The importance of reducing debt
May 25th, 2009 at 9:52 am by David FarrarBrian Fallow in the Herald looks at why we now have a debt problem:
Over the past five years, government spending has increased by 50 per cent – twice as fast as the economy or tax revenues have grown.
Even in the same budget as which Dr Cullen finally gave tax cuts, he still increased spending by $4.5 billion. He didn’t even leave enough money for his Super Fund contributions – and that was before the flobal recession.
But now tax revenues are falling as the recession lays waste to the tax base. Treasury secretary John Whitehead says it will be some time in 2011 before the level of economic activity is back to where it was in 2007.
So three or more years of no extra income, yet the continual spending increases give us a huge deficit and debt problem.
This would see gross government debt double by 2013, relative to the size of the economy, and in the absence of a policy response climb to over 75 per cent of GDP by 2023. That is where it peaked in 1987; only by 2023 there will be the added pressure of baby-boomer pressure on health and superannuation costs.
This is what the situation would be under Labour. Labour have condemned basically every saving National has made, and just demanded more and more spending.
Whitehead in a speech on May 15 spelled out what that level of debt would mean. It would be $49,000 for every man woman and child in the country: “A family of four would basically have another mortgage of close to $200,000″.
$200,000 debt for a four person family. Not much of a future.
“But as we see it the most effective way the Government can begin to get on top of expenses is by reducing the spending allowances for future Budgets, currently set at $1.75 billion for the 2009 Budget and increasing by 2 per cent a year in each of the next three Budgets.”
Over four years that provision is a cumulative $18 billion in new spending. “We expect the Government to halve those spending allowances,” Purdue said.
Reducing the provision is sensible. In the late 1990s it was only $600 million a year. At $600 million a year then over four years it is only $6 billion as opposed to $18 billion.
Related posts:
- Key signals less debt while Goff promises more debt
- The risk of debt
- A path out of debt
- Debt under a Labour-led Government
May 25th, 2009 at 10:11 am
David, if National were to win an election, how would we know?
Vote:May 25th, 2009 at 10:13 am
Did you read Rod Oram in yesterdays Star Times? According to his figures we rank 3 lowest out of 18 of all the AAA rated countries (that is the top rating). My concern is the external deficit accumulated on the foreign account. Shouldn’t the govt do something about private borrowing for non productive purposes such as property investment. I agree keeping the budget in surplus does not hurt but I would have thought there are much bigger fish to fry.
Vote:May 25th, 2009 at 10:49 am
“Only” $6 billion? – that’s a huge reduction from $18b but it’s still a very big number.
Vote:May 25th, 2009 at 10:57 am
We have no debt, the prudent managers of the last 9 years took care of that for us. Oh hang on… read the numbers rather than the BS spin… bugger – OK help me out her people, what about the last 9 years was prudent management because Cullen said it was and I need to tow the party line or I’ll be banned from the standard.
Vote:May 25th, 2009 at 11:11 am
–Did you read Rod Oram in yesterdays Star Times?–
He said, quite rightly: “But Treasury’s forecast was nonsense. It assumed the government would make no change in spending strategy or priorities. Yet Treasury knew that any government, whether National or Labour-led, would have adjusted its fiscal policy.”
Please stop spinning this fantasy theory of future debt levels that nobody would let happen and lead some decent discussions about spending and tax priorities.
Vote:May 25th, 2009 at 11:14 am
Didn’t Muldoon do the same thing as Labour when he was on the way out?
Vote:May 25th, 2009 at 11:17 am
It’s impossible for all Labour’s extra spending to be justified in terms of net benefit to the country. Simply agreeing with it and looking to trim *future* spending still leaves all that waste in place, and condemns the country to trying to win a yacht race with a huge sheet anchor out the back.
Maybe National needs to be honest and say that it won’t cut out waste as it’s too electorally damaging to try and instead will just manage our decline. Labour would have us decline faster so I guess it’s a sort of a win.
The electorate is, I think, too stupid to realise that we are in a hole and need to cut back things like Working for Families – a vast socialist ediface with numerous draw backs and heavily regressive. Possibly the worst public policy disaster of all.
But let’s not pretend that we are going to improve our performance by just holding spending increases and locking in all the waste implicit in Labour’s huge and unaffordable spending binge.
Vote:May 25th, 2009 at 11:41 am
Cullens fiscal management has been an absolute disaster.
