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Fiscal Institutions in New Zealand: The question of spending caps and

spending reviewsJohn Janssen

February 2011

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A timeline of budget management

From 1989:

FixedNominalBaselines

From 1997:

FiscalProvisions

For details and fit with overall fiscal legislation refer:Fiscal Institutions in New Zealand and the Question of a Spending Cap http://www.treasury.govt.nz/publications/research-policy/wp/2010/10-07

From 2002:

FiscalManagementApproach

From 2011:

FiscalManagement

Approach+

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Fixed Nominal Baselines

• Prior to 1989 the budget process involved regular adjustments to personnel costs

• Operating and capital adjusted annually with 1-year ahead forecasts only

• Early 1990s – fixed nominal baseline over a 3-year forecast period that changed only with specific policy decisions

• Formula-driven indexation to non-departmental spending (eg, inflation indexation of transfers; volume changes)

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Operating balance for 1997/98: Forecast and policy changes

Forecasts of the 1997/98 operating balance ($billion)

Policy and Forecast changes from 1994 DEFU to actual result ($billion)*

1994 Update 7.6

Revenue: Policy 1.0

1995 Budget 7.8

Revenue: Forecasting 1.1

1996 Budget 3.3

Expenses: Policy 2.7

1997 Budget 1.5

Expenses: Forecasting 0.6

1998 Budget 2.8

Other forecasting 0.2

1998 Actual 2.5 Total: Policy 3.7 Total: Forecasting 1.5 Actual less initial

5.1 5.2

* Change is expressed in terms of the impact on the operating balance. Totals do not sum due to rounding. Source: Adapted from Table 1.4, OECD (1999).

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Fiscal Provisions

• 1997 Budget introduced a $5 billion (cumulative) spending cap on new initiatives over fiscal years 1998 – 2000

• Spending cap sat on top of fixed nominal baselines and formula-driven indexed items

• Rules established to determine what counted against the spending cap

• Spending cap re-labeled as fiscal provisions – for both operating and capital

• Included as line items in fiscal forecasts (3 years ahead)

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Decomposition of operating expenses

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Fiscal Management Approach

• 2002 Budget re-labeled the fiscal provisions as operating allowances and capital allowances

• Shifted the focus to the paths of operating balance and debt rather than just the nominal allowance

• Fiscal allowances reviewed twice a year with reference to updated forecasts and progress against fiscal objectives (especially debt-to-GDP)

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Sources of spending change

• Anticipated price and volume effects for formula driven items built into forecasts (eg, rising cost of pensions from population ageing)

• Discretionary initiatives as part of the fiscal allowance. Expectation that allowances adjusted only in response to structural changes in the fiscal outlook

• Changes in forecast costs due to revisions of initial forecast (eg, higher than anticipated take-up)

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Revenue surprises

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Operating allowances

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Operating balance

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Aims of proposed spending cap

• Increase transparency around the total level of spending with more focus on baselines, relative to discretionary allowances

• Provide some inertia in response to revenue surprises

• Looked at experiences of Sweden, Netherlands and Finland

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Key features of proposed cap

• Absolute dollar figure for operating expenses

• Exclude unemployment expenses and finance costs

• Set for three years with the third year set on a rolling basis

• Margin of 1% to act as a buffer for unforeseen events

• Cap set by current administration rather than prescribed in legislation

• Transparency around potential breaches and policy reaction

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• Risks around spending cap: complexity; flexibility; target rather than upper limit; still cycle versus trend identification challenge (especially in rolling third year)

• Current system places a cap on discretionary spending via the operating and capital allowances – which have been set at much lower levels than mid-2000s

• Increase the range of expenses subject to scrutiny – to improve control over higher-than-expected increases in expenses

• Set aside a portion of the existing allowance to deal with these

Selected approach – FMA+

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• Shift resources to frontline services (headcount cap for core government administration)

• Improve balance sheet management (publication of detailed investment statement)

• Investigate mixed ownership model for some commercial assets

• Alternatives to public provision (eg, PPPs)• Better administrative and support services• Drawing on skills beyond the core public services (eg,

Defence Review; Review of Expenditure on Policy Advice)

Other changes

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Future developments?

• Recent Taskforce suggestion that Public Finance Act be amended to require the Minister of Finance to specify a five-to-ten year target for future operating expenses (capacity exits in Act but not typically used)

• Independent Fiscal Council

• Taxpayer Bill of Rights – limit spending growth to inflation rate and population growth, with any higher spending subject to a referendum

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A timeline of budget management

From 1989:FixedNominalBaselines

From 1997:FiscalProvisions

From 2002:FiscalManagementApproach

From 2011:FiscalManagement

Approach+

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Main lessons

• Classification – discretionary/other; cycle/trend

• Context – surplus environment (pressure to revise a cap upwards); deficit environment (shift to other tools such as reviews)

• Change – some change is inevitable as people learn the rules

• Continuity – credibility and understanding of broad approach – with adjustments at the margin

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Extra slides

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Changes in Core Crown operating expenses relative to 2009/10 year