Hemmed in

Yesterday's Budget Policy Statement, the BPS, as expected, showed that the government's fiscal options are heavily hemmed in. As Jenée Tibshraeny put it in the Herald, "even if economic growth hadn’t slowed as much as it has, it was always going to be difficult for the coalition Government to cut taxes, reduce public sector spending, ramp up the delivery of infrastructure and get the books back to surplus by 2026-27" (her earlier piece in reaction to last December's Half-Yearly Economic and Fiscal Update or HYEFU is worth a look, too).

There's also another factor in play. It's right for the BPS to say that "Tight fiscal policy in the near term will also support monetary policy to bring inflation within target, and maintain it there", but you wouldn't want to push your luck over-aggressively tightening fiscal policy when monetary policy has also tightened substantially. A combo of monetary and fiscal over-ease got us into too-high inflation territory, but we don't want to make the opposite mistake and have the combo of over-braking on both fronts. It's another reason why deferring the planned surplus a bit further into the future makes cyclical management sense.

Fiscal policy faces tough trade-offs, and they may even be a tad more hemmed-in again than the BPS expects. Treasury, in the placeholder forecast update it issued to go with the BPS, has already heavily revised down its estimate of GDP growth in the year to June '24, from 1.5% in the HYEFU to 0.1% now, but there's still downside risk to that estimate. Treasury said that "We expect pressure on household budgets from the erosion in real wages over the past few years, and the decline in household wealth from past falls in house prices, to contribute to declines in real consumption spending until the second half of 2024. On a per capita basis, consumer spending has fallen rapidly, and this scenario envisages that continuing over 2024". 

There's clearly a retail recession of some severity underway, and it could get worse. It's not just the real wage erosion and wealth effects that Treasury mentioned, it's also the hit from monetary policy (the peak pain of mortgage repricing hasn't quite been hit yet), the latest rise in petrol prices, and the imminent bill shock from next year's rates demands. Some ratepayers will be lucky to get away with a high-single-digit percentage, and a lot more will be looking down the barrel of a double digit increase somewhere in the teens. Walk around any shopping strip these days, and you'll find more store windows have gone dark: the chocolatier near us in Warkworth closed this month, and the jeweller flagged it away towards the end of last year. The outlook for the GST take on discretionary consumer spending is going to be distinctly soggy.

There's also downside risk to tax revenues from businesses and the self-employed. Treasury's already well aware of weaker than expected tax inflows: in the financial statement for the first seven months of the year, Treasury noted that "Corporate tax revenue and net other individuals’ tax revenue were $0.5 billion and $0.3 billion below forecast, driven by lower terminal tax revenue for corporate tax and reduced assessed and estimated taxable profits". On Stats NZ's figures, business operating profits in the December quarter were only 0.5% up on a year later, whereas provisional tax paid (as I understand the system) is based on the assumption that profits will have risen by 5%. Overpayment versus the actual outcome triggers tax refunds. There are tax boffins within Treasury who live and breathe this stuff, and maybe they're already onto the scale of it, but I do wonder if they're downbeat enough.

More positively, there was quite a lot to like about how the government intends to go about resolving the trade-offs they face. In particular I liked the look of "Improving public services by shifting spending to higher-value areas and focusing on results": there was a strong theme at this year's Waikato Economics Forum (as I reported here and here) that current programmes are not delivering the value they should, and that better designed, innovative and cost-effective 'social investment' initiatives need to get more support. And while, personally, I wouldn't be putting the highest priority on tax cuts, I can see the merit of one proposal, namely reversing the stealth tax of the past decade that happened as a result of not indexing tax rate thresholds for inflation.

If I was to push one priority over others in this forthcoming scrum, it would be infrastructure. Yes, it's clearly a fact that everyone can't have what they would ideally want from fiscal policy, given our starting point and the economic outlook, and no doubt us infrastructure enthusiasts will take our lumps, too. And I understand that we have currently limited capacity (what with low unemployment and other constraints) to make a big immediate splurge on fixing our infrastructure deficit. 

But there has to be a more serious attempt to fix our infrastructure than we've managed so far. As this report by Sense Partners for the Infrastructure Commission showed, we're already $110 billion odd short of what we need, and if we're not careful that could blow out to some $230 billion (in today's money) over the next thirty years. And quite apart from the new stuff that's needed, we're not even spending enough to keep the existing stuff in good working nick: this report by the Infrastructure Commission found that "renewal spending is below depreciation for state highways, local roads, water supply, wastewater and stormwater infrastructure, and gas distribution infrastructure".

The BPS talked about "Developing a long-term, sustainable pipeline of infrastructure investments"; it said that the government "will top up the multi-year capital allowance (MYCA) by up to $7 billion, with the final number to be confirmed in the Budget"; debt will be used inter alia "to fund high quality investments that provide benefits to New Zealand over time, including those that increase the productive capacity of the economy"; and the government will be "unlocking new funding and financing models to catalyse private investment". That's all good on paper: I just hope that between now and the Budget on May 30, when the decisions on competing claims get thrashed out, we don't do what we've always done, and kick the infrastructure can even further down the increasingly potholed road.