Fiscal Institutions in New Zealand and the Question of a Spending Cap

A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Mears, Tracy; Blick, Gary; Hampton, Tim; Janssen, John Working Paper Fiscal Institutions in New Zealand and the Question of a Spending Cap New Zealand Treasury Working Paper, No. 10/07 Provided in Cooperation with: The Treasury, New Zealand Government Suggested Citation: Mears, Tracy; Blick, Gary; Hampton, Tim; Janssen, John (2010) : Fiscal Institutions in New Zealand and the Question of a Spending Cap, New Zealand Treasury Working Paper, No. 10/07, New Zealand Government, The Treasury, Wellington This Version is available at: http://hdl.handle.net/10419/205610 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ www.econstor.eu Fiscal Institutions in New Zealand and the Question of a Spending Cap Tracy Mears, Gary Blick, Tim Hampton and John Janssen N EW Z EALAND T REASURY W ORKING P APER 10/07 N OVEMBER 2010 NZ TREASURY Fiscal Institutions in New Zealand and the Question of a W ORKING P APER Spending Cap 10/07 MONTH/ YEAR November 2010 AUTHOR Tracy Mears Email New Zealand Treasury [email protected] Telephone 64-4-917-7024 Gary Blick Email New Zealand Treasury [email protected] Telephone 64-4-917-6027 Tim Hampton Email New Zealand Treasury [email protected] Telephone 64-4-917-6952 John Janssen Email New Zealand Treasury [email protected] Telephone 64-4-917-6931 A CKNOWLEDGEMENTS The authors would like to thank Renee Philip and Coco Lu from the New Zealand Treasury for their contributions to this paper. Jana Kremer provided useful insights as a discussant of the paper at the Banca di Italia conference in Perugia in March 2010. Mark Blackmore from the Reserve Bank provided valuable external review. Any remaining errors are the responsibility of the authors and not the reviewers. NZ TREASURY New Zealand Treasury PO Box 3724 Wellington 6015 NEW ZEALAND Email [email protected] Telephone 64-4-472-2733 Website www.treasury.govt.nz DISCLAIMER The views, opinions, findings, and conclusions or recommendations expressed in this working paper are strictly those of the author(s). They do not necessarily reflect the views of the New Zealand Treasury. The Treasury takes no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. The paper is presented not as policy, but to inform and stimulate wider debate. Abstract New Zealand’s fiscal policy framework has been in place for nearly 20 years. At its core is a set of principles around maintaining prudent levels of public debt and running fiscal surpluses on average over time. This framework, combined with an extended period of economic growth, contributed to New Zealand entering the economic recession of 2008- 2009 with historically and internationally low levels of public debt. While the current fiscal policy framework has helped achieve and maintain defined, prudent levels of public debt, it does not require the government to define a target level for spending. Since 2004 government spending has increased as a share of GDP. Most of this reflects increased spending during the extended economic upturn through the middle of the last decade. The economic recession of 2008-2009 also played a small role in increasing spending, largely through the automatic stabilisers as New Zealand did not implement a substantive expenditure-based stimulus package. The Government therefore committed to investigating whether a spending cap would be an appropriate addition to the existing fiscal policy framework. This paper outlines the motivation for a spending cap and – drawing on international experience – presents a proposed design. A benefit of the proposed cap is that it would have reinforced the existing limit on new discretionary spending initiatives through the annual Operating Allowance being fixed at $1.1 billion. It would also have placed a limit on other forecast expense increases that occur via the six-monthly Baseline Update process. However, the complexity of the proposal may have led to significant communication challenges, and some confusion about how it would operate alongside the existing system. Reflecting on this analysis, the Government decided not to introduce a formal cap on total spending at Budget 2010. JEL CLASSIFICATION E62 - Fiscal Policy H61 - Budget; Budget Systems KEYWORDS Budget management, fiscal institutions, fiscal management approach, fiscal performance, fiscal policy, Fiscal Responsibility Act, fiscal rules, government expenses, New Zealand Government, Public Finance Act, spending cap. Fiscal