecasts are a part of that limitation. I guess not a few officials are looking forward to the 31 May budget with apprehension. So should their Minister.

* For example, I am less enamoured with the incidence of the proposed income tax cuts. If they are intended to ease pressures on households from inflation, as the minister says, it might be better to target them more on households paying high mortgage interest rates. But there are not as many votes in such a strategy.

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This article by Brian Easton was first published on Pundit