Prudent levels for government net worth really matter

Dr Bryce Wilkinson
NZ Herald
22 October, 2021

The government’s Budgets in 2020 and 2021 arguably breached the Public Finance Act 1989. This is a serious concern.

First some background. Governments are inherently more prone than most of us to spend borrowed money freely. Spending freely today is popular, paying for it today is not. Incumbent governments can hope to pass the debt problem onto the next government. It is the adult version of “passing the parcel”.

Constitutions, written or unwritten, exist to limit the power of government. Otherwise, a political majority in Parliament can persecute groups of citizens, wreck economic activity and get the nation much too heavily in debt.

If these constitutional limits are weak, or exist but are inadequately supported by public opinion, awful things can happen. The risks are particularly high during periods in which governments have assumed emergency powers.

New Zealand last ran into problems of this nature in the early 1980s. Draconian wartime legislation from World War II was left on the books when it should have been rescinded. It allowed the third National Government to control economic activity by decree.

Deficit spending became the norm. Gross government debt spiralled up. By the year ended March 1985, more than 20 per cent of tax revenues were needed just to finance the public debt. It took a decade of painful adjustment to get that statistic below 10 per cent.

The 1984 general election triggered a foreign exchange crisis. It immediately became a constitutional problem because the outgoing government initially refused to accept the incoming government's decisions.

No one who was there at the time wants to see New Zealanders experience such painful adjustments again. But insufficient fiscal discipline creates vulnerability.

Both the succeeding Labour and National governments implemented measures to better protect New Zealanders from such events in the future.

The fourth Labour Government (1984-1990) rescinded the remnants of the World War II legislation that gave government too easy recourse to emergency powers.

The Government also passed legislation to make it clear who had the power to govern immediately after a general election. In addition, it made it harder for the government to dictate to the Reserve Bank without the public knowing. It floated the exchange rate and made it a free float. Only a free float ensures that the authorities will not run out of foreign exchange again.

The fourth National Government (1990-1999) built on these safeguards. It passed a Fiscal Responsibility Act in 1994. The Act's purpose was to make it harder for future governments to run up the public debt at the expense of the future wellbeing of New Zealanders.

Helen Clark's fifth Labour Government shifted those fiscal responsibility measures, unchanged, into the Public Finance Act. That is where they are today.

The Act requires governments to achieve and sustain public debt and Crown net worth at prudent levels to "provide a buffer" against future events that could "impact adversely".

The measures further oblige the incumbent governments to tell the public each year what it regards as prudent levels for the public debt and Crown net worth. This "Budget Policy Statement" must be issued well before the government's annual Budget Statements.

These provisions are important because "rosy scenarios" are always seductive whereas adverse events occur too often for comfort. In addition to self-inflicted crises of the 1984 variety, they include natural disasters, wars, global financial crises and serious health epidemics.

The measures allow for Budget deficits and higher public debt and lower Crown net worth in exceptional circumstances. Covid-19 certainly counts as an exceptional circumstance.

But the legislation allows this only if (1) the departure is temporary and (2) the Minister of Finance explains three things: the reasons for the departure; the intended remedial response; and the timetable for restoring prudent levels

Arguably, Budgets 2020 and 2021 did not satisfy these requirements.

Budget 2019 preceded awareness of Covid-19. In it the Government committed to reducing net core Crown debt to 20 per cent of GDP "within five years of taking office" and to "maintaining it at prudent levels thereafter". Specifically, it would keep it within a 15-25 per cent of GDP range.

It projected that total Crown net worth would be sustained around 45 per cent of GDP. (That represents a buffer of almost 17 months of tax revenues.)

Covid-19 struck half a year later. The Minister of Finance rightly said it justified a temporary departure from its afore-mentioned prudent levels.

But Budget 2020 projected large non-temporary departures from the Government's 15-25 per cent range for net core Crown debt. No clear reasons were given for long-standing departures. No new target range for prudent debt was given. Nor did it set any timetable for remedying the situation.

Budget 2021 failed to restore compliance. Treasury projected net debt to peak at 48 per cent of GDP in 2023 and to still exceed 30 per cent of GDP in 2033. That is not a temporary departure.

It projected that the total Crown net worth would bottom out at 24 per cent of GDP in 2025. That represents a buffer of 11 months of projected total Crown tax revenues.

Budget 2021 baldly asserted that debt "remains at prudent levels through the forecast and projection periods". This is inconsistent with its 2019 view about what constituted prudent levels for public debt and net worth.

At least two things can be said in the Government's defence. The first is that Treasury advised the Government that the projected path for the public debt is prudent. But these Treasury's projections simply assume no further adverse shocks.

That is not a prudent approach. Global public debt excesses, inflation concerns, tensions with China and financial system risks seem to be rising by the month.

The second point in the Government's favour is that the final Crown accounts for the year ended June 2021 were a very pleasant surprise for any Minister of Finance. Spending was lower than forecast and revenue higher. That meant lower debt and higher net worth. Net worth gained even more from asset valuations. The Crown owns a lot of property.

So, after all that, total Crown net worth in June 2021 was back at its pre-Covid June 2019 ratio of 46.2 per cent of GDP. What is imprudent about that? It has only been higher than 46 per cent of GDP in five of the past 28 years.

Three points answer that question. The third is the most important. First, the ever-higher property prices relative to income that have benefited property owners are an appalling policy outcome. The imbalance is surely unsustainable. Second, core Crown net debt in June 2021, at 30.1 per cent of GDP, was still above the Government's 2019 prudent range.

Third, that favourable outcome is irrelevant to this article's central question – were Budgets 2020 and 2021 legal?

Compliance with safeguards of a constitutional nature is important. Parliament and the Auditor-General should demand better compliance and accountability from the government of the day. Bland, target shifting, complacency must be challenged.

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