Part 1: Introduction

1.1
In November 2016, the Treasury published He Tirohanga Mokopuna: 2016 Statement on the Long-Term Fiscal Position (the 2016 Statement). The Treasury is required to produce long-term statements at least once every four years. We have previously commented on the 2013 statement, Affording Our Future: Statement on New Zealand's Long-term Fiscal Position (the 2013 Statement).

1.2
In this report we comment on the 2016 Statement. The Treasury published a number of background papers alongside the 2016 Statement, and we refer to these where relevant.

1.3
Financial sustainability is of critical interest to our role in giving an independent view of public sector performance and accountability to Parliament and New Zealanders. As in our 2013 report, we wanted to look at the 2016 Statement in terms of how it describes what the state of the government finances might look like and what challenges and opportunities the public sector and the country as a whole might deal with in the future.

1.4
Professor Norman Gemmell, Chair in Public Finance at Victoria University of Wellington, provided expert advice, particularly on the economic aspects of our work.

1.5
In this work, we considered whether the Treasury has:

• considered the long-term outlook and the challenges and opportunities for the Government's finances over the long term; and
• communicated its findings in an understandable, informative, and useful way.

1.6
Various terms can be used interchangeably when talking about financial projections. For consistency and clarity, we have:

• used the term "financial" instead of "fiscal", except when referring to the Treasury's long-term fiscal statements, its legislation, or when fiscal is used as part of other people's work; and
• used the term "projection" instead of "forecast" or "prediction", except where legislation specifically refers to forecasts.

1.7
The term "scenario" is used a lot in this report. In the context of this report, we use scenario to mean a description of what might plausibly happen in the future – this could be one situation or a set of future circumstances. A scenario is not a forecast or a prediction – it is one possible way the future could unfold. For this reason, developing a scenario involves more than adjusting just one variable.

1.8
In this Part, we:

• explain the requirement for the Treasury to prepare a long-term fiscal statement;
• summarise previous long-term fiscal statements and our first review in 2013;
• outline other approaches to long-term projections;
• review the Treasury's concerns with the sustainability of public finances; and
• outline what we cover in the rest of this report.

The legislative requirement for a long-term fiscal statement

1.9
The Public Finance Act 1989 (the Act) is one of the five major statutes that underpin the public sector's financial management system. The Act's objective is to help improve public sector performance by promoting "responsible fiscal management" through increased transparency and greater accountability.¹

1.10
Under the Act, there are two annual documents that set out the Government's fiscal ambitions:

• the Budget Policy Statement, which explains the Government's shorter-term intentions; and
• the Fiscal Strategy Report, which explains the Government's longer-term objectives.

1.11
The Treasury prepares forecasts of the Government's economic and financial performance and position to support these two documents. These forecasts are:

• regular economic and fiscal updates (the Budget or half-year or pre-election updates), which reflect the Government's current policies and intentions for the upcoming five-year period. These updates are collated from individual agency forecasts through the Government's internal management reporting database, CFISNet; and
• regular fiscal strategy projections, published in the Fiscal Strategy Report and covering the 10 years after the initial five-year forecasts. This medium-term outlook follows the same structure as the Economic and Fiscal Update and assumes that current policies and intentions remain in place for the 10-year period.

1.12
The fiscal responsibility provisions of the Act specify that the Treasury must prepare "a statement on the long-term fiscal position" at least once every four years. The Act does not specify the content of the statement or how it should be prepared. It requires only:

• a statement of responsibility asserting that the Treasury has used its best professional judgements about the risks and the outlook; and
• disclosure of significant assumptions underlying any projections.

1.13
The Secretary to the Treasury is responsible for preparing the long-term fiscal statement.

Previous long-term fiscal statements and our first review in 2013

1.14
Including the 2016 Statement, the Treasury has published four long-term fiscal statements since 2006. Figure 1 summarises the first three statements.

