A little noticed reference in the 2012 budget speech to strengthening the Public Finance Act has the potential to influence the shape of all future budgets so deserves close attention.
The government is proposing changes to the PFA which will require governments to:
consider the impact of their fiscal strategy on the broader economy, in particular interest rates and the exchange rate
set out their priorities for revenue, spending and the balance sheet
take into account the impact of fiscal policy decisions on future generations, and
report on the successes and failures of past fiscal policies.
It will also consult other political parties about the possible introduction of a cap to restrict spending increases to population growth and inflation. The spark for this is ACT which negotiated it into its 2011 confidence and supply agreement with National. ACT favours a variation of the hard-line Colorado Taxpayer Bill of Rights (TABOR), of which more later.
First, let’s ask what’s the problem being addressed here?
The New Zealand reporting framework is already characterised by a high measure of transparency. Finance Ministers are required to report regularly on the fiscal outlook, including a Pre-Election Economic and Fiscal Update, and budgets must contain both long and short-term fiscal objectives, and must identify and, where possible, quantify any fiscal risks.
These disciplines were introduced through the Fiscal Responsibility Act 1994, the key provisions of which were folded into the PFA in 2005. But, much as the general fighting the last war, the PFA is fixated on paying down debt and achieving a balanced budget. This is because the FRA and the PFA were designed to prevent a repetition of the galloping deficits running from the mid 1970s to the early 1990s, during which time net public debt rose from around 5% of GDP to above 50%.
They were not successful in containing government spending during the good times between the late 1998 and the end of 2007 when New Zealand experienced its longest economic expansion since 1945. The government’s focus for the first several years of this boom was to reduce debt and to increase savings through the Cullen Superannuation Fund but in the latter years, as tax revenues continued to exceed forecasts and political pressure on the government increased, so did spending with the result that core Crown expenses as a proportion of GDP rose from 28.9% in 2003/04 to 34.7% in 2008/09. It is now at 35.2% but the government is aiming to haul it back to 30.2% by 2016.
Similar increases in spending were recorded in other countries in the same period, with the result that spending rules have now been introduced in some 25 jurisdictions around the world. A study of the effect in Finland, the Netherlands and Sweden, where the only real sanction for non-compliance is political embarrassment, has found that “in the absence of widespread political support, it is doubtful that the legislative status of a spending rule will have any impact on actual policy formation”.
But the lesson from Colorado is that the alternative is worse.
TABOR not only requires that the government must get the electorate’s consent via referendum to depart from the spending limits but also has an inbuilt “downward ratchet” under which permitted revenue and expenditure growth for each fiscal year is calculated on whatever is the lower of either the amounts allowed under the TABOR formula or the amounts actually expended or collected in the previous year.
Between 1993 and 1999 more than 1000 votes were held to override TABOR, of which more than 90% passed. Then in 2005, they voted to remove the ratchet and to suspend TABOR for five years.
Support for the caps have faded as TABOR has failed to deliver the expected growth dividend and as the quality of public services has deteriorated. Colorado has fallen from 24th to 50th among US states in the proportion of children receiving their full vaccinations and from 23rd to 48th for the percentage of pregnant women with adequate access to prenatal care. Public education standards have also declined.
National has already made it clear, however, that it will not be looking to implement the Colorado model. Finance Minister Bill English told the Wellington Employers’ Chamber of Commerce last month that the only sanctions for breach will be that the government will need to explain to Parliament why it happened and how it intends to maintain compliance in the future.
He has also said that the limit will exclude spending on natural disasters, finance costs, the unemployment benefit and asset impairments on the basis that these are either outside the government’s control or are needed to stabilise the economy in a downturn.
This is a prudent and sensible approach and should mean that New Zealand escapes some of the problems associated with a TABOR-style regime. It also avoids the issues associated with having one Parliament attempting to bind future parliaments.
A rule which would require governments to justify spending initiatives and to think about the ripple effects on inflation, interest rates and the exchange rate has some merit. But it will take the PFA, one of New Zealand’s constitutional pillars, into an ideological debate over the role and size of government and at what point the public sector becomes a drain on the private sector.
For this reason, the decision to develop the rules in consultation with the other parties in the House is to be welcomed.