Budget 2014 lifts government spending by $1.5 billion or 2 per cent in the coming year but that will represent a cut in real per capita terms.
A surge in net immigration - largely driven by fewer New Zealanders leaving for Australia and more returning - is pushing population growth over 1 per cent, while the Reserve Bank forecasts inflation to be 1.9 per cent in the year to June 2015.
The Treasury, like other forecasters, has been surprised by the rapid turnaround in net migration flows. The Budget forecasts the annual gain to peak at 38,000 this year, from 32,000 now, but it also sketches an alternative scenario where it hits 42,000, which would increase the population by nearly 1 per cent even before natural increase (births minus deaths).
The $372 million fiscal surplus forecast for the 2014/15 year is around only 0.5 per cent of forecast revenue and well within the margin of error for the operating balance (excluding gains and losses). Three-quarters of the way through the current year the tax take is running $900 million or 2 per cent below forecast.
For Budget 2015 and beyond the Government has increased from $1 billion to $1.5 billion the operating allowance, which is the amount it allows itself for new initiatives, whether spending increases or "modest" tax cuts.
Finance Minister Bill English emphasised the need at this stage of the economic cycle for the Government's fiscal policy not to put upward pressure on interest rates.
A $500 million increase in the operating allowance for future Budgets was around the upper limit before it would materially impact on interest rates, he said.
Budget 2014: Brian Fallow analysis:
Treasury advice released yesterday concluded that lifting future operating allowances by $500 million per Budget would have an upward impact on the official cash rate of around 15 to 30 basis points, if it took the form of higher government spending, and around 10 to 20 basis points if it was used to cut tax.
It would also lift the real exchange rate by 0.5 to 1 per cent for about three years.
Overall the Treasury expects fiscal policy to be contractionary - that is, subtract from demand in the economy - by around 0.7 per cent of gross domestic product a year over the next three years.
"We are trying not to repeat the mistake of the previous cycle when runaway government spending pushed mortgage rates above 10 per cent," Englishsaid. "It is tempting to crank another $1 billion out in spending but households, who have pretty high debt, will pay a price for that."
Measured against the size of the economy, government spending is forecast to ease from 31 per cent now to just under 30 per cent in four years. This is not in line with English's reported comments to party faithful in Queenstown at the weekend when he spoke of wanting to get that ratio down to 25 per cent in six or seven years.
Even with an extra $500 million for spending or tax cuts pencilled in for future Budgets, the Government's net debt is forecast to fall to 20 per cent of GDP by 2019/20, allowing contributions to the New Zealand Superannuation Fund to resume that year.
"After net debt has gone below 20 per cent of GDP we intend to maintain it within a range of 10 to 20 per cent of GDP over the economic cycle, while also making contributions to the New Zealand Superannuation Fund," English said.
Standard & Poor's reaffirmed its AA+ rating on New Zealand government debt. The Budget forecasts economic growth to pick up to 4 per cent by March next year before easing back to 3 per cent the following year and 2.1 per cent in the two years beyond that.
The Treasury is forecasting stronger near-term growth in private consumption than it was six months ago, with real wages rising 0.9 per cent in the year ahead and 0.6 per cent the year after.
The unemployment rate is forecast to drop below 5 per cent by 2017 but still be above the level it estimates would put upward pressure on inflation.
The current account deficit is forecast to widen from $7 billion or 3 per cent of GDP now to $17 billion or 6.3 per cent of GDP in four years.