5.3 Could rules relating to sustainability take more account of stability?
Fiscal rules and institutions are generally designed to support both fiscal sustainability and stability. The current approach in New Zealand supports the operation of the automatic stabilisers on the operating budget, but leaves Government some discretion as to the timing of capital expenditure. Barker and Philip (2007) analyse approaches taken in other countries to taking account of fiscal stability in setting the annual Budget. In general, fiscal rules and institutions seek to support monetary policy through allowing or requiring the operation of automatic fiscal stabilisers. Countries do not generally seek to implement strict rules which requireactive fiscal stabilisation. Nevertheless, some countries, such as those operating a fixed exchange rate regime, do seek to use active fiscal policy for stabilisation purposes. We analyse three possible approaches.
One approach some countries follow is to target a structural budget balance. This approach is followed in Chile, for example, where there is a fiscal rule specifying that government spending is equal to the sum of permanent taxation and permanent copper revenues. Cyclical increases in revenue are ring-fenced in the Copper Stabilization Fund. In Norway, surplus oil revenues are saved in the Government Pension Fund - Global. The Fund was established in order to offset the effects of declining oil income expected over the longer-term, and to smooth out the disruptive effect of volatile oil prices. Casual evidence from Norway and Chile suggests that these rules may have helped stabilise the exchange rate and current account balance over the business cycle. An equivalent approach for New Zealand could be to target the structural operating balance; that is the operating budget balance adjusted for cyclical factors. The structural balance could also be adjusted for the terms of trade. The terms of trade has a significant influence on fluctuations in New Zealand GDP (Buckle, Kim, Kirkham, McLellan and Sharma, 2007). However, the link between the terms of trade and fiscal revenue is weaker than in, for example, Norway and Chile. Furthermore, targeting a terms of trade-adjusted balance may be more difficult in New Zealand because the more diversified make-up of prices that determine New Zealand’s terms of trade may make decomposition of changes into structural or cyclical components more difficult.
Limits on government expenditure growth, discussed in the previous section, is another approach that could be aimed at improving both sustainability and stability. The aim of expenditure limits is to enhance fiscal sustainability by providing expenditure control. This approach would also complement stability if the expenditure limit prevented pro-cyclical changes to expenditure. Countries that set limits on the level of expenditure include Sweden, the Netherlands, the UK, Finland and the US. This approach is similar to the provisions approach that operated in New Zealand. As discussed earlier, the shortfalls of this approach were that it did not allow decision-makers to focus on the medium-term debt and operating balance impacts of their decisions, and it gave rise to arbitrary distinctions as to what did and did not count within the limit. Had such a rule operated over recent years in New Zealand, it is questionable whether expenditure limits would have been politically sustainable in the face of frequent upward adjustments to the structural operating balance.
A third approach could be to specify a rule which states that when realised fiscal cash balances are higher than forecast in the prior year, they will be allocated to increasing net public assets (the rule would also be applied on the down-side). This type of rule has been suggested in New Zealand (Reserve Bank of New Zealand, 2007). Because realised cash balances can differ from forecasts for a number of reasons, only some of which are related to the business cycle, this rule will best support macroeconomic stability when it is targeted. It could, for example, specify that unexpectedly high realised cash balances that arise as a result of a larger than expected output gap will be allocated to public debt reduction. This type of rule may also support sustainability if it helped avoid a tendency toward asymmetric treatment of unexpected changes to fiscal balances. A number of countries have recently taken the approach of using windfalls to build assets or reduce liabilities. For example, Australia used proceeds from the sale of Telstra to build the Future Fund. Canada has a rule whereby unexpected increases in revenue will be used for debt reduction, although the rationale for the rule was essentially to reduce public debt.
