The Treasury, our leading government department, has been in the spotlight after the release of the Crown’s financial statements for the year to June and the Auditor-General’s report on the Crown retail deposit guarantee scheme.

The documents show that the Treasury’s forecasts of the Crown’s financial performance have been far too optimistic and its management of the guarantee scheme has been poor.

The Crown reported a Budget – or “operating balance before gains and losses” – deficit of $18.4 billion for the June year, up from a deficit of $6.3 billion for the previous year.

The deficit has steadily increased over the three years of the current Administration.

The previous Labour Government had nine consecutive annual Budget surpluses.

The National Government is enormously popular, partly because Prime Minister John Key and Finance Minister Bill English are willing to throw money at almost every problem.

The latest $18.4 billion deficit represents 9.2 per cent of gross national product – one of the worst amongst the 30 OECD member countries.

Only Greece, Ireland, United Kingdom and United States have Budget deficit/ GDP ratios in excess of 9.2 per cent last year or this year.

Deficits have to be financed through additional borrowing, and the Crown’s gross debt went from $53.6 billion to $72.4 billion in the year to June.

This equals additional Government borrowing of $362 million a week for the year.

The escalating deficit is caused by several factors, including static tax revenue, continued increases in Government spending and the Christchurch earthquakes.

The individual tax take has declined from $27.5 billion in the June 2008 year to $23.1 billion in the latest year.

This is mainly because of the Government’s tax cuts last year.

Corporate tax is down from $10.1 billion to $7.3 billion, but GST revenue has risen from $11.1 billion to $13 billion over the same period.

This is where the Treasury and its forecasts come in.

When the Treasury first started looking at the June 2011 year – in December 2006 – it forecast total tax revenue for the period of $67.6 billion, compared with the actual outcome of $51.6 billion, and an overall Budget surplus of $6 billion.

It is difficult to forecast five years forward, particularly when there is a global financial crisis in between, but the problem with the Treasury is that its forecasts are usually far too optimistic.

Soon after the Key Government came to power in November 2008, the Treasury was still forecasting a deficit of only $3.1 million for 2011.

This deficit forecast was raised to $8.6 billion in the 2010 Budget, when income and corporate tax cuts – and an increase in GST from 12.5 per cent to 15 per cent – were introduced.

Right-of-centre governments often run large Budget deficits because they overestimate the positive effect of tax cuts on the economy, and the Key Government is no exception.

The Treasury also has a similar economic philosophy and made a 2011 year tax revenue forecast of $53.9 billion in last year’s Budget compared with the actual outcome of $51.6 billion.

Tax revenue has stalled, but Crown expenditure, particularly on social security and health, continues to climb. National Superannuation, which has risen from $7.4 billion in 2008 to $8.8 billion in the latest year, is by far the biggest social security item.

National Superannuation and health expenditure will continue to be a huge drain on the New Zealand Government as more and more people enter the 65-and-over age group.

The Christchurch earthquakes contributed $9.1 billion to this year’s deficit, $7.5 billion to the SOE deficit and $1.6 million to total Crown expenses.

The main contributors to the $9.1 billion Christchurch deficit were the EQC $7.5 billion, $700 million for the purchase of Christchurch red zone properties, $400 million for welfare support and emergency responses and $300 million for the AMI support package.

The Budget deficit would have been $9.3 billion without the Christchurch earthquakes, but these extraordinary events occur on a fairly frequent basis because New Zealand is under-insured and unprepared for disasters.

For example, there will be further costs associated with the Christchurch earthquakes in the current year.

There may also be additional expenditure associated with leaky homes, Treaty settlements, the emissions trading scheme, finance company guarantees, the Rugby World Cup, the Rena shipwreck and other items.

In this year’s Budget statement, the Treasury forecast a Budget deficit of $9.7 billion for the year to next June, to be followed by a $4.1 billion deficit in 2013, a $700 million deficit in 2014 and a $1.3 billion surplus in the June 2015 year.

Once again these forecasts seem to be far too optimistic but there will be another chance to assess the situation when the Treasury issues its pre-election economic and fiscal update on October 25. This should stimulate debate on this important issue, particularly as the Rugby World Cup will have finished and the election will be only weeks away.

The Auditor-General’s publication “The Treasury: Implementing and managing the Crown Retail Deposit Guarantee Scheme” highlights major inadequacies in the organisation’s management capabilities and the cost this imposes on taxpayers.

On October 12, 2008, at the peak of the global financial crisis, the Government decided to introduce the retail deposit guarantee scheme to avoid a flight of money from New Zealand to Australian institutions.

The scheme offered a Crown guarantee, up to $1 million, over money that individuals deposited with financial institutions, mainly banks and non-bank deposit takers, including finance companies, building societies and credit unions.

Under the scheme, the Crown guaranteed $133 billion of investor funds. The problem with the scheme was that it enabled finance companies to offer high interest rates to investors, which were government-guaranteed, and to lend this money to high-risk property developments.

There was a large flow of money out of finance companies before the scheme was introduced but a big inflow afterwards.

Nine of the finance companies covered by the scheme have failed and the Crown has paid $1972 million to depositors. Another $37 million is expected to be paid.

The largest payments have been: $1580 million to South Canterbury Finance depositors, $140 million to Equitable Mortgages and $131 million to Allied Nationwide Finance.

The Auditor-General is extremely critical of the Treasury’s management of the scheme.

She believes that the Treasury monitored finance companies to prepare for possible payouts rather than to modify their behaviour.

For example, South Canterbury Finance’s deposits grew by 25 per cent after the Crown guarantee was put in place and the company continued to lend to high-risk property developers.

The Crown’s liabilities could have been reduced if the Treasury had convinced South Canterbury Finance to adopt a more conservative strategy after October 2008.

The Treasury, according to the Auditor-General, appeared to take the view that “it was better to recover what funds it could after an institution failed than try to influence events before a failure”.

The Government expects to recover $900 million of the $2 billion paid to depositors, leaving a net deficit of $1.1 billion from the Crown retail deposit guarantee scheme.

Based on the Treasury’s optimistic bias, the deficit is likely to be greater than $1.1 billion – and this goes directly to the Budget deficit.

Government finances – Deficits and debt continue to rise

($ million) Twelve months ended
Jun-11 Jun-10 Jun-09 Jun-08
   Tax 51,557 50,744 54,681 56,747
   Other 5,993 5,472 4,801 5,072
Total Crown Revenue 57,550 56,216 59,482 61,819
   Social security   22,005 21,185 19,382 17,877
   Health   13,753 13,128 12,368 11,297
   Education 11,650 11,724 11,455 9,551
   Other 23,042 17,976 20,797 18,272
Total Crown Expenses 70,450 64,013 64,002 56,997
SOE surplus (deficit) -5,496 1,482 627 815
OBEGAL -18,396 -6,315 -3,893 5,637
Gross Crown debt 72,420 53,591 43,356 31,390

OBEGAL is the operating balance before gains and losses