Kiwiblog

Treasury has just published the crown accounts for the year ending 30 June 2009. This is basically the last set of accounts for the Labour Government, even though the new Government will have had some impact through decisions taken before the 2009 budget.

The 2008 budget said there would be a surplus of $3.1 billion. In fact the operating deficit was $10.5 billion.

The OBEGAL (the underlying surplus) was a deficit of $3.9 billion compared to the budget of $1.3 billion.

Treasury released yesterday the crown accounts for the first nine months of this financial year. Here’s the differences between what Labour projected in the PREFU and the reality six months later:

• Tax revenue down $1.9 billion
• OBEGAL down $2.1 billion from $1.9 surplus to $0.2 deficit
• Investment losses total $5.7 billion
• Acturial losses of $3.6 billion
• $0.7 billion gain on Kyoto
• Overall deficit is $7.7 billion – a blow out of $11.1 billion from the projected $3.4 billion surplus in PREFU
• Gross debt now $45 billion or 25.1% of GDP (do you recall Labour saying 22% would be a disaster?)
• Net debt (which I find more useful) is $5.1b or 2.9% of GDP – against forecast of 3.0%

The one off investment and acturial losses are not that major a concern for me, but the $2.1 billion change downwards in OBEGAL is a huge issue.

The monthly crown accounts are out. Not pretty, but could be worse:

• OBEGAL (the important figure – the underlying surplus) is $600 million in the black
• But OBEGAL is $850 million less than PREFU forecast which suggest OBEGAL for the full year will be close to a $1b deficit
• Operating Deficit is $5.5b due to $6b of losses
• Cash deficit is $5.7b, which is $1b higher than PREFU
• Gross Debt is 25.3% of GDP alreadybut net debt is only 1.3% of GDP (excl NZSF assets)
• Tax revenue $574m less than PREFU but much in line with DEFU

The set of economic forecasts inherited from Labour were bad enough reading last week. But then on Friday, I noticed that Finance Minister Bill English said that the economy is already nearly at Treasury’s worst-case scenario.

So how bad is the now likely worst case scenario:

• Unemployment peaks at 7.5% in mid 2010
• Economy contracts in year to March 2010 as well as March 2009
• OBEGAL deficits of $32 billion from 2009 to 2013 – averaging greater than $8 billion a year
• Gross debt to increase from $35 billion to $82 billion over four years – a $47 billion increase
• Net debt to increase from $6 billion to $54 billion
• Gross debt as % of GDP to go from under 20% to 39% in four years, and to 76% by 2023

This is a worse outlook than Labour left National in 1990. And you can’t even compare to the 1999 PREFU which was:

• Operating Balances growing to almost $2.5 billion
• net debt falling from 22% to 18%
• Economic growth of over 3% a year
• Unemployment to reduce from 7% to 5.7% over two years

Cullen was left with a wonderful set of projections.

So the next few years are going to be a disaster in fiscal terms. So who is at fault? Well of course the main responsibility is the global credit crisis – that goes without saying. But why are our fiscal fortunes so fragile, than a crisis such as this fucks our economy for the next decade or more? Let’s look at some of the possible culprits.

National’s tax cuts

If anyone blames the deficits and debts on National’s tax cuts, then they are incompetent or lying. The tax cuts were 99% funded from changes to KiwiSaver, and other expenditure savings. They have no impact on the deficit or debt.

In fact National’s tax cuts are (in hindsight) an even better idea than when first mooted? Why? Because they contribute towards a total fiscal stimulus package of 5% of GDP – this is one of the largest in the OECD and may help soften the recession.

But even better, the tax cuts are not funded from cutting current spending (which would detract from the stimulus) but by reducing subsidies into KiwiSaver which would lock the money up for decades.

We’ll come back to the issue of KiwiSaver.

