UPDATED 10.31am Privacy Commissioner John Edwards says the Ministry of Social Development's policy that requires social service providers to disclose client information goes too far.
Under the policy, providers will have to give the client information to the ministry when they apply for funding.
Mr Edwards said in a report released on Thursday the requirement was "excessive and inconsistent with privacy principles".
Listen above as Privacy Commissioner John Edwards speaks with Mike Hosking.
He said today there was a risk that the new funding arrangement between the MSD and non-government organisations (NGO) could deter some people who were in need of support.
"Not only could that put those people further at risk, and increases pressure on the NGOs, the ultimate result could be that those individuals become 'invisible' to Government and policy-makers," he said.
The new MSD contracts investigated by Edwards would make the provision of personal, detailed client data a condition of Government funding. Community groups cannot opt out of the arrangement.
The policy will be introduced in July, but Opposition parties now say it should be scrapped. It could apply to up to 4300 contracts linked to Work and Income, Family and Community Services and the Youth Development and Vulnerable Children ministries.
Edwards said no NGO received state funding "as of right", and it was important that Government took steps to ensure any programme it funded was effective. This required good data, he said.
He identified three main privacy risks: Individuals could choose not to seek help at all; to provide incorrect information to preserve their privacy; or NGOs could give people access to MSD services without providing their personal information, meaning they became "invisible" to the Government.
Edwards was also critical of MSD, saying it failed to clearly explain to NGOs what their data would be used for, who it would be disclosed to and how it could be used in future.
It had also put the policy in place "prematurely" without proper consideration of the privacy risks.
A possible alternative proposed by Edwards was to allow Statistics New Zealand to receive the information from NGOs, and that agency could provide anonymised analysis to the ministry.
Social Development Minister Anne Tolley, however, said that recommendation could not be accepted.
But she also challenged Edwards' conclusions, saying they were based on assumption and that there was no proof people would choose not to seek help rather than provide their personal details to MSD.
Labour's social development spokeswoman Carmel Sepuloni said the report confirmed that people most in need - clients of Women's Refuge or Rape Crisis - could be deterred from seeking support.
The findings "throw a huge spanner in the works" of the Government's flagship social investment approach, she said. Under this approach, the Government is increasingly looking to use large, detailed datasets to decide which social services should get funding.
"The Commissioner clearly states that this current data grab could not be deemed a better use of data and could instead deter those in need from seeking support and increase long term costs," Sepuloni said.
Green Party social development spokeswoman Jan Logie said the Government needed to immediately put a stop to the MSD contracts.
"With the Privacy Commissioner and community groups like Rape Crisis and Budget Services coming out against this data intrusion, the Government must realise that it will not achieve its social objectives by overriding individuals rights to privacy."
Tolley revealed yesterday that the ministry had to shut down its new information-sharing system after a privacy breach was discovered.
She said one social services provider was able to view information in another providers' folder, though the folder did not contain any data at the time.
MSD officials have now been asked to find a solution, and Tolley promised the replacement system would be "robustly tested".
So far, 136 providers had been asked to share their information, and 10 had agreed to do so.