A more radical approach is the establishment of a fiscal stabilisation authority or ‘Fiscal Policy Committee’ with a small number of fiscal instruments chosen for their potency in influencing the business cycle (see for example Wren-Lewis, 2003; Wyplosz, 2005). For example, Buiter (2006) suggests that for New Zealand a variable GST rate could be a suitable instrument. The idea is that the authority would only be allowed to make temporary changes in these instruments in order to provide an additional instrument to support traditional monetary policy instruments. Objections may, however, be raised that such approaches may be inconsistent with standing constitutional principles (such as the principle that taxation can only be imposed by Parliament) and may result in high compliance costs.
5.4 Should structure be determined by stability concerns?
Recent debate in New Zealand has also explored the linkages between fiscal structure and stability. One area of interest has been whether the taxation structure and regulations applying to the housing market are exacerbating volatility of house prices and hence exacerbating excess demand pressures.
The role of housing in the current business cycle was part of the motivation for a joint investigation by the Reserve Bank of New Zealand and the Treasury to explore whether there are supplementary stabilisation instruments available which could be deployed to complement monetary policy and in particular “enable less reliance to be placed on the OCR and, hence reduce some of the pressure on the exchange rate” (Reserve Bank of New Zealand and the Treasury, 2006, paragraph 9, page 8). Measures to slow house price appreciation were given particular consideration. These issues continue to be considered by a Parliamentary Select Committee established to review the operation of monetary policy in New Zealand and were considered in a recent conference hosted by the Treasury and Reserve Bank of New Zealand in December 2007 (See Buckle and Drew, 2008).
This recent experience has highlighted the issues associated with using discretionary fiscal and regulatory policy as instruments of stabilisation policy. In particular, without institutional solutions, fiscal or regulatory options have proven to suffer from implementation delays, have tended to raise issues of conflicts with other objectives, or have high costs when considered on micro-efficiency grounds. They may also raise distributional concerns. We discuss some of the options raised to highlight the institutional issues associated with fiscal policy.
To illustrate the policy lags, a year out from undertaking this work and despite extensive debate, the only proposal that has been implemented by Government has been a provision made in the 2007 Budget of an additional $NZ14.6 million over the next three years to strengthen IRD’s auditing of property transactions.
A proposal considered by the Reserve Bank of New Zealand and Treasury (2006) is to ring-fence losses on investment properties. This would remove the option available to property investors to use losses on rental property to offset tax liabilities from profits made elsewhere in their portfolio. This proposal would treat property losses differently from other losses, as under the Income Tax Act all losses are currently able to be offset against any form of income. In support of this exception it is argued that the degree of leverage available on rental properties, as opposed to other assets, provides a bias towards investing in property and hence has accentuated the property cycle.
Another option considered was a Mortgage Interest Levy (MIL). This is a discretionary levy on the interest rate applying to mortgages for residential properties, to be applied or removed at appropriate stages of the housing market cycle. The attraction of this idea is that it would apply a wedge between the interest rates paid by domestic borrowers and those interest rates available to foreign lenders, thereby partially substituting for increases in the Official Cash Rate but with less effect on the exchange rate. In addition to questions about effectiveness, this option illustrated the constitutional issues that would arise in devolving responsibility for fiscal policy to an independent authority. Giving the Governor of the Reserve Bank, for example, the power to impose the levy may raise concerns that it would conflict with the long-standing general principle that taxation cannot be imposed without the explicit involvement of Parliament.
One regulatory proposal that would seem to have merit on micro-efficiency grounds is the proposal to ease constraints on housing supply, including land supply. Recent research indicates that the cost of land relative to the costs of house construction has been a significant cause of rising house prices in New Zealand over the last 25 years. Grimes and Aitken (2006) find that house prices respond more strongly to demand shocks in New Zealand local authorities in which housing supply responsiveness is low compared with those in which supply responsiveness is high. However, changing these requirements takes time as they are set out in a multitude of council rules. Further, freeing up land for more housing may conflict with other objectives such as limiting urban sprawl and current plans relating to infrastructure investment. No changes have yet been made in this area.