Vote:May 25th, 2009 at 11:41 am
I’m sure I recall Key saying, during the election, that NZ didn’t have a savings or debt problem, it had a growth problem… that was the argument against surpluses, what’s changed other than which side of the House he’s on?
[DPF: What has changed is debt is now forecast to know out to $49,000 per person - at that level we would have a debt problem. One can be relaxed about minor deficits from time to time - but not about a permanent structural deficit of $10 billion. Except Labour who since the election have only campaigned on increasing the deficit.]
Vote:May 25th, 2009 at 11:45 am
he-man>Didn’t Muldoon do the same thing as Labour when he was on the way out?
Cullen, Muldoon, and Hitler all implemented scorched earth policies as they were removed from office. But Hitler had a Speer to ignore his orders and save what was left of Germany. Why couldn’t someone in Labour have stood up and stopped Cullen from buying trains, blowing our taxes on all sorts of low value tat, and borrowing to fund all sorts of election bribes.
Vote:May 25th, 2009 at 11:55 am
None of you get it do you.
We should be following the example of B Hussein Messiah Obama, the answer is to borrow as much as you can and spread it around like confetti.
If you run out of money or nobody will lend it to you then just print some more, when questioned by the press you smile, and answer “yes we can”.
Bloody simple really.
Vote:May 25th, 2009 at 12:39 pm
[DPF: What has changed is debt is now forecast to know out to $49,000 per person - at that level we would have a debt problem. One can be relaxed about minor deficits from time to time - but not about a permanent structural deficit of $10 billion. Except Labour who since the election have only campaigned on increasing the deficit.]
It’s clear that the supluses of the last decade were well above a structural level (all the more reason to praise the previous administration for resisting un-targeted tax cuts I think) but this collapse will eventually be corrected and tax revenues will return alleviating pressures government spending. Remember however, that National campaigned not on cutting spending, i.e. keeping WFF etc, but on increasing productivity. Increasing productivity, ambitious for NZ, reducing net PLT departures blah blah blah. I concede the crisis changes things and that English has a tough task with this budget, but much of this was known before the election and still smiling John wandered the nation promising every family a rainbow… how’s he going to deliver this and when?
Vote:May 25th, 2009 at 12:42 pm
re Paul Williams 11.41am
Yes, we have a growth problem. The trouble is that with government spending approaching 40% of GDP we have no chance of achieving significant growth. It comes back to having to trim Labour’s waste and get our spending down to around the 30-34% mark.
No matter what the weasel words, if government taxes the productive sector then wastes its resources on silly spending there’s no way the country can prosper.
Vote:May 25th, 2009 at 12:48 pm
DPF – do you think that holding spending is enough to get us through or do we need to tackle the waste issue? At least National should spell out the fact to the electorate that they are not tackling waste as they know that they will be voted out if they try, so they are content with a third best policy option which is to manage our decline, but that’s what the electorate is mandating them to do.
An alternative option is to come out with the facts, the options, the costs and benefits and give some visibility to the trade-offs. I note that Roger Douglas has issued a number of short policy papers over the last three weeks on budget options. See the ACT website for these. Of course the MSM have not reported one syllable. It really needs English or Key to lead on this as the MSM will not be able to ignore similar statements from them.
Vote:May 25th, 2009 at 12:57 pm
There’s an interesting assumption in your argument that I’d appreciate you elaborating. It is that the size of government spending determines the growth rate of the economy. Is this based on some historical analysis or something else? I don’t think I agree, incidentally, I think our growth problem is much more about the nature of the economy and particularly that we have low trade intensity due mainly to our export profile i.e. food and fibre commodities.
Compared with Australia, which is lucky to have vast mineral deposits and a far larger domestic economy, NZ’s growth was actually higher for most of the last decade but is now lower.
My problem with David’s earlier post is that Key promised solutions to this “problem” but I’ve not yet seen anything serious, not even the jobs summit. As I said, the current crisis could be said to change things but for the fact that it was known at the time Key made all his “ambitious” claims. Time to pony-up!
Vote:May 25th, 2009 at 1:33 pm
How does the govt spending/GDP ratio affect GDP growth? I was not aware the NZ had a particularly high ratio, nor was I aware that the US growth rate over the past decade was any worse the the EU.
Vote:May 25th, 2009 at 1:40 pm
Paul, there’s a lot of literature around on this point. See for example Winton Bates’ 2001 study: http://www.nzbr.org.nz/documents/publications/publications-2001/how_much_govt.pdf
For those want to shoot the messenger – they can go to Google and read roughly the same conclusions in many other reports.