Labour’s tax cuts

So how about Labour’s tax cuts? Is all this fiscal doom and gloom because Labour finally gave in and delivered tax cuts? Well it is certainly true that Dr Cullen has indicated he would have not cut taxes to the extent he did, based on PREFU’s numbers. And many people suspect Labour, if re-elected, would have cancelled some or all of their tax cuts.

The cost of Labour’s tax cuts over four years is $10.8 billion. So yes, if Labour did not cut taxes at all in their nine years of office, then the fiscal situation would be slightly better. Of course taxpayers would be worse off, but who cares about them!

But compare that $10.8 billion to OBEGAL deficits of over $30 billion and an increase in debt of almost $50 billion.  If Labour had not delivered tax cuts (and had not spent the money saved – a big if), it would have somewhat improved the fiscal outlook, but left households worse off, and made the recession worse.

Labour’s tax cuts were equivalent to a one off $3.3 reduction in taxation – the only personal tax reduction in nine years, where taxation went from $32 billion to $57 billion.  It is probably the most modest tax reduction program in the western world.

Labour’s Spending

What has really left us with a massive problem, isn’t Labour finally doing a $3.3 billion annual tax cut, but the massive increases in annual expenditure.

Expenditure has increased from $34 billion per year to $57 billion. That is a $23 billion hike – or seven times as great as the belated tax cuts.

Now of course some of this is necessary increases – even Sir Roger advocates you should increase spending in line with inflation and population growth. But off memory that is still $18 billion a year in extra spending.

And this is the problem Labour has left us. They massively increased spending in non-essential areas, on the assumption that we would have record growth and surpluses forever. They didn’t just keep funding and improving existing programmes (schools, hospitals) but they invented new schemes. Now these schemes were arguably good things – but they were funded based on an assumption of growth and surpluses. And together they combine to remove flexibility from future Governments.

Let us look, at just three of them:

The Cullen Fund

The Cullen Fund was based on a premise that as we are going to have surpluses for the next 30 years, then we should save some of those surpluses to meet the future cost of superannuation, so we won’t have to borrow money in the future.

The fatal flaw was always the assumption about surpluses, but as the years went on and they continued unabated, the opposition to the Fund diminished, and even National signed up to it.

But we are now in a very different situation. We have a structural deficit, and face massive borrowing for at least a decade.

So the Cullen Fund is now based on borrowing heaps of money today, so we do not have to borrow heaps of money in 25 years? Anyone else see the fatal flaw? Borrowing money to save money is the sort of stuff that cuased the credit crisis.

The Government should seriously consider suspending contributions to the Cullen Fund. We can’t save money we do not have.

KiwiSaver

KiwiSaver has much the same problem as the Cullen Fund. It is all well and good to help subsidise people’s savings, but not if the taxpayer is having to borrow money to do so.

Because who is going to have to pay back and pay the interest on all that borrowing? Those same savers. So once again we have the stupidity of borrowing money today, to help people save. That is not sustainable.

I like KiwiSaver. If we were going to continue with record surpluses, it would be great to have a scheme which provides massive incentives for people to save. But we don’t. Does anyone think Labour would in 2009 have announced the KiwiSaver subsidies they did in 2007? Of course not.

National has wisely already cut the cost of taxpayer subsidies to KiwiSaver. Arguably they need to go further and also look at whether the employee subsidy is affordable. If we need to borrow to find it, then it isn’t.

You see the employer matching contribution is a 1:1 subsidy already, which is massive. Hell most people are happy to get a 10% return on investment and the employer contribution gets you an instant 100% return. Now the employee subsidy gets you a further 100% return, so those earning up to $52,000 get a 2:1 subsidy or a 200% return on investment.

Unless the fiscal fortune improves, maybe the employee subisdy has to go also. Sure that means only a 100% return instead of a 200% return, but that is a lot better than the standard 10% return and I doubt it would discourage people going into KiwiSaver. Maybe raise the employer contribution rate to a maximum 3% so the total saved isn’t decreased.