Institutions in New Zealand and the Question of a WP 10/07 | Spending Cap i Contents 1 Introduction 1 2 Fiscal rules – theory and international experience 2 Definitions and objectives of fiscal rules 2 Prevalence of fiscal rules 3 Design features 3 Effectiveness of fiscal rules 3 3 New Zealand’s legislative framework 4 4 New Zealand’s Budget management process 6 Fixed nominal baselines 6 Fiscal provisions 6 Fiscal Management Approach 7 5 New Zealand’s economic and fiscal performance over the past decade 8 The 1998 to 2007 economic expansion 8 The 2008/09 recession and the global financial crisis 13 Overall assessment of the past decade 14 6 Designing a spending cap for New Zealand 15 Objectives of the cap 15 Design of a spending cap 16 Setting the cap 17 Breaching the cap 19 Main changes from the current system 20 Risks around adopting a cap 20 Other proposals for managing government spending 21 7 The Government’s response 22 8 Conclusion 22 References 23 Fiscal Institutions in New Zealand and the Question of a WP 10/07 | Spending Cap ii List of Figures Figure 1 – Output gap 8 Figure 2 – Operating balance before gains and losses 9 Figure 3 – Core Crown revenue forecasts 10 Figure 4 – Core Crown net debt 10 Figure 5 – Stated allowance versus Budget operating initiatives 2003 to 2010 11 Figure 6 – Operating allowances: final forecast year impact of Budget on operating expenses 12 Figure 7 – Core Crown expenses 12 Figure 8 – Real GDP per capita forecasts at Budget 2009 13 Figure 9 – Core Crown net debt projections at Budget 2009 14 List of Tables Table 1 – Changes in core Crown operating expenses 22 Fiscal Institutions in New Zealand and the Question of a WP 10/07 | Spending Cap iii Fiscal Institutions in New Zealand and the Question of a Spending Cap 1 Introduction New Zealand’s current fiscal policy framework has been in place for nearly 20 years. At its core is a set of principles around maintaining prudent levels of public debt and running, on average over time, fiscal surpluses. This framework, combined with an extended period of economic growth, contributed to New Zealand entering the an economic recession of 2008-2009 with historically and internationally low levels of public debt. While the current fiscal policy framework has helped achieve and maintain defined, prudent levels of public debt, it is does not require the government to define a target level for government spending. Over recent years, government spending has increased as a share of GDP. Most of this reflects increased spending during the extended economic upturn through the middle of last decade. The recent economic recession also played a small role in increasing spending, largely through the automatic stabilisers as New Zealand did not implement a substantive expenditure-based stimulus package. The Government therefore committed to investigating whether a spending cap would be an appropriate addition to the existing fiscal policy framework. Section 2 of this paper considers the literature on fiscal rules, how they have been used internationally, and how they have performed over the past few years. One thing that is apparent is that the appropriate design for a spending rule is dependent on the existing institutional arrangements. Therefore, section 3 outlines New Zealand’s current fiscal institutions and section 4 describes the evolution of Budget management processes. Section 5 provides some more context by outlining New Zealand’s economic and fiscal performance over the past decade. Section 6 outlines some of the key design choices that would be relevant if a spending cap was to be introduced in New Zealand. Section 7 then discusses some the Government’s reasoning for not going ahead with a cap on total spending at this point in time. Fiscal Institutions in New Zealand and the Question of a WP 10/07 | Spending Cap 1 2 Fiscal rules – theory and international experience Definitions and objectives of fiscal rules Fiscal rules are a type of fiscal institution – the arrangements that form a nation’s public finance framework. Institutions include the legislative framework for budgeting and fiscal planning, any policy guidelines or well-established norms, the public agencies involved in the planning and implementation of the budget process, and any independent entities that give advice or monitor performance. Kopits and Symansky (1998) define a fiscal rule as “a permanent constraint on fiscal policy through simple numerical limits on budgetary aggregates”.

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