Figure 1
The Treasury's previous long-term fiscal statements

1.15
Our first review and commentary was on the 2013 Statement. Overall, we found that the Treasury had done a good job in preparing the 2013 Statement, and had presented it in a way that was understandable and engaging. However, we found there was some room for improvement – particularly with how the projections supported the statement. In particular, we noted:

• a narrow focus, with the projection considering only the healthcare and superannuation challenges associated with population ageing;
• a lack of feedback effects and analysis of uncertainty;
• issues with the ongoing use of net debt as the primary measure of financial sustainability and its composition, excluding the assets of the New Zealand Superannuation Fund; and
• limited accounting logic, integration, and usability of the projection model.

Other approaches to long-term financial projections

1.16
When we looked at the 2013 Statement, we identified nine other countries that carried out similar long-term financial projection exercises. As part of our 2016 work, we reviewed how three of these countries approached long-term financial projections in more detail.² We also reviewed what other recent research papers have said about how governments should approach long-term financial projections (see paragraph 1.20).

1.17
Figure 2 summarises the main features of the approaches to financial projections taken by different governments. The Treasury notes there are also differences in the way countries present their long-term financial projections. In its view, there is no "correct or fully consistent way" to carry out a long-term financial projection exercise.³

1.18
Most countries in Figure 2 use demographic changes and focus on healthcare and/or pension spending in their financial projections. The United Kingdom's and Australia's financial projections appear to be largely consistent with the Treasury's approach. The exception in the table is the United States of America, which, although not allowing for a formal analysis of shocks or uncertainty, does provide a broader outlook and allows for revenue growth and feedback effects (for example, how the interest rate on debt rises as the amount of debt taken on increases).

Figure 2
Approaching long-term financial projections – New Zealand and other countries

Sources: Commonwealth of Australia (2015), 2015 Intergenerational Report Australia in 2055, Canberra; Office for Budget Responsibility (2017), Fiscal sustainability report, London; Congressional Budget Office (2016), The 2016 Long-Term Budget Outlook, Washington D.C.
* Relative to gross domestic product growth.
** For educational spending.
*** Includes education and disability insurance.
† Includes education, student loan growth, and private pension/savings tax subsidies.
†† Includes, for example, defence, transport, housing, and justice. The modelling distinguishes between discretionary and mandatory spending.
††† Has an extensive chapter on testing sensitivities to economic and fiscal conditions.

1.19
The approach of not allowing for other shocks and uncertainty is at odds with a number of research papers from international organisations and academics. For example, in a review of the use of strategic foresight in the United Kingdom, Singapore, and the Netherland's public sectors, it was observed that:

In an interdependent and complex world … [many] governments have realized that a single-issue focus is often insufficient in dealing with emerging threats and opportunities.⁴

1.20
Other papers have also stressed the importance of identifying, analysing, and managing the financial consequences of shocks and uncertainty on a government's long-term financial position. For example:

• As part of an external review of the Treasury's fiscal policy advice, Teresa Ter-Minassian, International Economic Consultant and former Director of the International Monetary Fund's Fiscal Affairs Department, looked at the Treasury's long-term analysis work in the 2013 Statement. Although noting that the scope of the analytical work in 2013 was impressive, Ter-Minassian suggested that improvements could be made to the projection model by integrating feedback loops and incorporating sensitivity analysis of shocks to demonstrate the need for fiscal buffers.⁵
• A June 2016 paper by the International Monetary Fund noted that "Comprehensive analysis and management of fiscal risks can help ensure sound fiscal public finances and macroeconomic stability". The analysis showed that (on average) countries have experienced a significant fiscal shock every 12 years, costing about 6.0% of gross domestic product (GDP). More severe fiscal shocks can occur (on average) every 18 years.⁶
• A 2011 paper by the Organisation for Economic Co-operation and Development (OECD) on improving risk governance for global shocks outlined the global shocks that have taken place since 2009. Despite the uncertainty of events like these, shocks can be qualified and evaluated by using previous experiences.⁷
• In a 2011 background research paper, the Treasury demonstrated the usefulness of scenario analysis by examining how severe shocks could affect the Crown's financial position. The paper suggested that a sustained decline in tax revenue presented the main risk and that, although low government debt provides a significant buffer to this risk, rapid changes to tax or government spending might also be required.⁸

The Treasury's concerns with the sustainability of government finances

1.21
Since the 2013 Statement, the Treasury has published two reports that discuss the challenges and opportunities that could affect the medium- to long-term sustainability of the Government's finances.

