Thomas Coughlan: Biggest Budget decision coming next month

Finance Minister Grant Robertson had good news to announce yesterday, but he faces difficult choices at the Budget. Photo / Mark Mitchell

OPINION:

You'll hear a lot about Grant Robertson's election year Budget next year.

A Budget is one of the incumbent government's key advantages in election year: monopolising months of attention on delivery and policy as voters sharpen their minds ahead of polling day.

For Labour, keen to burnish its credentials as a party of public services, it provides an opportunity to demonstrate the power of the state to deliver services, and justify why Labour governments typically opt for a higher tax burden than National ones.

The last time a Labour government extracted itself from an electoral pickle was 2005, the year they narrowly defeated the Don Brash National Party. The Budget that year created KiwiSaver, a big Working for Families boost, and left fiscal headroom for the 2005 elections rabbit-out-of-hat interest-free student loans policy.

Next year's election Budget will be slightly different to any of the last three decades. Inflation means the big political and economic question both parties need to answer isn't "what will you spend the money on?", but rather "how much will you spend?".

Under New Zealand's public finance laws, the question of "how much" isn't answered on Budget day in May, but at the Budget Policy Statement, usually held in December.

This is the day Robertson will tell us the operating and capital allowances - that's Budget speak for how much money is being set aside for new discretionary spending and investment (we're not talking about the $120-odd billion of existing spending - just the new stuff).

The operating allowance is the key number to watch out for. At the Budget, Robertson increased this to $4.5b. From this pot of money, he'll have to fund the bulging cost pressures in ministries as well as any election goodies the party can think of.

A sum of $4.5b would be the second-largest operating allowance of any of Robertson's Budgets (the largest being the $5.9b of this year's Budget).

Robertson will have to decide at the Budget Policy Statement whether to increase this further. A better-than-expected tax take at the Crown accounts would give Robertson plenty of political and fiscal room to do this - but this is no ordinary year. In any ordinary year, an increased allowance would be a good thing - it gives more money for spending goodies and tax cuts (remember, tax cuts are also "funded" through an allowance, in finance speech).

But this is no ordinary year. Robertson and the people who want his job need to find the balance between scraping together enough money to win an election, whilst also making a virtuously "small" Budget that doesn't stoke inflation and ideally helps to bring it down.

Now, you may think that $4.5b leaves plenty of room for goodies, but as both Labour and National are discovering, it leaves less than one would think.

A massive $2b has already been pre-committed through the new multi-year funding approach. This isn't terrible - it means areas like health already funding, but it means there's just over half of the original allowance for other initiatives and election bribes.

There's also the hit of inflation to government services. At the Budget, Treasury estimated growing cost-pressures in the public sector mean baseline expenditure would need to increase by $3.5b just to maintain existing service levels - leaving behind a mere $1b of the allowance for election promises or anything else. Again, in ordinary times, the Government could simply increase the allowance and fund both cost pressures and new initiatives.

In fact, if you look at Treasury's most recent forecasts (from May) and the Crown accounts released last month you could see a pathway to this. The May forecasts show that even with $4.5b in new operating spending, the Government will still post a healthy surplus the year later, in 2025. The Crown accounts - $10b better than forecast -would suggest that this surplus might occur even earlier, in 2024, leaving additional funds to plough into the budget or spend on tax cuts.

Alas, the problem with these forecasts is that they're likely fanciful. Winter in the northern hemisphere is likely to plunge European countries into recession, which will drag on New Zealand's growth. Treasury's new forecasts, HYEFU, to be released with the Budget Policy Statement, will almost certainly show lower growth and lower tax revenue meaning less to spend, while also showing longer and more persistent inflation, meaning more pressure on the Government to keep spending low.

Treasury estimates that every one per cent of GDP growth in 2023 is worth $1b in wage and salary revenue, and $550m in revenue from corporate profits. It's not impossible to see flagging GDP growth slashing public revenue by almost as much as National's indexation policy.