Working for Families

This is another major spending commitment that falls into the category of unaffordable with hindsight. Basically whenever Labour had spare cash they hoovered it up into this targeted welfare assistance programme. And now taxpayers are going to have to borrow billions of dollars to fund this programme.

Unlike the other two programmes though, this one can’t be easily reformed. Families have grown used to having the extra cash, and in the midst of a recession, it would be quite wrong to take the money off them.

But what does need to be done, is some medium-term work on a better tax and welfare system that has less tax churn.

We found out today how bad is Labour’s economic legacy. In 1999 National left Labour with a strongly growing economy, falling unemployment, low interest rates, and low inflation.

Today’s DEFU tells us what Labour has left National. And my God it is bad:

• Unemployment to hit 6.4% (and maybe 7.2%) within 15 months
• Gross debt to increase from under 20% to a massive 33.1% (and maybe 38.6%) by 2013
• OBEGAL deficits of $23 billion over next four years
• Cash deficits of $48 billion over five years

This is appalling.  Even the “upside” scenario sees a massive increase id debt, deficits and unemployment.

Deficits of up to $6 billion are just unacceptable. If we do not improve from the lgeacy Labour left us, we will be leaving the next generation with a mountain of extra debt.

It gets even worse over the ten year horizon:

• The costs of all the borrowing basically fuck the economy. We end up with a permament structural deficit with the books Labour have left us.
• Even after 2019, the crown will be running an permanent OBEGAL deficit of 2% of GDP, or $4 billion a year. Even the “upside” scenario sees an ongoing deficit of 0.7% of GDP. So Labour have left us with an economy that is stuffed, even under the more optimistic scenario. We just can not run a decade of deficits.
• Gross debt is now projected to hit 57% of GDP in 2023. Do you remember Helen and Michael telling us that hitting 22% of GDP would be reckless. Well they have left us with a debt on track to hit 57% of GDP!!!
• Even net debt, which had reached zero, is projected to rocket up to 47% of GDP

This is a set of books, every bit as bad as those left behind by Labour in 1990. They are horrible. Bill English has the toughest job in NZ for the next few years.

The task for the National-led Government is to improve on this. DEFU is basically what would happen if you continue with Labour’s policy settings. The tax cuts were fiscally neutral so don’t affect things. Over the next few years we should always refer back to this DEFU as what we would achieve under Labour. National has to deliver smaller deficits and less debt than DEFU is projecting. That is their challenge.

At Backbenches last night, Charles Chauvel said that Labour has left National a very good set of accounts with lots of money, and would be making sure they looked after it.

This caused some consternation in the audience and phrases like a decade of deficits emerged.

Anyway Dr Cullen has released the latest forecast from Treasury – as of Friday. So let’s see what National is being left with:

• Unemployment now to peak at 5.7% instead of 5.1%
• Nominal GDP to be $15 billion lower for 2009-2013 than in PREFU.
• The OBEGAL deficit and cash deficit to both worsen by around $1.5 per annum from 2010
• An extra $5 billion of debt up until 2013, compared to PREFU
• Real market investment to decline by 13% in 09/10
• GDP growth for 08/09 estimated t be just 0.4%
• OBEGAL deficit to hit $5 billion in 2012/13
• The cash deficit in 2012/13 to hit $9.1 billion

The nominal GDP figure puts it in perspective. The NZ economy will generate $15 billion less over five years.

The focus has to be on increasing economic growth.  Bill English is going to have a very hard time trying to get the Government out of a cycle of debt and deficit.

The PREFU is far worse than anyone could imagine. Thank God St Ruth and National changed the law in 1994 to force the Government to open the books up before an election – otherwise it would be a repeat of the last time a Labour Government left office – a fiscal mess for the incoming Government.

The Secretary of the Treasury, John Whitehead, did a presentation before we got the books. The room was silent as he wound out the bad news. The problem isn’t our financial markets – they are much better structured than in the US. It is the flow on effects of lower GDP growth and increased spending. So we don’t have a crisis, but we do have a very bleak fiscal situation.

