Coalition's first test of fiscal rectitude

By Rod Oram

Between the lines


When Cabinet meets today, it should pause to savour the strong economy before it gets down to its political agenda.

An election gift, the perky performance gives the new Government a breathing space. Rather than fight economic fires, Labour and the Alliance have time to set their Governmental structure, establish priorities and tackle high profile issues such as Police Commissioner Peter Doone.

But it is only a breather. The Government's room for fiscal manoeuvre is limited.

Very soon the budget setting process will force it to make some politically unpalatable tradeoffs between what it wants to do and what it can afford to do.

The problem is not the state of the economy but the fiscal strait-jacket the Government has to wear.

The economy should motor along this calendar year and next. Right now, it is growing at an annual rate of about 4 per cent. It's well balanced growth, with farmers and foresters enjoying a strong pick up and manufacturers pumping out exports. Best of all, the housing market is subdued and so poses no threat to inflation.

With our trading partners forecast to enjoy economic growth of about 3.5 per cent this year - the best rate since at least 1993 - the Government can bask in the sunshine of an economic "high".

If the Government's luck holds, growth could be even stronger than forecast, with every extra percentage point of growth in gross domestic product generating about $350 million of tax revenue.

Even short term it's got extra money to spend - about $700 million to $800 million this year thanks to cancelling National's proposed tax cuts and by raising the top personal rate.

But after Government spending has swollen from those sources, the budget strait-jacket will start to chafe. The problem lies in the nature of budget surpluses, as David Plank of Deutsche Bank points out. To get real cash out of the surpluses, the Government must run even bigger surpluses.

The operating surplus in the year ending June 2001, for example, was forecast at $800 million by the Treasury last October. But the cashflow was forecast at a negative $300 million.

The gap is caused by a number of non-cash items in the surplus calculation. It includes, for example, full profits of state-owned enterprises yet only some of them are paid out in cash dividends the government can spend.

And this is a overnment that wants real cash to spend, not just on services but on capital items such as new hospitals and schools. Moreover, it wants money to invest so future superannuation payments can be met in part from long-term funding rather than from taxes.

Finance Minister Michael Cullen is well aware of these dynamics. Today he will start driving the message home in Cabinet when he reminds his colleagues they have to come up quickly with fiscal plans and spending priorities.

The Government has to publish a draft budget - the Budget Policy Statement - by the end of March. Its proposals on the volume and quality of spending and how to fund it will give us the first chance to judge the new Government's level of fiscal responsibility.