This isn't just an issue for Labour - it's a problem for National too. National will inherit these conundrums if it wins office in 2023. The party can, strictly speaking, afford its tax cuts (in the same way Labour can afford to spend more). What it can't do is cut tax, lower debt, fight inflation, and maintain funding for public service levels all at the same time.

The real tension is between cuts, spending and inflation. Take the party's bracket adjustment policy, costing about $1.9b if it were implemented in 2024. That leaves just $1.1b from that year's operating allowance to fund everything else. If the party remains committed to increasing health and education spending by the inflation rate they'll have to increase the operating allowance to do it, meaning they'll be spending more in that budget than Labour currently plans to - adding to inflationary pressure (although it's fair to bank on Labour spending more than $3b that year too).

Now, National has already said some of the funding for public services will come from cutting wasteful spending elsewhere. It would need to, simply increasing the allowance, adding borrowing to fund both tax cuts and spending increases, would be inflationary (one area where Labour's Liz Truss comparisons are fair). But finding enough spending to cut to maintain service levels will be difficult.

Treasury has not published a "standing still" cost pressure figure for the 2024 Budget, but if inflation remains high, as it very well could, National may well find itself needing to fund $1.9b worth of tax cuts, plus another $3.5b of cost pressures, leaving it with a Budget larger than any delivered by the current government with the exception of Budget 2022.

Managing those cost pressures, while funding tax cuts, while fighting inflation would require some serious spending cuts elsewhere, cuts that may not be politically possible.

The Act and Green parties' economic realism on this is refreshing. Act says tax cuts need to be paired with spending cuts, the Greens say cost pressures need to be met with tax increases.

The tussle over the next Budget is really part of a larger story, playing out over decades.

National is right to argue that the tax burden is too high. Core Crown tax revenue is at 30.2 per cent of GDP, higher than at any point since 2008, when both Labour and National promised tax cuts.

New Zealand's over-reliance on taxing income means that this burden is being carried by ordinary workers, who are relatively highly taxed if you don't include support like Working for Families, received by some.

But Labour is equally right to argue that the cost of services is high - and getting higher.

Perhaps New Zealand's historic tax burden of 25-30 per cent of GDP is no longer adequate for a country with an ageing population facing threats like climate change and an increasingly uncertain security environment, but who is going to argue for taxing people even more to fund that cost?

While headlines focused on the below-expected expenditure at the Crown accounts in October, one line of expenditure was way up: superannuation, which increased by $1.2b in just a year thanks to an increase and recipients and payment rates, which are pegged to wages, which are rising faster than historically.

In 2002, we spent 4.5 per cent of GDP on superannuation, by Budget 2025, the middle budget of the next Parliament, we'll be spending 5.2 per cent. probably more, given the effects of inflation on the way payments are calculated). By the end of the decade, the figure will be 5.5 per cent.

Likewise health spending, which is 6.3 per cent of GDP this year, compared with 5.4 per cent in 2002. There are persistent calls to lift defence spending to 2 per cent of GDP from about 0.8 per cent of GDP (although other calculations have it higher).

These aren't small numbers - 2 percentage points of GDP in additional spending means $7.2b of additional revenue needs to be found from somewhere within that revenue window of roughly 30 per cent of GDP.

There is a fairly secular trend for higher levels of expenditure across government yet, for now at least, the level of taxation politicians are wedded to is roughly the same as we've experienced the last two decades. Any finance minister will have to choose between raising taxes somewhere, or embarking on a rethinking of the level and kinds of services we've come to expect from the state.

Piling all of that additional revenue burden on an overtaxed workforce would be difficult and potential solutions like capital gains, land and wealth taxes, even if you look beyond their political problems, would be difficult to roll out and often don't bring in nearly the revenue their creators would want.

The relative fiscal benignity of the past two decades may be over - only difficult choices lie ahead.