The Crown accounts are going into deficit, and will remain in deficit until 2018 – yes – a decade of deficits on the medium term projections. The deficit is forecast to be $31 million this year and up to $3.2 billion in 2012/13 – returning to surplus only in 2017/18. This is the OBEGAL excluding Super Fund Revenue.

Dr Cullen and Helen Clark are going to be very red faced over debt. Do you recall how they attacked National’s plan to borrow 2% more of GDP for infrastructure as an economic calamity and reckless as it would push debt up to 22% of GDP – 2% in excess of Dr Cullen’s ceiling of 20%

Debt is forecast to peak at 30.1%!!! It will be 24.3% by 2012/13 and 30.1% by 2018/19. After wailing about how the world would end if debt went to 22% of GDP, Dr Cullen is leaving NZ with a forecast rise to 30%.

The cash deficit next year is now forecast to be $6 billion and over five years a cash deficit of 31.7 billion.

Incidentally PREFU was done around five weeks ago so doesn’t take account of the very latest in the US such as the bailout. They do not expect this to change PREFU significantly but it does increase the risk of a sharp slowdown.

Treasury are forecasting close to 0% annual GDP growth until June 2009.

Some changes to the annual predictions are

• KiwiSaver costs up $280m by 2012
• Tax take down 900m
• Benefit costs 500m up
• Early Childhood Education Costs up 200m
• Debt servicing up 500m

The annual contingency for extra spending is $1.75 b per annum plus 2% inflation. But most of this is already allocated and for the next four years only $500 to $600 million a year is available for genuine new spending.

So what to do? Well the Treasury Secretary says if one can manage an average real GDP growth of 3%, then the long-term debt (2022/23) will reduce by 10%.

This for me is what the election must now be about. The status quo in terms of economic growth is not acceptable – a decade of deficits must not happen. So voters should ask which party will have the best policies and best people to boost economic growth.

I have previously given Dr Cullen pretty high marks for his fiscal management. Those marks were seriously downgraded today as he leaves us with ten years of deficits forecast and a 50% forecast increase in debt as a percentage of GDP.

There will be some focus on National’s response and their tax plans and infrastructure plans. The tax plans will be credible if they are largely fiscally neutral with reductions elsewhere in expenditure. And a lower tax economy will lead to higher economic growth – which is what it is all about.

The infrastructure plans will add 2% of GDP to gross debt – a small amount now compared to the 10% extra on these projections. The rationale is unchanged for them though – if they will add to economic growth by increasing productivity, then that is a good return on investment. Not all infrastructure investments will lead to higher economic growth, so the focus should be on the quality of the investment.

Bill English is about to inherit what may be the toughest job in New Zealand – turning around a projected ten years of deficits and 50% increase in gross debt as a percentage of GDP.

The Cullen Fund has lost almost $900 million in the last year.

This suggests that PREFU will show the Crown has gone into deficit or is budgeting a deficit now – for the first time since 1992. However the more important figure will be the OBEGAL, which is the underlying surplus.

Dr Cullen’s ninth and probably final budget is a cunning political device but economically risky and most of all incredibly hypocritical.

The entire budget is designed for one and one purpose only – to try and stuff over National and make it impossible for them to offer larger tax cuts without spending cuts.

Imagine the outcry from Dr Cullen and the left if Bill English as Minister of Finance did the following:

1. Run a cash deficit of $13.7 billion over four years to fund $10.6 billion of tax cuts
2. Ran the OBEGAL operating surplus so low that it will not be large enough to fund the Cullen Fund contributions until 2016
3. Reduced the contingency expenditure provision by $2.5 billion over four years (or $250 million a year)

You would have the left shouting from the treetops that Bill English is borrowing to fund tax cuts, that pensioners should start hoarding catfood because National is planning to starve the Cullen Fund of money, and that reducing contingency expenditure is slashing spending on health and education.

