Tomorrow the government’s books will be opened up. It is not expected to be a pretty picture. Oil prices and the credit crunch have forced the economy into recession. The debt to GDP ratio will be higher than was modelled in the Budget for three reasons (at this point, I just want to remind our excitable righties that fiscal modelling is not carried out by Micheal Cullen but by Treasury officials):
1) GDP is lower than expected: the Budget expected the GDP to be $180 billion in the year to June. In fact, it was $179 billion. It may have shrunk by another billion since, whereas the model had it growing by a billion. Even a constant level of debt increases as a % of GDP when GDP shrinks.
2) Tax revenue will be lower than expected: a recession hits corporate tax revenue hard. Employment, while not down, has not grown as modelled, so income tax revenue will also be lower than expected. Lower than expected consumer spending means lower GST revenue. All of which means that even if government spending was at expected levels, more money would need to be borrowed to make up the difference.
3) Spending will be higher than expected: So far, the number of people on the unemployment benefit has not increased so benefit payments have stayed low. However, other government spending has been higher than expected – high oil prices have driven higher than expected inflation, increasing government costs. Add to that the sign-up rate for Kiwisaver has been much higher than modelled. Treasury thought there would be 270,000 members by July 1, today there are over 800,000 – each costs the Government $1000 on sign-up and around $40 a week more. That adds up to around a billion more spent than expected this year. More expenditure means more borrowing.
Add in losses from the Government’s financial assets (the Cullen Fund, the ACC Fund etc) and we are looking at net government debt worsening by several % of GDP more than expected. So, tough times. What should we do? Well, we shouldn’t cut government spending, that would just deepen the recession. Measured increases in government spending (as Australia is undertaking) can prime the economy’s pumps, getting us out of recession quicker. We certainly should not increase debt any more than necessary, especially while international credit markets are in such turmoil; if there was ever a time for borrowing for tax cuts, now is not it.
How the parties react to all this will be an important test of their readiness to govern. Will they react prudentially or will they carry on as if nothing has happened and attempt to win the election at any cost?