1  Introduction

This paper has three purposes. One purpose is to propose a framework which views fiscal policy through three lenses and, in particular, considers the ways by which fiscal policy can be designed to enhance economic growth. A second purpose is to explain New Zealand’s current fiscal framework and to evaluate the extent to which the framework accommodates the various lenses through which fiscal policy is considered in this paper. The third purpose of the paper is to highlight and discuss current New Zealand fiscal challenges in order to identify areas to investigate which may yield improvements to the fiscal framework.

Governments have a range of economic and social objectives they endeavour to achieve by regulation, the design of institutions and also by the composition or structure of government spending and taxation (including the ownership of resources and control of service delivery). While political debates will tend to focus on the preferred set of economic and social objectives, economic debate tends to focus on the efficiency and effectiveness of policy in contributing to the achievement of these objectives. The scope for discussion on the role of fiscal policy is therefore very broad. This paper concentrates on the contribution of fiscal policy to long-run economic growth. Our justification is not that economic growth considerations necessarily dominate other reasons for fiscal decisions, but economic growth tends to be a common objective across governments and is an objective of the present New Zealand Government.[1] Furthermore, economic growth provides the base by which governments can finance their social objectives.

Our analytical framework suggests three lenses through which to view how fiscal policy impacts on growth. These lenses are fiscal sustainability, fiscal structure and fiscal stabilisation. Fiscal sustainability considers the importance of sound public finances and stable and predictable taxation rates and expenditure programs for economic growth. Fiscal structure considers how the composition of expenditure and taxation and size of government impact on growth. Fiscal stabilisation refers to the role of fiscal policy in contributing to macroeconomic stability and growth.

These considerations influence the way we think about how fiscal policy can be nestled within the broader framework for economic policy, including regulatory and macroeconomic policy. They influence, for example, the choice between regulatory and fiscal instruments. They influence how the growth effects of taxation and government expenditure should contribute to fiscal policy decisions. They also influence the extent to which fiscal policy can be used for the purpose of macroeconomic stabilisation or whether that role should primarily be the domain of monetary policy.

A key theme which emerges, unsurprisingly, is that fiscal decision-making frameworks need to be designed to be robust to political economy considerations and recognise that government decision-making will always be in a world of imperfect information and diverse motivations. As James Madison remarked over 200 years ago:

If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government to control the governed; and in the next place oblige it to control itself. A dependence on the people is, no doubt, the primary control on the government; but experience has taught mankind the necessity of auxiliary precautions.

(Madison, 1788)

Responses New Zealand has taken to strive for fiscal sustainability and an efficient fiscal structure, and to improve macroeconomic stability, are divided into those pertaining to the fiscal framework (that is, the legislative and institutional framework), those pertaining to fiscal policy (that is, those achieved through the setting by government of their fiscal policy objectives), and those achieved at the level of fiscal management (that is, through the day-to-day operation of fiscal policy according to budget rules or the information and advice provided to Ministers).

The remainder of the paper is structured as follows. Sections 2, 3, and 4 discuss fiscal sustainability, fiscal structure and fiscal stabilisation respectively. Each section reviews insights from theoretical and empirical research as to how each of these three aspects of fiscal policy can impact on economic growth and the challenges of achieving fiscal sustainability, good fiscal structure and an appropriate contribution to macroeconomic stability. These three sections then discuss responses New Zealand has made and they review outcomes under each role. Section 5 discusses the connections between each of the three roles of fiscal policy and the implications of these connections. This discussion is couched in the context of contemporary New Zealand fiscal challenges. Section 6 draws together the main conclusions to be taken from the paper.