I got to ask Dr Cullen a question on how he would answer the challenge that he is borrowing to fund tax cuts, and he answered that he isn’t, that he is borrowing to fund capital investment.

The irony is that I didn’t agree with the premise of my question – I was in fact quoting what Labour have said for the past few years about borrowing and tax cuts, and the further irony is that Dr Cullen’s response was the argument I have made in the past that borrowing is okay if for capital, not operating expenditure.

As I said above, this budget exists for one reason only – to try and stuff over National. The logical inconsistency of saying we can’t afford tax cuts when the surplus is close to $10 billion, and then delivering tax cuts when the surplus has basically shrunk to zero is staggering.

OBEGAL, the operating balance or surplus after one off gains and losses is forecast to be just $1.0b next year, reducing to $200 million in 2011/12. That is well below a prudent level – I have generally maintained the OBEGAL should be enough to meet the Cullen Fund contribution around $2 billion) and around $1 billion on top of that. So this level of surplus is around $2 billion to $3 billion below that. Cullen has gone from hoarding all the money to spending it all.

Core crown expenditure is forecast to expand from $54 billion last year to a whopping $70 billion in 2012.

Core crown revenue was $58.4 billion last year. The tax cuts sees it stay at around $62 billion this year and next year but then increasing to $69 billion in 2012. So Cullen has core corwn expenditure greater than core crown income for the first time since the last Labour Government. This is a potential repeat of 1990 in terms of leaving the next Government with a deficit.

Net core Crown debt is forecast to go from $1.8 billion to $13.2 billion.

Dr Cullen could hardly contain his glee at having spent everything. Basically the fiscal margin for the next five to six years is close to zero. A further downturn and you have have significant problems. He has happily thrown away his previous fiscal discipline.

So this will make it tougher for National. they certainly will be able to deliver tax cuts larger than these ones, but not massively larger unless they get more rigorous with saying no to various spending proposals. There are not a lot of easy options thanks to Dr Cullen’s empyting or the larder. If by some chance Labour do get re-elected Dr Cullen’s successor will be equally as grumpy with him as Bill English might be – don’t expect any Government can deliver any significant new spending initiatives in the next few years.

I don’t think it is entirely a bad thing that National may have to say no to some more of Labour’s spending. Yes there is a political risk in doing so, but it is at times of economic hardship that people expect the Government to manage its spending more carefully – just as households do. And National certainly has some capital in terms of a lead in the polls that it can use up.

Bernard Hickey looks behind the headlines in the Crown accounts. Forget the investment write-downs he says:

Government spending is growing at a rate of 9.8%, which was more than twice as fast as revenue growth at 4.5% and twice as fast as estimated nominal GDP growth at around 5%. The government is eating the economy.

Watch the OBEGAL. It is barking that the government is spending too much and taxing too much and employing too many bureaucrats. It is biting us with low productivity growth because our best and brightest are becoming highly paid bureaucrats who now call themselves senior policy analysts. We’re all paying for this with higher wages costs, higher inflation and lower GDP growth.

Ignore this month’s deficit. Pay attention to a government eating the economy.

Eating the economy. A very nice way of putting it.

Hat Tip: The Hive

Despite the headlines, the latest set of crown accounts are not as bad as some are saying.

This is because the important figure is the one called OBEGAL, formerly OBERAC.  This is the measure of the underlying structural surplus. Dr Cullen uses to refer to this one all the time until it got embarrassingly large and he then tried to revert to 1970s accounting standards by focusing on merely the cash surplus.

The OBEGAL to Jan 2008 was $3.1 billion against a forecast of $3.7 billion.  Now that’s somewhat disturbing as normally actual comes in way above forecast, but some of the difference may just be timing issues.

The full year OBEGAL forecast was $6.6 billion.   We’ll find out in May what that has been revised to – could possibly drop to the $5 to $6 billion range.  This is still definitely high enough to afford tax cuts but ironically quite a bit less than previous years when Cullen said they were not affordable.