Does the Government’s Big Surplus Mean it Can Spend Up and Tax Down?

The Government has reported a much bigger than expected budget surplus for the last fiscal year – $5.5b on one measure. I am out of the country so I cannot do the hard grind to tell you what happened (but remember that a deficit or surplus is a very small number compared with the two big ones which are subtracted from one another to derive it so that it is subject to high volatility). What I want to write about is what happens next.

Some readers will find what I have to say difficult, because I am going to eschew the neoliberal framework of the conventional wisdom in favour of commonsense. I am not saying that the commentariat are generally neoliberal at heart, nor is this government and the officials which advise it, nor was even the Key-English one. Rather they unconsciously use much of the neoliberal framework, because they don’t think things through.

A government is too big to be treated as if it is an ordinary household or firm which is the way that, too often, neoliberals think about fiscal policy (not to mention an aim to reduce the size of the government so their theories work better). When you are thinking about the government accounts, check you are not just scaling up you household experiences.

So what should we do with the surplus? Remember, it has already occurred – probably the corresponding cash is sitting in the government coffers. The windfall could be used for other things which are essentially a transfer of ownership, rather than an expenditure injection.. Michael Cullen (Minister of Finance 1999-2008) was adept at finding alternative uses when he ran large surpluses too, Here are some examples.

The foreign exchange reserves held by the Reserve Bank were substantially increased in order to deal with emergencies. However, they were not big enough to deal with potential international liquidity breakdown after the GFC. That was resolved by a system of swaps among the world’s central banks; one reason we could join in was because the rest of the world could see that we had a good public balance sheet.

Cullen also bought some assets for the government, including the renationalisation of Air New Zealand and Transrail after the inept management by their private owners, and the establishment of Kiwibank to fill in a gap which the private trading banks were ignoring. I do not particularly favour widespread nationalisation, but I support a cash injection to improve the capitalisation of Kiwibank and we may have to put in public funds to sort out the restructuring of the three northern ports (Auckland, Tauranga and Whangarie) to get better utilisation. We certainly should not be pursuing the Key-English strategy of extorting excessive dividends out of government trading enterprises.

Additionally, Cullen established the New Zealand Superannuation Fund (a.k.a. the Cullen Fund) which invests in private shares and the like. The official purpose is to offset the rising costs of New Zealand Superannuation but it is a kind of nationalisation or, at least, injection of government savings into private enterprise. I welcome it being an active investor in New Zealand business including, on occasions, reducing our dependence on overseas investment.

An ingenious Cullen manoeuvre was to give tax cuts which could not be spent but had to be saved, that being the effect of subsidies to Kiwisaver, thereby transferring some of the government savings to people (albeit not equally).

To the list could be added the government lending some savings to New Zealanders to buy their first homes (as happened long ago). The government has just borrowed $2.5b to enable the Housing Corporation to build more houses. The neoliberal framework (a.k.a. the budget responsibility rules) has meant the borrowing has been done in a roundabout way, costing an extra $60m; the rules/framework does not come cheap.

So we don’t have to use the surplus to pay down government debt. In my view it is probably at a prudent level – low by international standards. However, I acknowledge that households (and farms) have too much offshore debt. Allowing for the risks to the country that presents my guess is that we are still below the average for comparable economies. In any case we should be addressing the private over-borrowing failure directly – not guaranteeing the private sector when it fails.

(As an important aside, these various Cullen measures made it easier for the Key-English Government to manage the economy through the GFC, and the Canterbury earthquakes. The FTA which opened up the Chinese market was the other decisive cushion.)

What about public spending?. Could we not use the $5.5b or so on schools, hospitals and so on? That is in the future, so essentially the future deficit or suplus would be smaller from spending more.

Importantly, there is no reason that the unexpected surplus will repeat itself. Tax revenue cycles because of leads and lags, while the government has made a number of major commitments such as public-sector wage catchups, biosecurity outlays, spending initiatives which had not been fully implemented, various election promises still to be executed and coping with the consequences of the Key-English Government’s excessive austerity (including the failure of housing and other infrastructure to keep pace with population under the Key-English Government as well).

What we are really arguing here is how much government spending should be in the economy as a whole and how it should be funded. Let me start by excluding transfers from the government spending. They are important but need to be dealt with separately. To illustrate the problem, Working For Families is classified as government spending under accounting conventions although in economic terms it is more like a negative income tax. (Had the economist’s approach been used, the design of WFF may have been less clumsy.) Even more absurdly, the rhetoric describes a New Zealand Superannuitant purchasing bread as government spending whereas it is obvious to commonsense it is private spending funded by a public transfer.

So this column now concentrates on government purchases of goods and services (including the hiring of employees). The first policy question is what should be the balance between such public services and private purchases in the economy as a whole. That is a question of political judgement. Labour favours the public sector more than National – perhaps that is what the election was about, in the sense that more people thought that the Key-English Government’s austerity was excessive. Who knows what will happen in the next election? Perhaps they will vote for greater austerity again.

What is really needed is a serious public discussion. (For the record, New Zealand’s proportion may be at the lower end of those countries we like to compare ourselves with; I mention, so as not to duck the issue, I tend to support relatively more public spending, but that is for another column.)

But once we have agreed on a proportion (some caveats to be listed in the future column aside), we should expect government spending to grow at roughly the same rate as the economy as a whole.

How much should be funded from taxes and other revenue and how much from borrowing? It makes sense to borrow on projects which give a commercial return, such as housing. However, much infrastructure does not give a direct return even though it is vital for wellbeing – schools, hospitals ... (the transport network is funded primarily by taxes on the transport sector). In my view, at the very least the investment to maintain such infrastructure on a per capita basis should come out of current revenue (which has interesting implications for migration policy – another column).

Bother, I am running out of column space and there are many loose ends, to be dealt with in later ones. Another limitation is that we cannot reliably quantify much until the government publishes the Half Yearly Economic and Fiscal Update in December.

It would have been far easier to throw caution and commonsense to the winds, and have written a column advocating drastically higher spending or enormous tax cuts (or both). As usual much of the commentariat have obliged. What I have tried to do here is give you a sense of what the competent official advisers to the government are thinking – not pessimistically, I would imagine.