2.3  What approaches has New Zealand applied?

2.3.1  Fiscal framework

Sustainability concerns have influenced both the design of public institutions and the conduct of fiscal policy in New Zealand. For example, in terms of institutional design, the delegation of regulatory policy to independent agencies in many cases was considered to help manage risks to the government balance sheet. For example, the delegation of banking regulation to the Reserve Bank is intended to limit government’s exposure to financial sector distress, first by ensuring financial institutions are unlikely to fail and, second, by removing any explicit government guarantee of the financial system. Although these institutional responses are important to manage risks facing the government, this paper focuses on the design of fiscal institutions.

New Zealand has put considerable weight on the design of fiscal institutions to help avoid deficit bias and reduce and maintain a lower debt ratio, and to provide appropriate information for decision making. One of the key tenets of the Public Finance Act 1989 (PFA) is to allow for government decision-making to be disciplined through setting out requirements for information provision, transparency and accountability.[9] These disciplines can occur through the electoral process, through market mechanisms (such as increases in risk premia on lending) and rating agencies or through external commentators.[10]

However, although transparency will discipline government by holding decision-makers to account, market-led adjustment can be abrupt and costly.[11] Furthermore, transparency is not necessarily sufficient to avoid deficit bias because future generations do not have a voice. Hence the PFA transparency provisions are reinforced in New Zealand by the principles of responsible fiscal management.

2.3.2  Principles of responsible fiscal management

The principles of responsible fiscal management, specified in Section 26G of the Public Finance Act 1989, are summarised in Table 1. They are a set of guiding principles designed to be appropriate under any administration. Aside from the requirement that, once prudent levels of debt have been achieved, governments must maintain those levels by ensuring that on average (over a reasonable period of time) total operating expenses do not exceed total operating revenue, the principles do not impose mandatory targets. This approach was deliberately chosen as it was considered that there was no solid justification for any target over a long period of time and it allowed greater flexibility to take account of other objectives, such as macroeconomic stability (Janssen, 2001).

The idea of using guiding principles that are prescribed in legislation has also been adopted by Australia and the UK. In the UK, the actual fiscal rules (that is, the “golden rule” and the “sustainable investment” rule) have to satisfy the guiding principles. This approach is in contrast to the Stability and Growth Pact in the European Union which fixes an upper limit on public deficits and debt.

Restrictions on the budget balance are the most common fiscal rule applied internationally. In a study of these rules, Poterba (1997) concludes that balanced budget rules are effective in influencing fiscal outcomes. In common with many other countries, the New Zealand principle is defined to apply on average, allowing deficits when growth is below trend and surpluses when growth is above trend. This approach provides scope for more efficient financing as it allows for tax smoothing and the operation of automatic stabilisers. It also supports sustainability to the extent that it prevents cyclical increases in revenue being spent on ongoing expenditure.

The New Zealand balanced budget principle is specified to apply only to the current operating balance, therefore allowing borrowing to fund capital spending. To avoid a large build-up of debt, the principles also require that government maintain a prudent level of debt and net worth and make these intentions transparent. In this regard, governments in New Zealand have set self-binding debt targets as a long-term objective.

2.3.3  PFA: Reporting requirements

The fiscal responsibility section of the PFA requires the production and reporting of comprehensive financial information. These requirements seek to improve decision making by ensuring decision-makers have comprehensive financial information available on the short, medium and longer term, improve accountability through transparency and reduce opportunities for manipulation by providing for independence in the preparation and audit of financial information.

Information requirements include production of a government balance sheet and fiscal forecasts on an accrual basis over a period of at least three years, and reporting of specific fiscal risks to which the government will be exposed. All Crown reporting entities are subject to reporting and monitoring requirements, including a statement of service performance that is included in the audited financial statements. These reporting and monitoring requirements were introduced as a critical component of the comprehensive programme of public sector management reform introduced during the late 1980s and early 1990s in which chief executives became explicitly accountable for the performance of government departments and were given greater discretion over the acquisition and utilisation of resources (McCulloch and Ball, 1992).

Independence requirements include the use of financial reporting standards, independent preparation of the fiscal and economic forecasts by the Treasury and independent audit of financial statements. Recently, International Financial Reporting Standards (IFRS) adjusted for the public sector have been adopted.[12] In addition, the Public Audit Act (2001) requires that the Auditor General provide an ex-post audit of appropriations administered by departments or Officers of Parliament to ensure that expenses and capital expenditure is appropriately authorised and incurred for the purpose for which it was intended. Under the Controller function in the PFA, the Controller and Auditor General monitor the incurrence of expenses and capital expenditure against appropriations throughout the year (The Treasury, 2005b, page 26).

The Fiscal Strategy Report (FSR), is a key tool to make government’s medium-term intentions explicit. In the FSR, the government is required to set long-term objectives (over a period of 10 years) and short term intentions (over a period of 3 years) relating to debt, operating balance, net worth, revenues and expenses. Government is also required to provide fiscal projections over a period of at least 10 years and assess the consistency of the projections with the 10-year objectives specified in the FSR. The objectives act as a form of self-binding rule which the government outlines to the public, and states how government intends to ensure it will maintain a prudent level of debt and net worth.

The sustainability framework has recently been reinforced by the requirement for the Treasury to publish at least every four years, a statement of the long-term fiscal position (LTFP) for a horizon of at least 40 years.[13] The first statement was published in 2006 (The Treasury, 2006). In contrast to the FSR, the Statement and projections it contains is a Treasury document based on The Treasury’s assumptions. Although, the Statement is required to be published, the fiscal framework does not require Government to adjust current fiscal policy if that policy is consistent with the debt objective over a 10-year time horizon, even if it implies a rising debt ratio over a 40-year time horizon.