Obviously the factors that impact on economic growth levels are many and varied, and the tax burden is only one. However, it’s pretty obvious that once government starts impinging on areas of economic activity where it has no comparative advantage then the deadweight costs of tax will guarantee a lower economic output. Similary, if funds are taken from the productive sector and squandered on redistribution without social benefit then that’s a loss too.
There will be an optimal tax burden that will vary from country to country depending on many factors, but no matter what country it is there will be, beyond some point, declining utilility for an increased tax burden.
It’s interesting that you mention Australia. It has a significantly lower tax burden, and it as undertaken a lot of regulatory and tax reform over the last decade, going in more or less the opposite direction to Cullen. Maybe their mineral wealth explains everything, but in that case why is the Congo so poor, considering it’s at least as wealthy in minerals as Australia. Personally I think the minerals argument is used as an excuse. Natural wealth is not a great correlator to economic prosperity – there are many countries will little natural wealth which have achieved high levels of economic performance.
Vote:May 25th, 2009 at 1:56 pm
What has changed is debt is now forecast to know out to $49,000 per person
Woohoo! Only half as bad as the citizens of the USA!
Vote:May 25th, 2009 at 2:56 pm
Hmmm. $600 million per annum over 4 years would equal…….$2.4 billion? Or did you inflation adjust? Or did you mean 10 years?
[DPF: It is cumulative - $600 mil in Y1, $1.2 in Y2, $1.8 in Y3 etc]
Vote:May 25th, 2009 at 3:46 pm
Right on freedom 101! We’ve been saying for years that no OECD country has achieved rapid, sustained economic growth with government spending at 40% of GDP or more –
Vote:http://www.nzbr.org.nz/documents/speeches/speeches-2006/060712_all_parties.pdf The ratio for central and local government combined on the OECD measure is now around 45%. This includes transfers but they also impose deadweight costs (indeed the excess burden may be higher than for government consumption spending).
Total government spending in Singapore and Hong Kong, both economies with much higher per capita incomes than New Zealand, is below 20% of GDP.
In its recent report on New Zealand the OECD wrote:
Econometric evidence for OECD countries indicates that large government size may be detrimental to growth in living standards (Afonso and Furceri, 2008). This evidence shows that each percentage point increase in total government spending as a share of GDP reduces the growth rate of real GDP per capita by 0.13 percentage point per year. The recent rapid rise in government expenditures (by 2.2 percentage points in only four years) is thus a disquieting development for an economy already suffering from sluggish per capita GDP growth.
The OECD recommended the adoption of a legislated cap on the growth of government spending.
Of course many other improvements in policy settings are needed to raise productivity and economic growth, but reducing the government spending share in the economy is a major one.
May 25th, 2009 at 3:48 pm
Just a question, are all these debt predictions based on an assumption that we’ll never recover from the recession? If so, why the heck are they relevant?
Surely tax income at the moment is abnormally low and should significantly improve in the future?
Vote:May 25th, 2009 at 3:53 pm
Roger Kerr, just a quick question if I may.
Looking beyond 2008, how are things going now for those low tax, lightly regulated European economies you like so much, oh I don’t know, Iceland? Ireland? Estonia? Latvia?
The reason governments spending is now rising as a % of GDP at the moment is that the taxpayer is having to bail out your friends in the international money markets.
Thanks.
Vote:May 25th, 2009 at 3:54 pm
New Zealand’s government debt is relatively low by international standards I thought?
Isn’t the problem actually private debt? How do we reduce private debt then, if that’s where most of our debt actually is?
Vote:May 25th, 2009 at 4:43 pm
Jarbury – the usual way to reduce debt would be to allow people to have sufficient income to pay down that debt. Many would argue that the government taxed citizens highly in the good years, allowing the government to pay down its debt (which is good), but preventing citizens from paying down their debt (which is bad). A decent proportion of this excessive tax take went into low quality goverment spending – so effectively we got low quality government spending instead of private debt reduction.
Another school of thought sees private debt as a constant – someone with more income will take on more debt, so allowing people to keep more money doesn’t reduce private debt. Private debt is instead driven by liquidity and the willingness of banks to lend – so the right answer is to tighten liquidity and lending criteria. If that were our intent we seem to have succeeded in achieving that goal.
Vote:May 25th, 2009 at 5:18 pm
Thanks for going some way towards answering my questions PaulL.
