Media have reported that there may be a debate between Nicola Willis and Ruth Richardson over fiscal policy. I thought it would be useful to lay out what I see as the key fiscal problem, and put context around it.
Now I’m not unbiased here. Nicola I regard as a long standing friend. We were opposition staffer colleagues together over 20 years ago. She is one of the most awesome and competent people I know. I also admire how she has managed to be an amazing mother to four young kids, while also having a successful career at senior levels in business and politics.
As a Young National in the 1980s and 1990s Ruth was one of my political idols. She saved New Zealand from fiscal disaster. She now Chairs the Taxpayers Union which I co-founded (but left the board around 30 months ago to give me more time to be a parent). I am also a big Ruth fan.
So I’m very fond of both of them. But I can also critique people I’m fond of. I thought John Key was great and had a superb relationship with him – and I also was critical at times of some of his decisions.
So what is the real problem New Zealand has that has Ruth and the Taxpayers Union so worked up?
Structural Deficits
The Government inherited a structural deficit from Labour. This is not a one off. The last three Labour Governments have left structural deficits for incoming National Governments to fix. This is not a bug, but a feature. They’ve done it every time. The last responsible Labour Finance Minister was probably Arnold Nordmeyer. This is why Labour should never be in charge again – they always leave a structural deficit.
Now it is important to understand the difference between a structural deficit and a cyclical deficit. A cyclical deficit is a temporary one. You have a global economic shock (Asian Financial Crisis) which reduces tax revenue for a year or two, or you may have something that requires a temporary large increase in expenditure such as the Canterbury earthquakes of Covid-19 support. But after that, the government books should return to surplus.
A structural deficit is much much worse. If left alone, it means you never get back into surplus. It means debt will just keep increasing, and interest on that debt keeps increasing. This then means less money for areas like health and education – or even greater levels of borrowing.
The economically prudent strategy is you run a moderate surplus normally so debt reduces, and then when you have an economic shock, you can afford to go into deficit for a year or two and keep the interest in the debt from getting too large.
So structural deficits are very very bad (especially for a small economy). So how does a New Government get rid of a structural deficit? There are broadly three paths.
Increase taxes
This is what Labour would do. They blow up spending so high, that they then claim they need to increase taxes to fund it. National was not elected to increase taxes. NZers already pay more in tax than Australians at every income level.
Labour and Greens pledged in 2017 to keep spending to under 30% of GDP. If they had kept to that, we would not have a structural deficit. Tax revenue would be more than sufficient as spending would be around $17 billion a year lower. We do not have a tax problem, we have a spending problem.
Cut Spending
One can get back into surplus by cutting spending. By this I don’t mean just reprioritising spending, but actually cutting the overall level of spending by the Government.
This is laudable but easier said than done. Governments can relatively easily cut future spending or entitlements, but taking away current programmes can result in a political backlash that can doom you or force you to back down later.
As an example of this we have Keir Starmer’s Government in the UK. They also inherited a fiscal mess, and they did some policies which I thought were the right thing to do such as cutting back the winter energy fuel payments. However this caused (amongst other things) a big backlash against the Government, with angry pensioners saying this is not what they voted Labour for. Labour have crashed in the polls. Starmer has a hugely negative approval rating, and nine months later they were forced to backtrack on it anyway so the net result was they didn’t actually save any money, and they just doomed themselves to be a single term Government.
The Government has cut spending in many areas. They have reduced the KiwiSaver subsidies (note this doesn’t reduce people’s current incomes – it just means they get less of a subsidy in future). They are the only Government in history (I think) to reduce the number of public servants. Bill English froze numbers, while Nicola and now Judith have seen them actually drop. And there has been a huge drop in spending on contractors and consultants.
Nicola was one of the only Ministers I can think of who rejected the sunk cost fallacy and refused to let Kiwirail force her to spend $3 to $4 billion on new ferries and port infrastructure on the basis they had already committed to so much spending, no politician would dare risk letting it go to waste. Nicola called their bluff and with help from Winston we ended up with new ferries for a much cheaper overall cost. But at the time of the decision, it was not known what the eventual outcome would be – it was a risky – but correct call.
Also I think Nicola deserves a lot of praise for how she handed the Reserve Bank demands for more money. Initially both the Board and Governor were staunch in their demands. Nicola could have buckled as she didn’t want to risk having a Reserve Bank Governor resign in a spat with the Minister. But she stood firm, and Orr resigned.
And the Government made changes to the pay equity law that would have made the structural deficit far far worse if unchanged. For doing so she was called the c word by a journalist in a column, and Labour decried the change as a war on women. But I’ll make you a bet. There is no way Labour will pledge to return to the pay equity law it its previous state in the first year of Government if they win. Quite simply there is not $14 billion available for it.
However despite all these worthy savings, core crown expenditure has been increasing not decreasing.
