Thursday, 16 May 2013

Today’s Budget – the fiscal balance (1)

You’ll have seen the main news in the Budget elsewhere – still on track for fiscal surpluses, reduced ACC levies, the sale of Meridian, housing initiatives – so you don’t need any recap here. I've concentrated on some of the more out-of-the-way but important aspects which don’t always get their fair share of air-time.

As always the main media focus is on the headline numbers for the fiscal surplus or deficit – where the government still expects to squeak into the black in the 2014-15 fiscal year with a tiny surplus of $75 million, and is then planning to run rather a small surplus of 0.3% of GDP in the 2015-16 year and a rather larger one of 1% of GDP in the 2016-17 year.

While these numbers get the headlines, they don’t really tell you what you most want to know. That’s because the fiscal surplus or deficit moves up and down of its own accord, depending on the state of the economy: in good times, tax revenues increase and payments on the likes of unemployment deficit go down, none of it due to any policy changes or good or bad management by the government. It’s purely a cyclical phenomenon.

To see what the impact of the government’s decisions actually is, you have to strip out those purely cyclical influences on the economy. How you do it in practice is more art than science, but various organisations give it a go, including (obviously enough) the Treasury itself. The ‘cyclically adjusted balance’, or CAB, is the result. As the graph below shows, the deficit today isn't really as bad as it looks. In the June 2013 year, the headline deficit is 2.9% of GDP, but the impact of the earthquake accounts for about 0.6% of GDP and the weakish state of the economy accounts for another 0.5% of GDP. Take those out – in other words, assume it’s a normal year with no major disasters and the economy in okay shape – and the deficit would have been only 1.8% of GDP.

That’s reasonably good news: we’re not starting from the sort of fiscal black hole that many other OECD economies find themselves in, where the true underlying state of the public finances is dire. A fiscal deficit of 1.8% of GDP isn't something you’d want to go on running indefinitely, but it’s not the end of the world, either, as a place to be starting out from.

The other bit of good news is that the fiscal surpluses that the government is projecting for future years are actually real – they’re not just a reflection of the economy getting better. In the graph, you can see that there’s no difference between the headline surplus numbers and the cyclically adjusted ones.

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