4  New Zealand's Budget management process

As with the legislative framework, the Budget management process has evolved over the past 20 years. This evolution can be split into three distinct phases: fixed nominal baselines; fiscal provisions; and the Fiscal Management Approach.[6]

Fixed nominal baselines

Prior to the introduction of the PFA in 1989, the Budget process involved making regular adjustments to personnel costs based on public sector wage negotiations. Operating and capital spending were generally adjusted annually to reflect expected cost movements. Government Budgets were made only for the year ahead with no forecasts of spending in subsequent years.

The early 1990s saw a shift to fixed nominal baselines, where the “baseline” is the agreed Budget allocation over the forecast period. Government spending was split into “formula-driven” and “fixed” (i.e. no change to nominal baseline amounts). Formula-driven indexation applied to non-departmental spending on benefits (e.g. inflation indexation of unemployment payments, wage indexation of public pensions), and volume adjustments. A specific policy decision was required to change non-indexed spending. A key issue to emerge was the effect of fixed nominal baselines on the short-term fiscal forecasts. For example, three-year fiscal forecasts between 1994 and 1996 included increases in government spending only for those areas affected by indexation. All other spending was assumed to remain constant over time. This yielded a profile of rising forecast surpluses. Together with concerns about agencies' abilities to meet rising costs this created pressure to increase nominal baselines.

Fiscal provisions

In its 1997 Budget, the Government adopted a $5 billion (cumulative) cap on new spending over the three fiscal years 1998 to 2000. This cap was on top of expenses already included in the fiscal forecasts (i.e. on top of the fixed nominal baselines and formula-driven indexed items). The cap evolved into a mechanism known as the fiscal provisions, which also included a set of rules for identifying which items would be treated as specific policy decisions and therefore “counted” towards the cap on spending. Formula-driven increases in expenses that did not “count” would still be permitted but did not impact on the amount available for new initiatives. For example, an increase in unemployment benefit payments due to higher unemployment would not be financed by (or “count against”) the fiscal provisions.

A capital expenditure provision sat alongside the operating provisions. The capital provision generally provides for new investments or where maintaining current operations cannot be funded from accumulated depreciation on balance sheets.

Fiscal Management Approach

In Budget 2002, the Government signalled a change to the fiscal provisions framework that:

• shifted the focus to the paths of the operating balance and debt rather than just the nominal new spending amount; and
• sought to ensure that spending intentions remained relevant as the economic and fiscal outlook evolved. Spending plans would be reviewed twice yearly with reference to updated forecasts and progress against fiscal objectives.

These new procedures were termed the Fiscal Management Approach, with the amounts for new initiatives being re-labelled as the Operating Allowance (for expense and revenue initiatives) and the Capital Allowance (for capital initiatives). This is the system that remains in place today. Under the Fiscal Management Approach there are three ways that the levels of expenses, revenue and capital items can change.

The first is changes in the profile of the expected values of expenses, revenue and capital resulting from current policy settings (referred to as the “profile”). For expenses, these changes will generally result from existing demand-driven programmes. For example, the current forecasts will build in an expectation of the rising cost of New Zealand Superannuation as more people reach retirement age. In Budget 2010 the forecast cost of New Zealand Superannuation in 2010 is $8.287 billion and in 2011 is $8.822 billion and in 2014 is $10.781 billion. This expected rising profile is built into the expense forecasts.

The second way in which expenses, revenue and capital items can change is via the addition of new discretionary initiatives as part of the Operating Allowance (for revenue and expenses) and the Capital Allowance. The focus of Budgets has tended to be on allocating those allowances to the Government's priority initiatives. The allowances are set with a view to achieving the Government's medium-term operating balance and debt objectives. For example, if the Government increases the rate at which New Zealand Superannuation is paid or changes the eligibility criteria, the fiscal impact of those policy decisions would be counted against the Operating Allowance in the year that the decision is made. New discretionary initiatives are then incorporated into the base and, therefore, the profile of forecast spending for future years.

The third way in which expenses can change is when there are revisions to the forecast expenses of existing programmes which are seen to be outside the direct control of government because they are demand or index driven (referred to as “changes in forecast costs”). For example, if there are revisions to the estimate of the population aged 65 years and over, or revisions to the forecast for average wage growth, then the expected cost of New Zealand Superannuation would change. This is because New Zealand Superannuation payments are linked to an eligibility age and the growth in wages. The forecast cost of New Zealand Superannuation for 2009/10 increased from an estimate of $8.246 billion in Budget 2009 to an estimate of $8.287 billion in Budget 2010.

These changes in forecast costs are incorporated automatically through the Baseline Update process. This occurs twice a year, as part of the updating of the fiscal estimates during the forecast round. Many of the non-welfare related Baseline Updates were originally envisaged as “counting” against the Operating Allowance. Over time this practice has changed, and some spending increases have not been counted against the Allowance, e.g. the increased costs of KiwiSaver, a subsidised saving scheme, due to higher than forecast uptake. The Baseline Update process also incorporates other changes to baselines, such as those due to policy decisions (e.g. a decision to bring forward forecast expenses) or valuation changes relating to impairments (mainly student loans and tax receivables, reflecting changes in future collectability of these assets).

This separation between demand-driven items that are automatically incorporated into the forecasts via the Baseline Update process and discretionary initiatives that count against the Operating and Capital Allowances puts some pressure on the boundary between the two categories. The Fiscal Management Approach specifies a set of rules as to what types of new initiatives must be agreed to within and outside the Operating and Capital Allowances. In addition, the government is ultimately responsible for setting the allowances in each Budget so as to achieve its fiscal objectives.

In setting the Operating and Capital allowances under the Fiscal Management Approach, information on the macro-economy is also considered. The weight put on macro-stability issues (“macro headroom”) relative to sustainability issues (“fiscal headroom”) has varied through time depending on the stage of the cycle.