In Robertson’s 2023 Budget, he forecast spending of $141.3b for 2024/25 and $147.6b for 2025/25. By PREFU they were $143.4b and $149.2b.
In Nicola’s 2024 budget she allocated $143.9b for the upcoming 2024/25 year – so $2.6b more than 2023 BEFU and $0.5b more than PREFU . And she projected spending of $147.7b for 2025/26.
In Nicola’s 2025 budget she allocated $150.3b for 2025/26 which is $2.7b more than both what Grant was projecting and what she herself projected in 2024.
Labour and their union allies have for two years been claiming that this Government is implementing austerity policies. This is simply deluded or a lie. There is no austerity.
However it is almost beyond doubt that if Grant Robertson had remained Finance Minister, we would be spending massively more. Grant never found an operating allowance he could keep to. He always had modest spending increases projected in the budgets, and ended up spending way way more. To be fair to Grant he was relatively fiscally restrained in his first term, but in hindsight Parliament made a huge mistake voting the Government so much extra money for Covid-19 with so little restraints on it. No-one thinks the Government shouldn’t have done a wage subsidy for employers who were forced to close down for weeks or months. But Labour used the excuse of Covid-19 to massively increase spending not temporarily but permanently. They funded journalism, arts etc – all in the name of Covid-19!
So Nicola Willis is spending more than Grant Robertson said he was going to spend, but beyond doubt is spending less than what Grant Robertson would have spent.
The problem is the level of spending remains at a level, where a path back to surplus is fragile at best, and unrealistic at worst.
This takes us to the third potential path to get out of a structural deficit.
Economic Growth (and fiscal restraint)
This path is basically let’s increase spending (which an aging population and health care needs puts upwards pressure on) but at a slower pace than revenue rises. If you have strong economic growth then that plus the impact of fiscal drag on tax brackets means tax revenue rises faster than spending and the deficit reduces over time, and eventually you get back to surplus.
This is basically what Bill English did. It is worth noting that Cullen projected 09/10 spending to be $61.9b, PREFU had it at $65.8b and Bill English first budget had it at $65.3b. So more than Cullen promised, but slightly less than what was projected at the election.
Now this approach is one that seemed sensible when National first came into office. Restrain spending, and let economic growth get you back to surplus. If you had asked me my opinion back then (I do not get asked on fiscal policy!) I would have said that was the sensible strategy.
The problem is economic growth has not been strong enough. The hangover from high interest rates from high inflation carried on longer than expected, and Trump’s tariffs have dented confidence etc. Labour claim the subdued economic growth is because National cut spending, but as I point out they haven’t – they’ve just spent less than what Labour would have – spending in real and per capita terms has not been cut.
So it is unclear if the books will be projected to return to surplus in three years, when we get an update next week. And the longer the path to surplus is, the less likely it is you will achieve it. There may be a change of Government. There may be another global shock. What is important isn’t so much whether the surplus is projected to be $100 million or a deficit of $100 million. What we need to see is a credible path to debt reducing significantly so that by the time of the next global shock we have a buffer.
So I do think it is very reasonable to critique the Government and the Minister of Finance on the fact that the path to repaying debt is fragile. If we are not running healthy surplus by the time NZers are silly enough to elect Labour again, then Labour will use that as an excuse for massive tax hikes.
The moderate fiscal restraint path was arguably the right decision in 2023 and even 2024. But my worry is that it is not going to work, and the Government does need to look at some more significant spending cuts – and yes some of them may be politically painful.
But before we go down that path, it is important to look at what are the constraints on the Minister of Finance doing that. And they are significant, and not ones that the Minister can unilaterally ignore.
Manifesto commitments
I am a big fan of parties keeping their manifesto promises. Not just because you can become unpopular if you break them, but trust in democratic institutions breaks down if people think Governments don’t deliver what they promised. Labour miserably failed to deliver on many of their promises – but to be fair not so much by changing their minds, but just by total incompetence.
The rise of populist parties in Europe and the US is partly driven by the public thinking the system doesn’t work. So political parties should work hard to keep faith.
National in 2009 and 2010 did break a couple of their promises. They scaled back their tax cuts package as it became apparent that they were inheriting s structural deficit. And they also did increase GST, but did it by way of a tax switch.
You could make the case that Nicola and National should have reneged on the tax cuts they campaigned on. My friends at the NZ Initiative tend to take that view. But I think that would have been the wrong call.
When Key and English changed their tax cuts package, NZ was caught up in the GFC,. This was a global economic shock, and the public accepted that you may need to change things as the facts change. But in 2023 there was no global economic shock. Yes Labour did leave a structural deficit, but you can’t point at an event as having changed things in the latter half of 2023.
