Thursday, 21 May 2015

Budget 2015 - the big picture

So here we are again: another year, another Budget - this one's 'A plan that's working' - and another round of sausage rolls in the Treasury lockup for Budget analysts.

Generally there are only two big things you need to know about any Budget. Despite the vast publicity it's going to get, neither of them (as I've said before here) is the precise level of the fiscal surplus or deficit in any one year. It's almost completely irrelevant, except for scoring cheap political debating points. The things that really matter are: whether it's realistically grounded on a reasonable view of the economic outlook, and whether it makes long-term sustainable sense.

Are the economic forecasts underpinning the Budget realistic? I'm a bit in two minds about this. On the one hand, the GDP growth forecasts for the next four years look a bit high. They average 2.8%, and don't drop off a lot: there's 2.4% pencilled in for the March 2019 year, when you might have thought that somewhere along the way the rundown of the Canterbury rebuild would have led to a larger slowdown. On the other hand, the assumptions about net migration look too pessimistic. Net immigration was 55,800 in the year to this March, and is expected to be 56,600 in the year to June '16, but then is assumed to drop like a stone to 12,000 in the year to June '17. Migration flows can change quickly, that's true, but that quickly? So I'm not surprised that one of the two alternative economic scenarios that got modelled as part of the Budget included one where net immigration was modestly higher.

Net net, maybe there's a bit of overoptimism about the runoff of the earthquake rebuild, and a bit of a downbeat estimate of likely immigration, leaving us roughly where we should be, but I'm left with a slight feeling that the growth forecasts could a bit too high. They're certainly a bit higher than the most recent consensus forecasts gathered by the NZ Institute of Economic Research, and you can also find forecasters in the marketplace (notably the BNZ) who see a substantially earlier and sharper slowdown.

There's also one internal oddity, which is that the participation rate - the proportion of people in the workforce, either employed or looking for a job, and which normally rises as good times roll in - does nothing of the kind in these forecasts. It's at a high level now, certainly, but then it's expected to drop a bit over the coming year, and stay at that level thereafter. That makes little sense to me, although it has a politically handy side-benefit for the forecasts: a lower participation rate makes the unemployment rate go down faster than it would have otherwise.

Overall, let's give the forecasts a pass mark. What about the longer-term fiscal plan?

First, the obvious: crises apart, in normal times what you want to see is steady progress. One step after another doesn't make for catchy headlines, but in fiscal policy dull is just fine. And on that score the Budget does okay, if you compare 2015 with where we're expected to be in 2019, as shown in the table below. The size of the tax take as a share of the economy goes down a little, the size of spending goes down by a bit more, and there's a steady rise in the fiscal surplus and a corresponding reduction in the size of the public debt.

It's also worth saying not only is this steady progress towards a sustainable fiscal outcome, but it's also pretty good when you compare it with some of the usual suspects, as shown below.

So why just 'okay' as an overall assessment?

Two reasons. Here's the first one (in the graph below) which shows that the government is expecting a $2.5 billion hit to its finances from decisions it will make in the 2017 Budget. We don't know precisely what they'll be, but a large part is likely to be tax cuts for low to middle income households. I'm as happy to take a tax cut as the next person, but when you're still in the earlier stages of a fiscal rehabilitation, I'm not sure that (say) a $1.5 billion tax cut on top of (say) an increased spend of $1.0 billion makes complete sense.

Especially, and secondly, as we're not completely out of the woods when you look at the real underlying picture of the fiscal deficit. By that I mean what does the deficit look like when you strip out transient cyclical influences - the deficit will appear to shrink in a business upswing, as the government takes in more taxes, but it will widen again when times are tougher. Beneath the cyclical waterline, nothing's really changed.

Fortunately, you can make a rough (and I do mean rough) estimate of the 'real' deficit, shorn of the business cycle effects, and it's shown in the table below as the 'Cyclically-adjusted balance', as opposed to the headline fiscal deficit which includes the cyclical effects, the 'OBEGAL'.

You'll see that the cyclically-adjusted balance comes in two flavours. One is plain, and one is sprinkled with a 'terms-of-trade' adjustment. The plain one is fine: the headline deficit and the 'real' deficit are pretty much the same. The one with sprinklings, however, makes the (arguably reasonable) assumption that we've been living in unusually good times when it comes to the prices we get for our commodity exports, and that we oughtn't count on them being around indefinitely. On that basis - and it might be over-cautious, but equally it might be just the sort of prudence you ought to steer by - we don't get back to surplus at all. It's deficits all the way. So again you get to the same point, that it looks a bit premature to be giving the deficit a $2.5 billion boost as early as 2017.

In sum, all pretty sensible, perhaps a bit optimistic on how things will actually pan out, but generally going in the right direction.

I won't go into many of the minutiae - you drown in press releases at Budget time, all the way down to ones publicising $2.1 million initiatives - but four caught my eye.

The end of the $1,000 starter subsidy for KiwiSaver. It came as a big surprise, but when I'd settled down, I thought - makes sense. There are 2.8 million of us who have two neurons to rub together and have already said yes please to a free gift of $1,000. If you haven't done it by now, why should the taxpayer bother with you?

That $52 million fund to help build housing on surplus government land in Auckland - fine idea, but a spit in the wind in terms of impact. It's not entirely clear how it's going to work - I asked one of the helpful Treasury people, and it seems as if the $52 million will be to buy the land from its current owners for housing development, with the precise development model yet to be determined - but if so it's not going to go very far. At a very, very conservative estimate of $100K per section, that will get 520 houses going, over a period of years. Well meant, but half of five eighths of the proverbial.

Funding for only 2 more charter schools - sorry, partnership schools. People have mixed views on them, but whatever your views, you'd want to see more policy experimentation going on than this. Particularly when one of Bill English's key priorities (rightly) is getting more value for each public dollar spent, and you'll never know if you are, if you stick to the same monolithic 'one size fits all' model that has typified much of health and education spending.

And finally that $25 million funding for 'Regional Research Institutes'. We don't know exactly where they'll be, and we don't know exactly what they'll do. But if I had to pick between them finding a cure for cancer or becoming boondoggle sops to "the regions are dying", my money would be on the boondoggle.

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