Finance Minister Nicola Willis and Prime Minister Christopher Luxon's strategy to reduce spending levels will have consequences, Treasury warns. Photo / Mark Mitchell
The Government’s goal to reducing public spending as a share of the economy could require the public to “accept a lower level of public services provided in some functional categories”, or wholesale changes to the types of services offered, according to a previously secret Treasury paper.
This may involve “reducing access to health and education services” and an “implied reduction in their quality”.
Hitting the spending goal might also mean freezing inflation adjustments to things such as Working for Families, which would reduce the real incomes of more than 300,000 households receiving the tax credits.
The Government set itself a fiscal strategy goal to reduce “core Crown expenses towards 30% of GDP over time” from about 32.7% currently.
In December 2024, Treasury officials wrote a paper that probed what would need to happen to spending on public services in order to hit that goal. The agency fought hard to stop the paper from being released.
In January the Herald requested a copy of the paper under the Official Information Act. This request was refused outright by Treasury.
The Herald appealed that decision to the Ombudsman, which saw a version of the paper released with extreme redactions.
The Herald continued to pursue the release of paper with the Ombudsman.
On Friday afternoon, Treasury released the entire paper, with only minor redactions.
The paper states in clear terms that reducing spending to 30% of GDP would mean permanently accepting worse public service levels, or reducing the types of public services the Government currently provides, the most obvious example of this is agreeing to raise the superannuation age.
Unless there was a windfall in “higher-than-assumed revenue or productivity growth”, then reducing spending of 33.6% of GDP to 30% would require some serious retrenchment in services.
The paper modelled what that retrenchment would look like. Each year, as the economy grows, the Government faces “cost pressures” which result from existing services getting slightly more expensive due to inflation.
The Government’s current strategy to reduce overall spending levels to 30% of GDP is to hold off on funding all of these cost pressures meaning that over time, while spending levels increase in nominal terms, they fall as a share of the overall economy.
The Treasury paper warns that this would mean public service quality diminishing - it also warns that this strategy might not be enough, and more wholesale reform of what types of services the Government offers and to whom may be required.
Officials warned that “maintaining medium-term fiscal sustainability will require significant reforms to policy settings and / or reductions to public services in some areas”.
The paper was delivered to the Government before one of its biggest spending reforms: the decision to wind back pay equity reforms, saving $12.8 billion - although just under half of that funding was used to pay for the InvestmentBoost tax change for businesses.
Finance Minister Nicola Willis told the Herald the paper highlighted “some well-known, long-term challenges facing NZ”.
However, she cautioned not to read too much into the modelling.
“It is important to remember that this particular Treasury model automatically allocates future funding across all spending areas according to a set rule, so its results are almost predetermined,” she said.
Willis noted that the Government had pre-allocated funding increases in health, and there was headroom for increased spending in education.
“Future governments will make additional choices. I can’t commit them to particular courses of action, but while I am finance minister investment in health, education and other key public services will remain Government priorities,” Willis said.
Her opposite number, Labour’s Barbara Edmonds said the paper laid bare the Government’s underfunding health and education.
“National’s plan means deeper cuts to health, education, and the services Kiwis rely on. In just two budgets, Luxon and Willis have underfunded health, cut women’s pay, and failed to deliver cost-of-living relief.
“These documents make it clear: more cuts are coming, because Nicola Willis can’t meet her fiscal plan without slashing health and education,” Edmonds said.
The 30% of GDP target is a carryover from the Clark-Key-English years when spending has tended to hover around that level in normal times and slightly higher in a crisis.
The issue Treasury identified is that thanks to an ageing population leading to higher superannuation and health costs, 30% of GDP buys fewer and poorer quality public services in the 2020s than it did in the 2010s and 2000s.
“The cost of providing public services has increased faster than for other goods and services.
“Government dominated service-based industries – such as health and education – have relatively low (and difficult to measure) productivity growth.
“Generally, we expect costs in low productivity growth industries to increase as the cost of the inputs (particularly labour) is set by industries with higher productivity,” Treasury said.
Treasury estimated that about 1-1.5% of GDP of the increase in total Crown spending (a sum worth about $4.3b or $6.6b in 2025 ) since 2017 could be attributable to the rising costs of delivering existing Government services such as health and education.
A further 1% of GDP in the increased costs could be due to “demographic trends”, mainly an ageing population. Treasury also thinks that as NZ has become wealthier, it has elevated its expectations.
Treasury said that “active policy choices”, mainly under the last Government, had increased some costs - and it also pointed the finger at the previous National Government for reducing health spending as a share of the economy.
Health spending fell as a share of the economy from 2018/19, “reflecting a benign wage environment, funding below demographic and inflationary pressures (contributing to DHB deficits), and minimal new spending”.
Since 2018/19, most of the increase in health spending “related to population, ageing, inflation, and wage pressures (broadly consistent with the drivers described above)”.
Other increases in spending on health were due to pay equity and by increasing the services that the health system offered.
Welfare was another area where spending had increased, partly thanks to an increase in benefit levels and partly thanks to more people claiming those benefits.
Debt servicing cost, higher now thanks to pandemic-era borrowing and higher interest rates, added another 1% of GDP to spending levels.
A redacted version of the paper, previously reported by the Herald noted Treasury modelled how much new money departments actually need to continue offering the same level of service they do today.
Three sectors, health, education and defence, were responsible for 75% of the rising cost of public services.
Treasury calculated health spending would need to hit 8.5% of GDP by 2038 to fund “an ageing population and non-demographic factors associated with costs and productivity”.
However, in order to hit the Government’s 30% spending goal, this figure may need to be reduced to about 6% of GDP by 2030. The difference between those two figures is about $10b in today’s money.
About 300,000 families with children currently receive Working for Families tax credits. This boosts family incomes through the tax system.
The amount of money people receive from Working for Families, and the earning threshold at which people become eligible for it, are fixed - and do not get adjusted automatically for inflation. This means the Government periodically needs to adjust Working for Families tax credit thresholds to ensure that it reaches the same number of low-income families it was intended for.
The same is true of the amount of money families receives - this also needs to be adjusted upwards to maintain its real value.
The Treasury paper warned that its modelling of the Government’s fiscal strategy “does not incorporate any cost pressures resulting from changes to benefit settings as incomes increase over the projection”.
That would mean that on top of the reduction in health and education spending, in order to hit the spending goal as modelled, the Government would need to freeze Working for Families thresholds, meaning hundreds of thousands of families would see their incomes reduce in real terms - and some of them would see their eligibility for the tax credits disappear entirely.
The result is a painful economic pincer, of lower public service delivery taking place at the same time as the income of lower-income households were reducing.