National leader Christopher Luxon, Act leader David Seymour, and NZ First leader Winston. 24 November 2023 New Zealand Herald photograph by Mark Mitchell
In February of this year New Zealanders learnt that the Government was running a “structural deficit” in the view of Treasury, its central economic agency.
Despite Treasury saying that closing this deficit should be the Government’s top priority, the former Government was never briefed on the existence of a structural deficit, according to information released to the Herald under the Official Information Act.
Treasury is currently recommending tough choices like spending cuts, restraint in the growth of new spending, tax reform, and even potential asset sales in order to deliver on the Government’s fiscal goals while in a fiscally restrained time.
Far from sounding the alarm, for much of the period leading up to Budget 2023, Treasury advised the former Government to increase spending levels, before belatedly advising ministers to reduce them.
Treasury eventually issued stern advice to Labour, warning New Zealand could be in line for a credit rating downgrade if it didn’t demonstrate a return to surplus.
The first Treasury briefing to a minister about the structural deficit was delivered to the Beehive on November 27, the day the current Government was sworn-in when ministers received not one, but two, separate briefings which mentioned the problem of a structural deficit.
As with many economic terms, the definition of a structural deficit depends on who you talk to, but broadly speaking, it indicates that the Government’s books are in the red not because of an unfortunate and temporary shock, like a pandemic, but because the Government, and the people in charge of it, have chosen to spend more money than they earn.
A structural deficit means the Government is unsustainably borrowing money to fund its spending in both good times as well as bad. This is usually thought to be unsustainable. Eventually reality catches up in the form of a painful fiscal crisis of high borrowing costs and unpalatable spending cuts and tax hikes to bring the books back into order.
A structural deficit, in other words, is a very serious, very bad thing. Commentators and economists had pondered whether New Zealand had a structural OBEGAL (Operating Balance Before Gains and Losses) deficit in 2023, but it was only in February that New Zealanders knew that the Treasury agreed with them.
The term was included in Treasury’s briefing to the incoming Minister of Finance Nicola Willis which Treasury gave on November 27, the day she was sworn in. It was released publicly later in February and published by the Herald.
On February 16, in a speech to the New Zealand Economic Forum, Treasury Secretary Dr Caralee McLiesh said that as “New Zealand is running deficits throughout the economic cycle, the country is now best described as having a structural fiscal deficit”.
“This will prove unsustainable unless change is made, as outlined in Treasury’s current forecasts,” she said.
McLiesh also set out the stakes of continuing to run structural deficits, saying they “increase vulnerability to the fiscal impacts of natural disasters and other economic shocks, increase debt servicing costs, shift costs to future generations, and ultimately reduce governments’ ability to provide public services”.
Just two days earlier, in response to patsy questions in the House, Finance Minister Nicola Willis said she had been warned in Treasury’s briefing that the Government was “currently running a structural deficit … largely because of growth in Government spending”.
The Herald asked Treasury for the first briefing that warned New Zealand was in a structural deficit. Treasury responded that its briefing to the incoming Minister of Finance on November 27 was “the first advice which explicitly mentioned a structural deficit”.
A second briefing advising Willis of initial directions for her fiscal strategy was also sent that day. This document has been withheld by Treasury.
Treasury told the Herald that while it had not explicitly warned the previous Government of a structural deficit, “Treasury’s advice has shown for some time, including at the time of Budget 2023, that the structural balance was in deficit”.
The spokesperson cited forecasts delivered to the former Government ahead of Prefu. It warned the Government that the massive growth in revenue post-Covid and following revenue shortfall “suggests a greater proportion of that rise was temporary than previously anticipated”.
“While a near-term deterioration in the fiscal outlook would be less concerning from a fiscal sustainability perspective if the drivers were entirely cyclical, we don’t think this is the case in this instance … any steps taken now that support longer-term fiscal sustainability would be helpful, provided they are enduring (structural) changes…” they said.
“Our analysis and understanding has continued to evolve with the Treasury explicitly stating for the first time in the BIM that there was a ‘structural deficit’.”
Budget 2023 was drawn up during a time of rapidly changing forecasts.
On October 20, 2022, Finance Minister Grant Robertson received Treasury advice on the allowances for the next Budget. An allowance is the amount of new spending included in the Budget.
The operating allowance for that year was set at $4.5 billion, but Treasury recommended large increases to the allowances not just in Budget 2023, but in subsequent budgets as well. Officials recommended increasing Budget 2023′s operating allowance from $4.5b to $5b, and Budget 2024′s from $3b to $4b while Budget 2025 and 2026 would be increased from $3b to $3.5b.
Cumulatively, those changes would bake in an additional $7.5b in spending over the four-year forecast period.
Treasury thought at the time that these changes could be made without compromising a return to surplus in 2024/25. The economic environment has deteriorated so rapidly that the surplus appears to have slipped to beyond 2028.
In the event, Robertson ignored Treasury’s advice and kept the allowances at their existing level. It was only in February after Cyclone Gabrielle that the allowances were increased on Treasury’s recommendation.
At that point, Treasury documents reveal the allowances were increased, not just in Budget 2023, but for 2024 and 2026. These Budgets were increased by even more than Treasury recommended in October, rising to $4b each year.
It means that eight months before declaring a structural deficit, Treasury was advising the Government to increase spending by roughly $7.6b across multiple budgets.
Then things went awry.
On April 1, the Government was given a nasty surprise in the form of a Treasury briefing that warned tax revenue was coming in far below forecast. In total, $9b in revenue was wiped from revenue forecasts.
The source of the Government’s fiscal woes appears to be the bottom falling out of the economy, resulting in much lower tax revenue. Seven months after Robertson had rejected advice to increase his allowances and return to surplus in 2024/25, he asked Treasury for “urgent advice” on options to return to surplus by 2025/26 fearing the surplus would now fall even later.
“Based on modelling the near-final Budget and Economic Fiscal Update (BEFU) tax forecasts provided to you on April 1, your Budget 2023 decisions to date, and other known matters, we are now anticipating a return to OBEGAL surplus in 2026/27,” Treasury warned.
Treasury advised reducing the future allowances to $3.5b or even back to $3b, which was the level included in the Budget Policy Statement. It reckoned these reductions would free up enough headroom to keep the surplus in sight.
At this time, Treasury also advised Robertson to look at a “fiscal sustainability and efficiency programme” which was included in the Budget. This programme would respond to the drop off in tax revenue by cutting deparments’ baseline spending, much like the current Government is doing.
News of the cuts was missed on Budget day but burst into the open when NZ First leader Winston Peters fired off a press release accusing the Government of trimming spending to cover up an alleged $20b hole. Peters was wrong about the $20b, the hole was closer to $9b, but he was right that the Government was cutting spending to respond to it.
Advice to Robertson for the remainder of the year warned that the chance of returning to surplus was diminishing, but Treasury never warned him of a structural deficit.
In July, he was advised that the Prefu forecasts should “demonstrate a return to surplus within the forecast period” and that Robertson should demonstrate a path to surplus or face the wrath of credit ratings agencies.
“Credit rating agencies’ reaction at Prefu can be expected to be limited given recent ratings reviews and their awareness of the upcoming election,” officials warned, but “[i]f the forecasts at Hyefu [Half-Year Economic and Fiscal Update] continue to show persistent deficits, then there is also a reasonable likelihood there may be some signalling of ratings action by credit rating agencies”.
So far, there has been no credit rating downgrade, although in September, S&P downgraded the relative score for New Zealand’s debt burden.
The fiscal rollercoaster raises two key questions about Treasury’s advice: the advice to Labour suggests the deficit is tied to New Zealand’s economic fortunes - if that is the case, can it be described as structural; and if the deficit really is structural, why did Treasury wait until the new Government was formed to sound the alarm - and whether that is in line with the neutrality expected of the public service?
Thomas Coughlan is Deputy Political Editor and covers politics from Parliament. He has worked for the Herald since 2021 and has worked in the press gallery since 2018.
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