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1.5  Interaction with the long-term fiscal framework

The mid-1990s saw further developments in the fiscal management framework. In 1994 the FRA was passed, requiring the Government to establish long-term objectives and track progress against them. At the same time, New Zealand was moving out of a period of fiscal crisis. Government spending began to increase more rapidly, though still at a rate less than revenue growth.

Budget management processes needed to adapt to the challenges of a surplus environment. A key issue that emerged was the relationship between fixed nominal baselines and the fiscal forecasts. Three-year budget forecasts prepared under GAAP[5] between 1994 and 1996 would include increases in government spending only for those areas that had automatic indexation. All other spending was assumed to remain constant over time. While this assumption could arguably have been justified over the early 1990s during the period of fiscal crisis, by 1994 this was no longer the case.

Because the fiscal forecasts did not allow for increased spending in future Budgets, they understated the likely spending profiles. This resulted in optimistic projections of the progress towards the long-term fiscal objectives, which reduced the discipline on the annual Budget process[6]. This forecast “bias” is illustrated below:

Operating Balance for 1997/98 – Change in Forecasts
Operating Balance for 1997/98 – Change in Forecasts.

There were also pressures from a political perspective to find a better way to represent spending intentions in the forecasts. In 1996, New Zealand moved to a proportional representation voting system and the first Coalition Government was elected. The government formation process threw up two challenges for the coalition:

  • to alleviate any concerns that a coalition government would usher in a period of instability, incoming Ministers needed a way to demonstrate fiscal prudence;
  • there was now an opportunity for portfolio ministers from different coalition parties to bid up spending in their sector, by turning the issue into a coalition dispute.

Both pressures could be managed if some kind of overall spending cap was agreed by both parties. The response was a statement from the new government committing to a $5 billion cap[7] on new spending over a three-year term of government to 1999/2000, on top of changes already included in the forecasts (i.e. on top of the formula-driven items).

Treasury officials were charged with working out how the $5 billion spending cap would work in practice. The cap evolved into a mechanism now known as the “fiscal provisions”.

Notes

  • [5]Generally Accepted Accounting Practice – use of accounting standards that in New Zealand are the same for the private and public sector. GAAP is defined in the PFA.
  • [6]The 10-year progress outlooks did include higher spending track scenarios and therefore did provide some measure of a more realistic path towards long-term objectives.
  • [7]Equivalent to 1.6% of GDP on average across three years.
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