Most of our private debt is sunk into (over-priced) housing though isn’t it? And slapped on credit cards to pay for plasma TVs that we couldn’t really afford….
Vote:May 25th, 2009 at 5:21 pm
Jarbury – true. I’m no rightie but every time I see a hard-done-by beneficiary interviewed on tv (about how wronged/traumatised/wounded he is by whatever newsworthy matter of the day is applicable) in front of his rented home with a huge silver plasma tv in the front room, I find myself wondering where the justice in some of this welfare state bizzo is!
Vote:May 25th, 2009 at 5:56 pm
What is low quality government spending? Probably better to ask what is the highest quality spending our government could provide? I would have thought anything that directly contributes to increasing productivity- R and D, training our workforce, keeping workers healthy, transporting goods and infrastructure, encouraging venture capital for start up ideas etc. i would have thought tax breaks to rich guys who spend it on property developments or speculate on foreign share markets should be low on the list- hence the need for a capital gains tax.
Vote:You could argue to the cows come home what the right level of tax and spending should be, but I would have thought cutting for the sake of cutting without explanation (why are we cutting the fast forward agriculture research fund for eg?, why are we cutting universities?) is dumb. Sure get rid of the rorts and tax non productive activities but you do need to think about the future past the next Standard and Poors review. I see no spending economies who are doing any better than the high spending ones at the moment.
May 25th, 2009 at 7:10 pm
Low quality spending is spending which is less productive than what could be achieved had the money not been taxed and processed through a bureaucracy. Because of deadweight costs the return from government spending to break even on the transaction needs to be at least $1.20 for every $1 of tax. Many studies show that deadweight costs are much higher than that. It’s very hard for government to return more than the dollar it takes, so at least at the margin government spending/tax hampers wealth creation. There will be an optimal level of tax & spending, maybe 30% or GDP for an economy like ours, and maybe even as low as 20%.
Vote:May 25th, 2009 at 8:24 pm
Perhaps I should have expressed it in relative terms. I’m interested in the lowest quality government spending.
My view here is that the benefits of government policy are usually overstated and the costs understated. Pretty much any halfway competent bureaucrat can manage to fiddle the numbers that much (and not just government bureaucrats). If you try to define an arbitrary cost/benefit (e.g. we’ll only spend money that has a cost/benefit ratio of at least 0.5), you’ll just encourage gaming of the system. Counting intangible benefits, hiding costs in other line items, etc etc.
Given the difficulty of getting a good quality cost/benefit, I’d come at it the other way.
1. Start by asking “what proportion of our economy do we think the government should be?” There are pretty good benchmarks around the world, I’d personally prefer to be more at the anglo saxan/free end than the scandanavian end.
2. Next, ask how we think we should fairly raise that amount of tax. What areas of life do we think we should tax – wealth (e.g. inheritance tax), investment (e.g. capital gains taxes), income (income tax), spending (GST), activity (stamp duty), sin (excise). We can probably have a much better tax structure than we have today if we try to make it broader based, and target those areas that least distort the economy, or where they do distort, create distortions that we like (such as less sin than would otherwise occur).
3. Next, ask how we’d like to divvy that money up (at a high level) between the various government functions. How much do we think we need to spend on justice, social welfare, etc etc. Hold back 15% for step 5
4. Then ask all the departments to work out what they can fund from their allocation, agree to fund all that. Of the things that aren’t funded, ask them to bring forward the ones that they consider most beneficial
5. Compare those activities across all the departments, and work out which we want to spend that last 15% on.
6. For the last handful of things that we spent money on, have a decent public debate every year (or maybe 3 years) about whether we’d rather pay for that, or rather keep the tax in our pockets. And a decent public debate over whether the next thing on the list that isn’t funded is something that we’d be prepared to pay more tax in order to have. Use this process to reset the overall level of tax take.
7. Perhaps do this process once in every term – so a government would come into power, then provide their budget for the 3 year period, including planned taxes. Perhaps they could campaign on their budget – the programmes they’d fund, the taxes they’d collect (the public debate would give them enough information to do that). So we’d have decent information when voting as to which things our incoming government would be funding, and how much tax they’d be collecting.
8. Maybe a referendum process to change this if it needs to be changed – so an expectation that a government will stick to it’s 3 year plan unless the world dramatically changes, and if it does, they have to go back to the people to ask.
Ah well, I guess that’s all a pipe dream.
Vote: