4.3 Adding new principles and reporting requirements to the PFA consistent with the transparency approach

30. The Treasury's preferred approach involves a series of additions and amendments to the fiscal responsibility provisions, consistent with the existing transparency-based framework. The Treasury's recommended changes would expand the set of factors that governments need to consider when setting its fiscal strategy. The changes relate directly to the issues outlined in the problem definition above and are summarised under those headings below.

4.3.1  To ensure that governments consider the interactions between fiscal policy and economic cycles

31. Treasury recommends that the following provisions be added to Part 2 of the Public Finance Act:
    • A principle of responsible fiscal management that governments must take the impact of fiscal policy on economic cycles into account, with a view to minimising interest rate and exchange rate pressures;
    • A reporting requirement that the Fiscal Strategy Report include an explanation of how the government has considered the interaction between fiscal policy and economic cycles when formulating its fiscal strategy, including any implicit trade-offs and the expected impacts on the economy, with particular reference to interest rates and exchange rates.
32. The new principle of responsible fiscal management would require governments to have regard to economic stability when formulating fiscal strategy.
33. The reporting provision would require governments to communicate how they have considered economic stability when formulating their fiscal strategy, including the stage of the economic cycle, any trade-offs with other fiscal objectives, and the impacts they expect their strategy to have on the economy. This reporting would take place in the Fiscal Strategy Report.
34. Given the methodological challenges inherent in measuring the stage of economic cycles, and the judgements involved, reporting on this as a dimension of fiscal policy lends itself to a narrative involving a range of variables, rather than a single measure.
35. One of the key benefits of ensuring that governments take into account macro-stability in setting fiscal strategy is that fiscal policy should be less pro-cyclical. This will put less pressure on monetary policy, resulting in lower interest/exchange rates than otherwise.
36. A stronger focus on economic stability will result in future governments using future revenue windfalls to pay down debt or build up assets - rather than for discretionary initiatives that may over-stimulate the economy during an upturn.
37. One of the consequences of avoiding pro-cyclical fiscal policy during a period of buoyant economic activity is that a government may consider it necessary to run large operating surpluses. The requirement to take macro-economic stability into account may help governments to manage cyclical pressure to use cyclical revenues for structural changes such as increased structural spending or tax cuts.
38. This change is not without international precedent. The Australian Charter of Budget Honesty Act includes the principle of “moderating cyclical fluctuations in economy activity, as appropriate, taking account of the economic risks facing the nation and the impact of those risks on the Government's fiscal position.”

4.3.2  To ensure that governments are transparent about the areas they are prioritising, leading to greater efficiency in managing resources

39. Treasury recommends that the following provisions be added to Part 2 of the Public Finance Act:
    • A principle of responsible fiscal management relating to the need for governments to manage resources efficiently and effectively;
    • A reporting requirement that the Fiscal Strategy Report include an explanation of the Government's medium-term priorities for new and existing spending and the management of the expenditure base and balance sheet; and
    • An extension of the current principle dealing with predictability of the level and stability of tax rates so that it also refers to the need for the tax system to raise revenue efficiently and fairly.
40. This dimension has three core elements relating to public expenditure, taxation revenue and the Crown balance sheet, and has parts that relate to the principles and the reporting provisions.

Spending and the balance sheet

41. The concept of “managing public resources efficiently and effectively” could be added to the principles of responsible fiscal management. This principle would cover existing and future expenditure (operating and capital) and the management of the Crown's balance sheet. This change would provide Ministers (and officials) with a clearer mandate to emphasise the efficient stewardship of resources during good times as well as times of constraint.
42. To support this principle, a reporting provision could be added to require the government to state clearly and consistently the medium-term priorities that will guide its resource decisions with respect to:
    • the allocation of new capital and operating spending;
    • the reprioritisation or re-allocation of existing expenditure and assets over time; and
    • the management of the expenditure base and balance sheet.
43. These priorities would bring more transparency around what the government is trying to achieve through its management of public resources. These priorities would complement what already occurs with the tax revenue strategy and build on the current Government's approach to setting investment intentions in the Investment Statement of the Government of New Zealand. This change would help shift the focus of budget decision-making from additional spending initiatives at the margin to managing the baseline and balance sheet as a whole.

Taxation revenue

44. The existing principle contained in s26G(e), which relates to tax revenue, states: “Pursuing policies that are consistent with a reasonable degree of predictability about the level and stability of tax rates for future years.” This principle could be broadened to include the concept of raising tax revenue efficiently. Although the stability and predictability of tax rates is important, this is not all that matters. Other elements matter, including: raising sufficient revenue to meet government priorities; minimising behavioural distortions; keeping administrative costs low; and fairness. Most of these elements can be captured succinctly by referencing the raising of revenue efficiently.
45. The tax principle is a useful signalling tool, and something officials and Ministers can use to push back against particular proposals for tax system change. We would expect the proposed change to have a modest, but nevertheless positive, impact. It would provide a stronger legislative mandate for officials and Ministers to use in promoting fiscal policy that is consistent with a good tax system.