1.22
These reports, Holding on and letting go and the 2014 Investment Statement, were both published in 2014. In these reports, the Treasury acknowledged that the world had changed significantly in recent years and would continue to do so.⁹ The types of challenges and opportunities that accompany these changes are not just economic – they could also include education, jobs, the natural and physical environment, health and safety, and personal and social well-being.¹⁰ They will also affect the future composition and size of the Government's assets and liabilities.¹¹ Managing such challenges and opportunities will need a strong economy and a state sector with a strong and resilient balance sheet.

1.23
Aligned with these earlier reports, the 2016 Statement explains that various factors affect the financial sustainability of future governments over the long term.¹² Alongside government policy options, such as changes to taxation or spending areas, these factors include New Zealand's:

• ageing population;
• natural resource risks (climate change, water quality, natural disasters);
• economic growth;
• education, skills, and employment outcomes; and
• social inclusion (for all New Zealanders).

1.24
These areas of discussion are consistent with the results of the Treasury's public engagement, which were summarised in their reflections document, Conversations about things that matter. The most common themes that emerged from consultation with the public were the natural environment, society, skills and education, and the economy.

1.25
The 2016 Statement's main conclusion is that:

While current government finances remain relatively strong, fiscal pressures are projected to build over the next 40 years. Population ageing is projected to apply pressures through slower revenue growth (resulting from less participation) and increased expenses (primarily through New Zealand Superannuation and healthcare). In the future, we may also see threats to our natural resources (e.g. climate change, water quality and natural disasters) as a fiscal pressure.¹³

Structure of this report

1.26
In Part 2, we outline the Treasury's intentions and what the 2016 Statement tells us about the well-being of New Zealand and the challenges and opportunities that governments might face in the future. We also look at how well the financial projections support the 2016 Statement.

1.27
In Part 3, we review the 2016 Statement's projections and how they compare with previous statements. We also consider what the projections tells us about the financial challenges and opportunities ahead.

1.28
In Part 4, we consider the 2016 Statement's projection model, how it has changed since 2013, and review the reasonableness and robustness of the assumptions that are used.

1: Public Finance Act 1989, section 1A(2)(c). The Act also covers lines of accountability, parliamentary scrutiny, and reporting obligations.

2: The other six countries' reports were in a different language, only in summary form, or could not be obtained from the usual public sources.

3: The Treasury (2016), "Long-Term Fiscal Analysis – Testing our synthesis". An internal seminar presentation, slide 9.

4: Habegger, B (2009), Strategic foresight in public policy: Reviewing the experiences of the UK, Singapore, and the Netherlands, Switzerland, page 49.

5: Ter-Minassian, T (2014), External Review of the Treasury's Fiscal Policy Advice, Washington DC, page 50.

6: International Monetary Fund (2016), Analyzing and Managing Fiscal Risks – Best Practices, Washington DC, Executive Summary and page 7.

7: Organisation for Economic Co-operation and Development (2011), Future Global Shocks – Improving Risk Governance, pages 2 and 14.

8: Fookes, C (June 2011), Modelling Shocks to New Zealand's Fiscal Position, see the Abstract.

9: The Treasury (2014), Holding on and letting go: Opportunities and challenges for New Zealand's economic performance, Wellington, page i.

10: The Treasury (2014), Holding on and letting go: Opportunities and challenges for New Zealand's economic performance, Wellington, page iii.

11: The Treasury (2014), 2014 Investment Statement: Managing the Crown's Balance Sheet, Wellington, page 1.

12: The Treasury (2016), He Tirohanga Mokopuna: 2016 Statement on the Long-Term Fiscal Position, Wellington, page 6.

13: The Treasury (2016), He Tirohanga Mokopuna: 2016 Statement on the Long-Term Fiscal Position, Wellington, page 6.