The Treasury

Global Navigation

Personal tools

2.2  How are the provisions operationalised?

New Zealand is now partway through the second set of three-year fiscal provisions. Set out below are the steps we went through to operationalise the framework. Since 1996 these processes have been gradually refined and institutionalised.

Step 1: Agree the amount of the provision

The first step was to advise the incoming government on an appropriate three-year target. Establishing fiscal provisions requires a Government to consider what its long-term objectives are in relation to the operating balance, debt reduction, and future expense pressures. This will determine what resources are available in the short-term.

By way of example, the current Government’s fiscal provisions have been set at $5.9 billion (GST inclusive) over the 1999/2000 – 2002/03 period[10]. The calculation was based on the most recent set of fiscal forecasts at the time (October 1999), and the Government’s potential longer-term parameters.[11]

Step 2: Allocate the provision across three years

The second step was to allocate the total provision over the three-year period. The original $5 billion provision was defined as a cumulative, three-year total (see diagram below), and this framework is still used. The provision needs to be phased across the three years in accordance with the expected profile of decisions. In illustration, the current government’s three-year fiscal provisions are set out below:

Cumulative Provisions – Including the 2000 Fiscal Strategy Report Extract

Cumulative Provisions – Including the 2000 Fiscal Strategy Report Extract.

The expense track includes a fiscal provision of $5.9 billion (GST inclusive) for the next three years[12] to be used on priority policy objectives. The allocation of the provision has been finalised during the Budget 2000 process on a cumulative basis at (GST inclusive) $420 million for the remaining months in 1999/2000, $1.2 billion in 2000/01, $1.8 billion in 2001/02 and $2.4 billion in 2002/03 (0.4%, 1.1%, 1.5% and 2.0% of GDP respectively).

Provisions are cumulative, assuming that a decision taken to increase a department’s baseline in 2000/01 will generally represent a permanent increase. The provisions provide for the annual increase to “roll out” into the following years. Each individual cumulative provision totals to the $5.9 billion total allocation.

The allocation of a budget target over a three-year period represented a step forward for budget management. Previously, the focus had been on the “annual” budget pot available for distribution. A three-year spending programme allows the government to phase in more significant initiatives such as tax cuts, while showing how they could be credibly funded as part of a three-year policy process. It also enables Ministers to deliver significant one-off packages in key portfolios, rather than drip-feeding annual funding increases. For example, Ministers would have the option of deferring a suite of environmental initiatives to a later budget in order to enable significant tax cuts in a current budget.

Step 3: Clarify the “principles” governing impacts on the provision

The third step was to establish the “principles (or rules)” that determine which items would be treated as forecast changes, and which would be treated as specific policy decisions that would “count” against the provisions. Development of the principles turned out to be far from simple, and the principles have evolved considerably since 1996 (Annex One outlines the current guidelines as set down at October 2000).

Compared with the previous system, the key innovation in developing the principles was to include all policy decisions that impacted on the operating balance. In the past, tax policy decisions and policy decisions affecting state-owned enterprises and Crown entity surpluses had tended to be made in isolation of “spending” budget decisions. These have now been explicitly brought into the budgeting framework to enable the Government to consider all policy proposals (that impact on the operating balance) as part of the same decision-making process.

Step 4: Implementation

The final step was to implement the framework through:

  • informing ministers and departments of the allocations and principles (by issuing Treasury circulars);
  • adjusting Cabinet Office procedures by requiring that all Cabinet papers state the impact on the fiscal provisions of specific policy recommendations;
  • establishing Treasury procedures to record decisions impacting on the provisions;
  • adjusting budget processes: the original Budget Baseline Update process has now been redefined to exclude any proposals impacting on the provisions – all such proposals must now be considered as part of the Budget Initiatives round;
  • incorporating reporting against the fiscal provisions in the budget documents. Targets are stated in the Budget Policy Statement; and the impact of policy decisions is documented in each Economic and Fiscal Update (Annex Two provides an example from the 2000 Budget documentation illustrating the level of transparency of disclosure).

In effect the fiscal provisions have set up a second fiscal monitoring process, in parallel with the monitoring of the overall operating balance.

2.3  The provisions tell only part of the story

The fiscal provisions are only one element of the operating balance – they represent the discretionary policy decisions that are most easily controllable by governments in the short term. Other elements – such as benefits and revenue changes, or valuation changes, are less amenable to the direct short-term control of the Government. The provisions framework therefore helps ensure that annual budgeting decisions can focus on shorter-term pressures, while longer term pressures are able to be addressed either by the three-year framework provided by the total provisions target, or by the medium-to-long term targets established in the Budget Policy Statements and Fiscal Strategy Reports required under the FRA

One obvious driver of the operating balance that is beyond the direct short-term control of the government is the impact of the business cycle[13].

A second driver, with the move to accrual accounting, is fluctuation due to changes in liability valuations. At the moment, two significant liabilities (Accident Compensation Corporation outstanding claims obligation and Government Superannuation Fund (GSF) unfunded liability) are valued on a fair value basis and subject to discount rate changes. New Zealand GAAP is heading in the direction of applying the fair value approach to a wider range of assets and liabilities, and therefore increasing the potential impact on the operating balance.

