The Requirements for Long-run Fiscal Sustainability Bob Buckle - - PowerPoint PPT Presentation

The Requirements for Long-run Fiscal Sustainability

Bob Buckle Victoria University of Wellington

Affording our Future Conference 10 December 2012

• Can Governments in the future:

– Continue to provide the range and type of public services currently offered, – without incurring excessive and unsustainable levels of taxes and/or public debt?

• Can governments afford in the future what

governments are offering today?

What is fiscal sustainability?

Why does it matter?

• Levels of Government debt can influence:

– Inflation and the real exchange rate, – Risk premium on borrowing, – Risk of sudden reversals (of foreign lending), – Scope for governments to “income smooth out” in response to adverse shocks (recessions, financial crises, natural hazards).

• Taxes have efficiency, growth, distribution effects.
• Inter-generational effects (high debt today ⇒

higher taxes tomorrow).

The GFC has highlighted these risks

20 40 60 80 100 120 2006 2007 2008 2009 2010 2011 2012

Government Debt, Ireland 2006-2012

High Government Debt can be costly

200 400 600 800 1000 1200 1400 1600 2007 2008 2009 2010 2011 2012 UK Germany Ireland

5-year sovereign credit default swaps

Finite-horizon inter-temporal budget constraint

• =

Target future public debt to GDP ratio Inherited level of public debt plus sum

• f interest paid on

that debt over the future. Sum of future primary balances (t-g) and interest paid (or earned) on those balances.

• Returning to “What is fiscal sustainability?”.
• Budget conditions required to achieve an

acceptable level of govt. debt in the future (See Fig. 4 in the paper):

What is a suitable debt target?

• Several possible fiscal targets or anchors.
• Many governments, including NZ, target debt:

– Doesn’t presume an optimal size or role of Govt. – May be a weak discipline on spending when tax revenue growth is high.

• In NZ, Public Finance Act requires government to

manage total debt at “prudent levels”.

• “Prudent” will depend on: Who holds the debt,

level of private debt, reputation, risk appetite.

Recent NZ Govt debt and targets

50 100 150 200 250 General government gross debt as % GDP (2011)

How does NZ’s level of Govt debt compare?

% GDP

Projected Govt revenue and expenses (as % of GDP)

Source: Treasury

Projected Govt debt and net worth (% GDP)

Source: Treasury

Which parts of the budget are expected to change?

Source: Treasury

% of nominal (GDP) 2010 2020 2030 2040 2050 2060 Δ (% points) Health 6.9 6.9 7.9 9.1 10.1 11.1 4.2% Superannuation (NZS) 4.4 5.3 6.5 7.2 7.3 8.0 3.6% Education 6.2 5.2 5.1 5.1 5.1 5.2

• 1.0%

Other Op. Allow. Covered (eg. Justice) 8.3 7.4 7.4 7.5 7.5 7.6

• 0.7%

Non-NZS Welfare 6.8 5.0 4.3 3.8 3.3 3.0

• 3.8%

Debt-financial Costs (DFC) 1.2 1.9 2.4 3.8 6.0 9.5 8.3% Total Expenses 33.9 31.5 33.5 36.4 39.3 44.4 10.5% Revenue (majority tax) 30.2 32.3 32.6 32.5 32.5 32.6 2.4% Operating Balance (R-E)

• 3.7

0.8

• 1.0
• 3.9
• 6.8
• 11.8

Balance excluding DFC

• 2.5

2.7 1.4

• 0.1
• 0.8
• 2.3

Operating balance with and without a debt target

Source: Treasury

• 14%
• 12%
• 10%
• 8%
• 6%
• 4%
• 2%

0% 2% 4% 6% 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049 2051 2053 2055 2057 2059 Operating balance, Cost pressure scenario Operating balance, Sustainable debt scenario

What’s influencing these projections?

• Assumptions about tax revenue as % GDP.
• Interest rates on Govt. debt.
• Assumptions about indexation of welfare

payments.

• Impact of ageing, income growth,

expectations on welfare, health services, etc.

• Demographic and labour force projections.

Demographic Projections for NZ

1960 2010 2060

Fiscal reform has happened before

• Welfare reforms after two world wars and the

1930s depression.

• Growth of education after post-war “baby boom”.
• Institutional reforms post-1985.
• And in the future, role of the state could be

impacted by:

– Changing preferences as real incomes rise and technology changes, and – Demographic change due to lower fertility rates and people living longer.

Fiscal sustainability is a concern to many developed economies

• NZ concern over sustainability reflected in

– Public Finance Act in 2004. – Two previous Treasury Long-Term Fiscal Statements (2006 and 2009).

• Fiscal sustainability assessments by OECD, IMF

and by other countries.

• Population ageing is a common concern, but not

the only influence on fiscal sustainability.

Percent of the Population Older than 65 as a Share of Population Aged 15-64

Source: OECD

Population ageing across the OECD

Population ageing, rising incomes and the fiscal position

• Population ageing is a “good news” story:

– People living longer; labour participation amongst

• lder age groups rising.
• Will have economic and fiscal effects.
• Treasury captures some of these and other

effects using their Long-term Fiscal Model.

• A range of government expenditures are age-

and income-related, e.g. public health care and superannuation.

Timing of policy reform

• Timing and pace of adjustment important.
• The future and fiscal projections are uncertain.
• May be benefits to waiting for more information

before committing to fiscal reform.

• But, there may also be costs to waiting:

– Size of fiscal adjustment may rise as total debt and debt servicing costs rise. – Reform may get harder as more voters move into the

• lder age brackets.

Illustration: Delaying fiscal adjustments

• If fiscal adjustment starts in 2015:

– Need annual operating balance surpluses of 1.9% of GDP for a decade to pay down debt to 20% within a decade.

• If fiscal adjustment starts in 2020:

– Need annual OB surpluses of 2.2% of GDP for a decade to pay down debt to 20% within a decade.

Conclusions and conference issues

• Fiscal sustainability matters.
• Population ageing, rising incomes and

expectations will influence fiscal futures.

• Governments have to decide on:

‒ Suitable fiscal anchor (or debt target), ‒ When to act, ‒ Whether to act - public services and/or tax rates, ‒ How to reform public services (health, superannuation or other services). ‒ Decision framework to assess benefits and costs of the options.