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
0
20
40
60
80
100
120
2006 2007 2008 2009 2010 2011 2012
Government Debt, Ireland 2006-2012
High Government Debt can be costly
0
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
of 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.
0
50
100
150
200
250
General government gross debt as % GDP(2011)
How does NZ’s level of Govt debt compare?
% GDP
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%
20
07
20
09
20
11
20
13
20
15
20
17
20
19
20
21
20
23
20
25
20
27
20
29
20
31
20
33
20
35
20
37
20
39
20
41
20
43
20
45
20
47
20
49
20
51
20
53
20
55
20
57
20
59
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.
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
older 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 older 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.