By way of example, for the year ended 30 June 1999, the GSF unfunded liability increased by around $600 million (0.6% of GDP) from that forecast – due largely to a change in how the discount rate was calculated. No change was required to the fiscal provisions, as no long-term threat existed to the achievement of the Government’s objectives (see Annex Three for an illustration of how focusing on fiscal provisions influences the trend of the operating balance – and why short-term fluctuations from “fair value” changes need to be considered from a longer-term perspective)[14].

In setting the three-year target for the operating provisions, the Government faces uncertainty regarding economic performance and likely cost pressures. The Government needs to take into account the fact that fiscal plans may need to change if circumstances turn out different to current forecasts. Key uncertainties that impact on the operating balance include:

  • the economic outlook and its impact on fiscal parameters - economic conditions impact directly on revenue streams, finance costs and beneficiary numbers;
  • changes in the value of Crown assets and liabilities - for example, a decrease in real interest rates increases the value of both the ACC liability and GSF liability, therefore reducing the operating balance.

These impacts, driven by the economic cycle, are beyond the immediate control of the Government. As a general approach, we would recommend that no change be made to the provisions target in response to forecast changes due to the factors described above. This allows the automatic fiscal stabilisers[15] to operate through the cycle.

However, it may be appropriate for the Government to consider adjusting the provisions in the case of an economic shock that is likely to have long-lasting impacts. For example, at the time of the 1998 Asian crisis forecasts and projections showed that progress towards the previous Government’s long-term objectives was significantly reduced. See Janssen (2001) for details.

In response, the previous Government agreed to progressively reduce the three-year provisions target of $5 billion to $4.25 billion[16]. The result was to ensure steadier progress was made over the three-yea period towards the long-term objectives.

Essentially, the provisions provide the Government with an opportunity to credibly demonstrate that it is following through on its fiscal intentions. The operating balance is subject to too many other factors to be a complete measure by itself in the short-term.

2.4  Benefits of the provisions

Progressively through the last three years, the provisions framework has become:

  • the way in which the Government can demonstrate that short-term fiscal policy is consistent with achievement of longer-term objectives;
  • the means of improving budget decision making, to ensure a more strategic three-year focus rather than solely an annual focus; and
  • a tool for Ministers to focus on a more definable and manageable “target” than the operating balance (as discussed in section 2.3 above).

A more realistic total spending profile was (and is)presented for the forecast years. The result has been:

  • fiscal forecasts that provide a better indication of expected progress towards the Government’s long-term objectives (therefore enhancing the credibility of the fiscal forecasts); and
  • that the fiscal provisions have become one of the anchors of fiscal policy by which the Government is judged.

The increased prominence that commentators have placed on the fiscal provisions has increased the focus of the Government on its decision-making, and therefore introduced greater certainty into fiscal planning. The Government can see what it needs to do to meet its fiscal objectives, and knows whether it can meet its policy and fiscal objectives without running out of resources.

Fiscal provision limits support sound day-to-day fiscal management. By defining an overall limit first, the framework has focused decision-making on trade-offs between policy options. All decisions impacting on the operating balance, whether spending, revenue or SOE surplus decisions, are considered in a common framework.

In terms of budget management, ministers and chief executives have clear signals on which to base expectations of new resources in each budget round. Provided that the limit is sufficiently tight, ministers and chief executives will be encouraged to reprioritise within their budgets. This should also help the Government deliver value for money.

Notes

  • [10]Equivalent to 1.7% of GDP on average across three years.
  • [11]Long-term fiscal parameters included:
  • [12]The $5.9 billion provision covers three years. However, because the parliamentary term begins in November and the financial year begins in July, the expenditure needs to be allocated across four financial years. The small amount of expenditure allocated in 1999/2000 year provided for new government initiatives implemented before the Government’s first budget took effect from 1 July 2000.
  • [13]Refer Buckle, Kim and Tam (2001) and Tam and Kirkham (2001).
  • [14]In the 2001 Budget, a new fiscal indicator was introduced – OBERAC – Operating Balance Excluding Revaluations and Accounting policy Changes. OBERAC removes revaluation movements and accounting policy changes to provide a measure of underlying financial stewardship. For a fully explanation refer New Zealand Government (2001) pp 76 .
  • [15]In considering the fiscal position, it is important to focus on trends and to abstract from short-term fluctuations about the trends. If government spending and tax plans remain unchanged during an upswing, higher tax revenues and lower spending on unemployment result in improving fiscal surpluses (and vice versa in the case of a downturn). These fluctuations occur because actual output in the economy fluctuates about its productive potential. Allowing these so-called “automatic stabilisers” to operate across the economic cycle takes pressure off monetary policy and reduces fluctuations in employment and output. For these reasons the Government’s general approach is to let these automatic stabilisers operate unhindered.
  • [16]While the previous Government reduced the fiscal provisions, other decisions made at the time had more of an influence over the longer-term – ensuring that the long-term targets could still be attained.
Page top