4.2 Alternative fiscal anchors

Many governments around the world target debt as an anchor for fiscal policy. However, debt is not the only possible target. Governments may also choose to target some measure of the fiscal balance (such as a maximum deficit-to-GDP ratio) or the components of the government's inter-temporal budget constraint, such as tax or expenditure.

A debt targeting approach focuses attention on ensuring debt is kept at prudent levels, while giving discretion around the composition of tax and expenditure (referred to in Barker et. al. (2008) as "fiscal structure"). Government debt as an anchor of fiscal policy has one advantage over other potential fiscal anchors, such as tax or spending anchors, because it does not take a view on the optimal size and role of government. Or put another way, a debt anchor provides governments with a high degree of flexibility about the level and mix of spending and taxation while also satisfying their debt target.

Debt targets have been criticised for providing weak disciplines on government spending prioritisation especially during periods of strong revenue growth. Some countries have introduced spending limits to provide greater discipline to government spending decisions. Spending limits generally involve limits on total, primary or current spending, either in absolute terms, growth rates or as a share of GDP (Mears et. al., 2010).

Hong Kong has a general principle that over time the growth rate of government expenditure should not exceed that of the economy (ie, an expenditure-to-GDP limit). Sweden introduced a spending cap in 1997, and the cap is decided each year by Parliament on a rolling three yearly basis. The spending cap supplements the budget balance rule, which requires the government to run a budget surplus of 1% of GDP over the economic cycle. A surplus target was chosen to help avoid pro-cyclicality of fiscal policy and to pre-fund some of the costs associated with population ageing (Sweden Ministry of Finance, 2012).

Other jurisdictions have had more stringent spending and taxation limits. The state of Colorado in the United States amended its constitution in 1992 to limit per capita spending to the rate of inflation and decrease the amount of revenue the state could keep and spend if revenue fell during a recession. The Colorado spending limit can only be changed by voters. The Colorado experience is that the spending limit, combined with other constitutional provisions that required the government to increase spending in some areas, such as education and transportation, meant the government was required to make sharp cuts to expenditure in other areas. Voters in the 2000s have approved increases in the spending limit to allow greater spending in certain areas, such as education and transport (Wilkinson, 2004).

The 2008 Treasury Briefing to the Incoming Government recommended New Zealand governments adopt an additional fiscal anchor in the form of a medium term expenditure or revenue constraint as a share of GDP. The OECD (2009a) have also recommended New Zealand consider a spending cap. Mears et. al. (2010) put forward a possible spending cap designed for New Zealand. The proposed spending cap would be a nominal dollar figure for core Crown expenses (excluding unemployment benefits, debt financing costs, re-measurements losses and debt impairment). The cap would be set for three years with the third year updated annually on a rolling basis. It would be set by the government and not bind future governments. At that time the government decided not to introduce a spending cap, because while it was thought to have some benefits, its complexity in particular presented some risks.

The 2011 Confidence and Supply agreement between the National and ACT parties in New Zealand includes an agreement to introduce a legislative spending limit to "better constrain excessive future increases in government spending"[19]. The spending limit restricts expenditure (core Crown operating expenditure, excluding finance costs, unemployment benefits, asset impairments and spending on natural disasters) to grow no faster than the rate of population growth and inflation. Given that nominal per capita GDP has tended to grow more quickly than prices, if left unadjusted, such a spending limit would see government spending decrease as a proportion of the economy over time.

The PFA, while specifying debt as the primary fiscal anchor also requires the government to set fiscal intentions and fiscal objectives for a wider set of fiscal aggregates, including revenues, expenses, the operating balance, and net worth). The National-led Government has introduced the Public Finance (Fiscal Responsibility) Amendment Bill, which would amend the fiscal responsibility provisions of the PFA to extend them beyond their current focus on achieving and maintaining prudent levels of government debt. The proposed changes will require governments to:

1. Have regard to the interaction between fiscal policy and monetary policy
2. Ensure that the Crown's resources are managed effectively and efficiently;
3. Have regard to the likely impact of fiscal policy on present and future generations; and
4. Report on the extent to which the Government has kept to its fiscal strategy.

These changes reflect the fact that the PFA has been very successful in focusing governments on reducing debt, but less so in taking into account the impact of fiscal policy on the economic cycle, and in particular the monetary policy response that fiscal policy decisions can sometimes lead to. The requirement to take into account impacts on future generations provides a link in the fiscal responsibility provisions to the requirement in the PFA for the Treasury to produce four-yearly statements on the long-term (40+ year) fiscal position.