4.3.3  To ensure that governments consider future generations when formulating fiscal policy

46. The Treasury recommends that a principle of responsible fiscal management that governments must have regard to the impact of fiscal policy on current and future generations be added to Part 2 of the Public Finance Act.
47. A reference to inter-generational impacts of fiscal policy could be added to the principles of fiscal responsibility. It would require the government to consider the impact of current policies on future generations.
48. The fiscal responsibility provisions currently have a medium-term focus of a maximum of 15 years. Yet fiscal policy decisions invariably have longer-term effects. The Statement on the Long-term Fiscal Position, which the Treasury is required to produce at least every four years, takes a long-term view and models the expected impacts of current policies decades into the future. There is scope for closer integration of the fiscal responsibility provisions with the Long-term Fiscal Statement. An explicit inter-generational approach is particularly useful now, when New Zealand's changing demographic structure means that our current decisions are likely to have different impacts on different generations.
49. There is international precedent for this. The Australian Charter of Budget Honesty Act 1998 includes the principle of “ensure that its policy decisions have regard to their financial effects on future generation.”
50. This addition would provide the government with a clearer mandate to highlight the impact of current decisions on future generations, including issues of inter-generational equity. It will also bolster the role of the Long-term Fiscal Statement, and provide the Treasury with a clearer mandate to highlight issues of inter-generational fairness.

4.3.4  To ensure that governments look back and assess past fiscal policy

51. The Treasury recommends that the following provisions be added to Part 2 of the Public Finance Act:
    • A reporting requirement that the Fiscal Strategy Report contain the Government's assessment of its past performance against its fiscal strategy; and
    • An independent review of fiscal strategy.

A reporting requirement for governments to assess their past performance

52. The fiscal responsibility provisions are currently forward-looking on the strategy that the government is about to set or has already set. There is no requirement for a government to look back and assess its progress. A requirement could be added for governments to look back and assess their past performance against their fiscal strategy, including how and why that strategy has been changed over time.
53. The reporting requirement would require governments to report on past performance of their fiscal strategy in the Fiscal Strategy Report. The idea is to increase the onus on governments to discuss and justify any changes in their fiscal objectives and intentions. It will also encourage governments to tell a clear story about progress being made towards their fiscal strategy.

An independent review of fiscal strategy

54. To complement the government's own assessment of its past fiscal performance, an independent review of performance against the government's stated fiscal strategy, and of the Treasury's performance as an advisor on fiscal policy, could be required. Such a review would be held every four years or once during each parliamentary term.
55. The aim would be to secure an independent assessment of fiscal policy that would generate public debate as well as debate within Parliament. The reviews could have included a panel of reviewers, with candidates drawn from New Zealand and/or an offshore, fiscal authority. Alternatively, this role could be delegated to an Independent Fiscal Council, if one were to be established.

4.3.5  To ensure that current good practices remain part of our reporting framework

56. Treasury recommends that the following provisions be added to Part 2 of the Public Finance Act:
    • a reporting requirement that the Fiscal Strategy Report must include a revenue strategy that outlines the Government's priorities for the tax system; and
    • a reporting requirement that the Treasury produce an Investment Statement at least every four years, describing any significant assets and liabilities on the Crown's balance sheet, how they have changed over time, and how what the Crown owns and owes is forecast to change over the coming five years.

Tax strategy

57. By convention, the Fiscal Strategy Report has, in recent years, had a revenue strategy appended to it. It is a succinct and useful reference document to communicate what the government is trying to achieve. It is sometimes used as a reference point to help officials and Ministers respond to tax policy proposals. There is no legislative requirement for the inclusion of this document and the risk is that future governments will decide not to produce this useful communication tool.
58. A requirement that a revenue strategy be attached to the Fiscal Strategy Report could be introduced. The requirement to produce this strategy would be high-level rather than prescriptive. It would require the government to outline its priorities for the tax system.

Investment statement

59. The emerging practice of a government Investment Statement could be added to the fiscal responsibility provisions. As with the Long-Term Fiscal Statement, the Investment Statement would be:
    • produced by the Treasury, with the emphasis on the quantifiable elements of the Crown balance sheet (e.g. composition, forecast movements, and funding sources); and
    • produced at least every four years, given the relatively slow-changing nature of much of the factual information about the balance sheet.
60. A standalone Investment Statement would ensure that the balance sheet continues to receive in-depth focus and that the direction pursued by governments and the associated trade-offs, receive sufficient attention. The release of the Investment Statement could be timed to avoid overlapping with Budget day and ensure sufficient public attention for the Statement.

4.3.6  Package of recommendations

61. As a package, these recommended changes would help to achieve the objective of requiring the government to take into account and publicly discussing a greater range of the dimensions of fiscal policy. There will need to be a broader emphasis on the stage of the economic cycle and on how resources are being managed. The additional reporting requirements will make the process by which the government arrived at its fiscal policy more transparent and also highlight the major trade-offs and choices involved.
62. We expect that the proposed changes would provide increased discipline on the part of the Treasury to consider actively, and to advise consistently on, the stability and structural dimensions of fiscal policy. The changes would also better assist the Minister of Finance to raise issues of fiscal constraint and caution with colleagues.
63. The overall impact is expected to be modest in the short term. Looking to the future, we feel the changes could be of most use after a return to fiscal surplus has been secured and particularly in response to any revenue surprises during the next economic upturn.
64. At best, a macroeconomic stability dimension could mean that any such windfalls would in the first instance be used to pay down debt further rather than boost discretionary stimulus at a time when the domestic-oriented sectors of the economy are already operating above capacity. In an economic upturn, all things equal, this would reduce the risk of pro-cyclical fiscal policy, and consequently put less pressure on interest/exchange rates and tradable sector than would otherwise be the case.

Treasury conclusion: recommended changes will require governments to take into account and publicly discuss all aspects of fiscal policy.