Brian Gaynor 's Opinion

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor: Optimism plays part in big-picture Budget

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Positive 2015 forecast is reliant on a substantial increase in tax revenue and tight control on spending

During Robert Muldoon's time in power in the 1970s and early 1980s Budget statements were all about micro issues. Photo / NZ Herald
During Robert Muldoon's time in power in the 1970s and early 1980s Budget statements were all about micro issues. Photo / NZ Herald

Budgets are not what they used to be. In the 1970s and early 1980s there would be queues outside Government Printing Office outlets waiting for Budget statements to be released when the Finance Minister began his evening address.

These were then rushed back to offices for senior executives to trawl through while junior employees wanted to know whether petrol taxes or cigarette duties had been increased.

If the latter eventuated there would be a rush to the nearest petrol station or tobacconist before the higher taxes or duties became effective at midnight.

Budget statements were all about micro issues and stockbrokers would work through the night trying to work out which stocks would be negatively or positively affected. Clients would receive a newsletter on their desks before the market opened next day telling them which companies they should buy and sell.

Fortunately these micro-oriented Budgets are a thing of the past - most of the emphasis these days is on the big-picture issues, particularly Crown revenue and expenditure, the Budget surplus or deficit, capital expenditure and Government debt.

The most important feature of Finance Minister Bill English's 2013 Budget is the forecast surplus of $0.1 billion for the June 2015 year. The Budget's deficit/surplus profile - which will go from a deficit of $9.2 billion in the June 2012 year to a tiny surplus three years later - is illustrated in the accompanying table on the OBEGAL (operating balance before gains and losses) line.

The positive 2015 year forecast is based on a substantial increase in tax revenue and tight control over expenditure.

The main tax revenue sources in 2012 were: individual income tax $24.2 billion, GST $14.6 billion and corporate tax $8.6 billion.

The Treasury believes that income tax collections will increase by $2.6 billion in the 2012 to 2015 period, GST by $2.0 billion and the corporate tax take by $1.6 billion. The Fiscal Outlook stated that "these increases outpace the growth in the economy and see tax revenue rise as a share of GDP each year".

It is important to note that these forecast increases are based on higher incomes and expenditure rather than tax rate increases.

Most of the recent labour market weakness has been in the lower income areas. The top end of the employment market is strong and this benefits the Crown's tax take as individuals on $80,000 or more account for 49 per cent of total income tax even though they represent only 11 per cent of the total work force by number.

GST revenue is expected to increase, mainly because of a much higher residential property investment, and "corporate tax is expected to rise over the forecast period as business profitability continues to improve as growing domestic activity allows firms to rebuild margins which have been compressed in recent years. In addition, an assumed running down of tax losses that built up over the recession contributes to the forecast growth in corporate tax".

The Crown's revenue projections through to the June 2015 year are demanding but they can be achieved if the upturn in economic activity is maintained.

However, the New Zealand economy has been relatively unsuccessful in achieving a sustained economic recovery over the past 40 years.

The Treasury is also optimistic on the expenditure side as it is forecasting a mere $4.4 billion, or 6.4 per cent, hike in total Crown expenses in the three years ended June 2015.

Social security represents the biggest expenditure item with NZ Super payments expected to increase from $9.6 billion to $11.5 billion between the June 2012 and June 2015 years. This means that all other social security expenditure - which includes the domestic purposes, invalid, sickness and unemployment benefits - will increase by only $0.2 billion over the same three-year period.

This will be a major challenge for the Key Administration but it is hoping that a stronger economy will reduce the pressure of social security spending with the notable exception of NZ Super.

Health is another area where the Government is extremely optimistic as it is forecasting spending increases of just $0.7 billion, or 4.9 per cent, between the 2012 and 2015 years.

The low projected increase in health expenditure is surprising as more and more individuals enter the 65-plus age group and the number of people covered by private health insurance continues to fall. The latter even includes those in the 60-and-over age group.

Education spending growth is also expected to be relatively subdued, as are other costs. The main other costs in the June 2012 year were: debt interest payments $3.5 billion, law and order $3.4 billion, transport and communications $2.2 billion, economic and industry services $2.1 billion and defence $1.7 billion.

Another Budget line is the net performance of state-owned-enterprises (SOEs) and Crown entities (CEs). The former includes the electricity generators, KiwiRail and Solid Energy and the latter ACC, Radio New Zealand and Television New Zealand.

The SOE/CE contribution is expected to improve over the next few years as the performance of these entities picks up. This is particularly true of KiwiRail, which has been a major drag on the Crown's financial performance over the past few years.

New Zealand had 16 consecutive Budget deficits between 1978 and 1994 followed by 14 straight surpluses from 1994 to 2008.

The latest streak of four consecutive deficits is expected to continue for a further two years with the Finance Minister expecting a return to surplus in the June 2015 year.

This is achievable as long as the economy continues to improve but long-term Budget forecasts are notoriously unreliable.

For example the 2009, 2010 and 2011 Budgets forecast deficits of between $4.1 billion and $4.4 billion for the June 2013 year compared with the latest deficit forecast of a $6.3 billion.

Another important point is that the Budget deficit/surplus figures do not contain any proceeds from the partial sale of Mighty River Power, Meridian or the other Crown-owned enterprises. It also does not contain any capital expenditure items. These approaches are consistent with normal accounting standards.

Thus not all Crown revenue and expenditure is included in the Budget deficit/surplus figures.

For example, the Government believes its total costs associated with the Canterbury earthquakes will be $15.2 billion, comprising $12.9 billion in operating expenses and a further $2.3 billion in capital expenditure. The former is included in the OBEGAL figures but the latter is not.

These capital expenditure projects include the redevelopment of a number of Christchurch hospitals and the rebuild of several tertiary education institutions in the Canterbury region.

Student loans are also excluded from the OBEGAL figures.

As capital expenditure will exceed the cash flow from operating activity, even when the Budget returns to surplus, then Crown net debt will continue to increase beyond the June 2015 year.

The Key Administration's partial privatisation programme is based on the strategy to continue building schools, hospitals, roads and other major capital projects without incurring additional debt.

Budget documents show that Crown net debt would be $72.7 billion at the end of the June 2015 year, instead of $68.2 billion, if there were no partial privatisations.

Opponents of the partial asset sales argue that they are being offered shares in something they already own.

A better way to look at it is that New Zealanders, through the Crown, will continue to own 51 per cent of these partially privatised companies but they will also have more hospitals, schools and other major capital projects funded from the sale proceeds of these companies.

The partial asset sales strategy means that many of these projects can be funded without the Crown having to raise additional overseas sourced debt.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the Financial Markets Authority (FMA) in 2011. He is also a Portfolio Manager at Milford Asset Management.

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