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A Guide to the Public Finance Act (2005)

Principles of responsible fiscal management

The Public Finance Act sets out five principles of responsible fiscal management. These principles are summarised below.

Principles of responsible fiscal management

The Government must pursue its policy objectives in accordance with the following principles of responsible fiscal management:

Debt and fiscal balance

  • reducing total debt to prudent levels, so as to provide a buffer against factors that may impact adversely on the level of total debt in the future. Until prudent levels of debt have been achieved, the Government must ensure that total operating expenses in each financial year are less than total operating revenues in the same financial year
  • once prudent levels of total debt have been achieved, maintaining those levels by ensuring that, on average, over a reasonable period of time, total operating expenses do not exceed total operating revenues

Net worth

  • achieving and maintaining levels of total net worth that provide a buffer against factors that may impact adversely on total net worth in the future

Fiscal risks

  • managing prudently the fiscal risks facing the Government, and

Predictability and stability of tax rates

  • pursuing policies that are consistent with a reasonable degree of predictability about the level and stability of tax rates for future years.

Each principle is discussed in turn.

Debt and fiscal balance

Historically New Zealand had a high level of public debt which made the economy vulnerable to the impact of adverse events. The first principle is a two-tiered test which was intended to reduce this vulnerability and to sustain the resulting improved position. It requires that debt must be reduced and this reduction must be achieved by running operating surpluses. The second tier of the principle prevents governments from achieving prudent debt levels simply by selling assets.

The second principle requires that the Government maintain debt at prudent levels. In order to achieve this objective a government will need to ensure that operating revenues are greater than operating expenses on a regular basis. That is, a government will need to live within its means over time.

What is a “prudent” level of debt?

The Public Finance Act does not define the term “prudent”. The Government is therefore required to interpret this term and to justify its interpretation to Parliament and the public.

There is no one level of debt, for example, that could be considered prudent at all times. What may be considered prudent at any given time is influenced by the prevailing structure of the economy and its vulnerability to shocks, demographic changes, the cost of debt servicing in relation to total government spending, and the structure of the Government’s balance sheet. These and other relevant factors are likely to change over time.

Net worth

The third principle requires that the Government maintain a level of net worth that provides a buffer against adverse future events such as economic shocks and demographic changes. The Government needs to consider what level and composition of net worth will allow it to take action to meet these events.

Fiscal risks

The fourth principle requires that the Government identifies and manages prudently the fiscal risks facing the Government. Fiscal risks can arise in relation to:

  • financial position, for example, changes in the value of assets and liabilities and the potential for off-balance sheet items such as guarantees to give rise to liabilities, or
  • operating flows, for example, changes in the tax base and the risk of certain expenditures exceeding budget.

By ensuring that fiscal risks are monitored, the principle helps to reduce the level of uncertainty associated with the Government’s future financial performance and position.

Predictability and stability of tax rates

The fifth principle requires that the Government aims to provide a reasonable degree of predictability regarding the level and stability of future tax rates. This principle reflects the importance of stability in tax rates for private sector planning and decision making.

Departures from principles

Governments are allowed to depart temporarily from the principles of responsible fiscal management. The legislation requires, however, that a government specify its reasons for departure from the principles, how it expects to return to the principles and when. The Act recognises the need for some short-term policy flexibility, but it also requires that departures are transparent and temporary.

Targets

Although the legislation does not specify targets, it provides a framework within which the Government is required to set long-term fiscal objectives. In order to demonstrate that it has acted in accordance with the principles of responsible fiscal management a Government will need to explain these fiscal objectives and review them on a regular basis.

Factors influencing the development of the principles

The requirements of Part 2 of the Public Finance Act are based on the requirements of the Fiscal Responsibility Act of 1994. The 1994 Act was intended to require transparent reporting of a government’s fiscal intentions and to encourage governments to consider the long-term consequences of policy decisions (see Appendix 1). The principles established in 1994 can also be seen as a response to concerns about New Zealand’s fiscal performance at that time (refer Figure 1).

Figure 1: Net Public Debt as a Percentage of GDP

Although New Zealand’s fiscal performance has improved since the principles were first established, the principles continue to provide a useful framework for Ministers to consider the long-term consequences of policy decisions.

International developments

New Zealand was one of the first countries to legislate principles of responsible fiscal management and require a comprehensive suite of fiscal reports on a government’s short- and long-term fiscal outlook.

Since the passage of the 1994 Act, two international agencies, the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) have developed guidelines for jurisdictions attempting to improve fiscal transparency.

International agencies

The IMF Code of Good Practices on Fiscal Transparency (adopted 1998, revised 2001) contains the following general principles:

  • clarity of roles and responsibilities
  • public availability of information
  • open budget preparation, execution and reporting, and
  • independent assurances of integrity.

The IMF measures country performance against the Code and publishes this information.

The OECD Best Practices for Budget Transparency are designed as a reference tool for member and non-member countries to use in order to increase the degree of budget transparency in their respective countries.

Two other jurisdictions, Australia and the United Kingdom, have also used similar approaches to New Zealand in developing legislation that establishes principles and requires Governments to operate in accordance with those principles.

Australia

The Charter of Budget Honesty Act 1998 (the Charter) aims to improve the Commonwealth Government’s accountability for fiscal policy formulation. The Charter requires that governments release annual fiscal strategy statements (usually with each budget) based on principles of sound fiscal management. Australia’s fiscal framework is consistent with the key features of the IMF Code.

United Kingdom

The framework within which the United Kingdom Government formulates and implements fiscal policy (including debt management) is set out in The Code for Fiscal Stability (March 1998).

The Code requires fiscal and debt management policy to be formulated and implemented in accordance with a set of principles of fiscal management.

A government must state explicitly its short- and long-term fiscal policy objectives, and must ensure these objectives are consistent with the fiscal principles embodied in the Code. A government must also report regularly on progress in meeting its fiscal objectives.

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