Walking the fiscal tightrope

The Government has signalled that it continues to take its forecast operating allowance for Budget 2025 very seriously and that areas of core government spending are not immune. Cat Moody, a Managing Principal at MartinJenkins, reflects on the Government’s fiscal tightrope walk as it balances major areas of public expenditure with future investment in a challenging economy.

As a former Treasury official, I pay more than average attention to the Government’s fiscal postures and the direct and indirect signals it sends about its approach to economic management.

The Government’s commitment to its very tight fiscal parameters in Budget 2024 and 2025 seems to be unwavering. When Budget 2024 was released, the Minister of Finance clearly indicated that operating allowances for Budgets 2025 to 2027 will be even lower, at $2.4 billion per Budget. That’s significantly lower than the allowances set by the previous government, and lower than those set out in National’s fiscal plan.

Exploring the base

Headlines often focus on spending at the margins, but the Government’s indicated operating allowances over the next three years will require it to carefully examine total expenditure to identify where a next round of savings could come from. Keeping steady on this fiscal tightrope is clearly going to require more than simply laying off more public servants in Wellington, even as public servants gear up for another round of cuts.

In this context, it was great to see Treasury putting the sometimes tedious detail of the Estimates of Appropriations into a user-friendly interface that paints the following (big) picture:

Source: https://nzbudget-expenditure.orbviz.com

The major dials of government spending are still in the social spheres – health, education, and social development. And much of this expenditure is non-discretionary, and difficult to influence without making difficult policy choices. But we can already see the Government tentatively lifting the lid on these major areas of expenditure.

In health, the Commissioner Lester Levy has reiterated his longtime view that the current total funding is sufficient to deliver health services and just needs to be spent more efficiently. But this is in tension with the strong views coming out of the primary health sector that the funding model isn’t sustainable, and the demographic pressures that an aging population places on the health sector.

Back in 2021, Treasury’s own Long-Term Fiscal Position Statement assumed increases in health expenditure from 6.9% of GDP in 2021 to 10.6% in 2061. Demographic change accounts for around one-third of the projected increase, with increasing demand for healthcare, rising prices for health services, and wage growth making up most of the remainder. Treasury is about due to provide the applied analysis to inform this update, as it’s required to do every four years, and this will be one of the more interesting areas of analysis.

The Government will therefore probably need to find significant opportunities within the baseline and explore trade-offs in order to stay within its fiscal parameters. This is also a warning that outgoing Secretary to the Treasury Caralee McLiesh shared as she departed her role.

In social services, the announcement of a “traffic light” system for beneficiaries on JobSeeker Support, which was foreshadowed in National’s election campaign, indicate that the Government has been looking hard at benefit numbers and its spending in this area.

But the sleeper fiscal issue is New Zealand Superannuation, and its increasing costs as a proportion of total government spending. Because this expenditure is non-discretionary, its shifts are usually not as transparent to the public. But in the current environment, its escalating costs are going to squeeze other areas of government spending.

Demographic changes mean that, with current policy settings, spending on Superannuation will increase by $6.2 billion between 2024/25 and 2027/28. Absent significant policy changes, the Government has very few levers it can pull to reduce this cost, and so this funding will have to come from elsewhere in the system.

There are reform options available – but they’re all politically precarious. Government will need to consider whether it heeds the call of the sector to adjust the KiwiSaver scheme to increase the rate of contribution. That would be a hard task, but the Government could consider it alongside an easing in monetary policy settings, to reduce the direct bite for New Zealanders.

In the context of the current coalition, another hard task would seem to be slowly increasing the age threshold for NZ Superannuation to 67, which was the original National Party position.

But even if the Government could progress those hard options, the changes would be unlikely to deliver the short-term fiscal savings it will be after.

Responding to wage pressures

Another indicator of things to come was the Workforce Policy Statement from the Minister for the Public Service, Nicola Willis, in August. This gave a clear steer on the Government’s expectations and priorities for employment relations across the public sector, with a strong emphasis on fiscal sustainability and performance.

The August statement came out the same day that major employment data was released, highlighting that public-sector wages are continuing to provide inflationary pressure, with the labour cost index in the public sector rising to a high of 6.9% annually. Historically, these wage pressures have often been one of the first calls on operating allowances. The Holidays Act remediation for the health sector alone is near on $1.6 billion in 2025.

In some ways, this statement was also a reminder of the core concept of “fixed nominal baselines”, the Public Finance Act’s primary mechanism for influencing agency and baseline expenditure. Under this fiscal approach additional funding is not provided as a matter of course for population growth or wage pressures; instead, agencies and chief executives are asked to meet those cost pressures by finding savings within their own baselines before coming to the Crown.

The Minister’s Workforce Policy Statement makes clear that additional funding from the Crown for cost and wage pressures will be a last resort only.

Pushing back in upcoming collective bargaining

By turning off the promise of additional Crown funding, the Government will be forcing Crown agencies to push back heavily in upcoming collective bargaining. Meeting future pay increases through existing baselines will be quite an adjustment for those agencies that are labour-intensive and highly unionised such as Health, Education, Corrections, and Police, and also those that are labour-intensive but not unionised, like the New Zealand Defence Force.

This is a large lever to pull, as there are 51 public-service collective agreements across 24 departments, and 55,000 public servants covered either by collective agreements or by individual agreements that mirror the applicable collective agreement.

Minister Willis was warned about this pressure in her Briefing for the Incoming Government. This also drew her attention to the 25 active pay equity claims, covering another 166,881 people. In this briefing, the Public Service Commission also said it expects another 10 to 15 claims in the next three years, with the majority of these focussed on the public and publicly funded sectors.

Cat Moody, a Managing Principal at MartinJenkins

Making strategic choices

So, what does all this mean? It means the Government is going to have to think very strategically about how it can fund some of its emerging priorities, including a significant re-examination of its baseline expenditure in core social-service areas.

The fiscal allowances are going to be tight and the ability to achieve big fiscal savings without making significant policy changes is largely exhausted. Further, in order to deliver on any new strategic priorities, the fiscal ask is likely going to be more than the social-investment approach can deliver in the forecast period.

The choices available to government will include blunter policy interventions to tackle those core areas of spending, some new revenue tools (like the recently announced tripling of the International Visitor Conservation and Tourism Levy) to soften the pressures in some areas, or revisiting its operating limits – or simply hoping that the economy and the Government’s tax receipts rebound sooner than expected.

Either way, for organisations that depend on revenue from government, and especially those hoping to secure new revenue from government, the pickings are most likely going to be slim.

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