Also the tax cuts were broadly fiscally neutral due to savings elsewhere. More importantly they were needed. NZers were in a cost of living crisis and these tax cuts were targeted at low and middle income households. Someone on $1 million a year got the same tax cut as someone on $80,000. In fact the tax cuts were basically just a partial compensation for fiscal drag from not having inflation adjusted tax brackets. Nicola delivered partial inflation indexation – which was a major campaign demand from the Taxpayers’ Union. I’d like to see indexation made automatic, once we are back in surplus.
Coalition Agreements
If you want to have a stable government, you need to do everything you can to deliver commitments made to your coalition partners. Now ACT’s agreements generally didn’t want more spending, but NZ First did have some.
Cabinet risk appetite
The Minister of Finance (unless they are Muldoon) is not a law unto themselves. They can’t unilaterally tell their colleagues that they are chopping $10 billion from their portfolios. They certainly do have tough bilateral meetings looking for savings, but the senior leadership of Cabinet basically agrees to the overall fiscal strategy and how hard you cut spending, if you do – and where.
Yes the Minister of Finance is a very key player in these discussions, but they are not God. They have more say than the No 20 in Cabinet, but the reality of how things work is the six to eight senior most Ministers tend to collectively decide what the risk appetite is.
Coalition Partners
As I have said ACT is fiscally very conservative. They would cut spending everywhere, except Pharmac, if they could. NZ First is not traditionally fiscally conservative. Their demands are usually huge amounts of money for provincial projects, for oldies, for favoured industries such as racing and most of all for whichever ministry Winston is in charge of. MFAT don’t even know how to spend all the money Winston gets for them. To be fair Shane Jones has been much more fiscally conservative this term, and I often hear praise from Ministers for him in terms of his willingness to reduce spending in some areas. Basically NZ First will resist spending cuts in areas that are core to them, but may be persuadable in areas they are agnostic on and even enthusiastic in areas they dislike (taxpayer funded public health activists).
What I would do
So one can recognise the constraints around cutting spending, and also acknowledge there has been considerable fiscal restraint in various areas, but also come to the conclusion that it still isn’t enough. We are still spending around 34% of GDP on core crown expenditure, when Labour and the Greens in 2017 said that we shouldn’t go beyond 30%.
Here is a few examples of what I would have done differently (some with benefit of hindsight) or would do in future.
- Public Sector numbers. Yes the Government did reduce the numbers. The media ran such a hysterical campaign in conjunction with the PSA (every minor reduction was a major story) that NZers think staff numbers were cut by 25%, when in fact it was under 5%. I think cutting numbers back to 2017 levels is unrealistic, but I do think Cabinet left it too much to chief executives. I might suggest agencies be reduced to 2017 levels but adjusted for population and economic growth since then.
- Free Tertiary Fees. National’s policy was to change the free tertiary fees subsidy from the first year of study to the final year. I welcomed this at the time as it would cost taxpayers less, and provide an incentive to finish. It also meant no real uproar from students. But now the fiscals are so challenging, this is a luxury we can’t afford. It is still a subsidy to a group of people who will go on to be very wealthy due to their degrees. It has not got poorer people going to university. National should scrap the thing entirely. And as no one is currently receiving free fees, you don’t risk as great a backlash. You justify it on the basis of the data showing it goes overwhelmingly to people from wealthy families, and is not helping poorer families access tertiary education.
- School Lunches. At the time it seemed a smart move to keep free school lunches but save money by going to some centralised providers. Who would be against saving money. But with the benefit of hindsight I think this was a mistake. If they had cancelled the entire programme they would have had a few weeks of bad headlines, but then nothing – there would be nothing left to report. Now you get an endless litany of stories where School A or School B complains about their meals. The Government should have said that parents manage to feed their kids every weekend, and through 14 weeks of school holidays and it is their job to also feed their kids on school days. Recognising there are some kids whose parents are not particularly competent, you could have a voucher system for meals for the odd kid who turns up without lunch. I recognise that this is probably now too late to change though.
- Have a spending cap. I would cap spending for each year at whatever was in Grant Robertson’s last budget. This would mean that if Labour tries to claim it is austerity, you can say “No it’s exactly the same as what you said you would do”. Yes Labour would have ended up spending more but they can hardly openly claim their Budget forecasts were junk as they have no fiscal discipline.
I could give more examples, but I’m not setting up a political party. The point I am trying to make is I do think the current approach isn’t going to work to get us back into repaying debt quickly enough. I think the Government does need to risk some political backlash by cutting more spending so that debt doesn’t keep rising. But I also think the Government and Nicola Willis have done many good things fiscally, and that the Minister of Finance does have constraints, as I have outlined, as to what she can do.
My hope from any debate between Ruth and Nicola is that it will help shift the Overton Window from Labour claiming the Government is cutting too much spending, to a realisation that actually they are not cutting enough.
The political challenge is that almost all voters generally support a reduction in spending – so long as it is in areas that doesn’t disadvantage them. But I do think New Zealanders do recognise the massive increase in spending under Labour was unsustainable and that reducing debt is a must have, not a nice to have.
