The NZ Initiative's Khyaati Acharya on putting a leash on government fiscal profligacy

By Khyaati Acharya*

Keeping public expenditure on a tight leash is a challenge at the best of times.

But maintaining fiscal discipline and avoiding exuberant and foolish spending – particularly during economic booms – is a standard to which we should always hold our governments.

Finance Minister Bill English recently reassured New Zealand that, despite the challenging task of fiscal sustainability, our economy is growing and our national accounts are showing some signs of returning to a surplus in the near future. Tentative though this surplus may still be, ensuring Crown accounts remain on track and that Government avoids making poor spending decisions is key to strengthening our position in the global economy.

The government’s current fiscal position is enviable. This is thanks both to the low net debt that Labour’s outgoing administration bequeathed to the incoming National administration, and to the Minister of Finance’s determination to return to fiscal surpluses despite the substantial new entitlement programmes he also inherited from Labour.

The challenge may become more difficult as better economic times whet voter appetites for a loosening of the public purse-strings; the myriad tantalising election bribes offered earlier this year do not bode well for future surpluses.

It stands to reason that maintaining a prudent debt position is a necessary buffer against unpredictable and adverse future events. These include economic shocks like the Global Financial Crisis, natural disasters like the Christchurch earthquakes, and the pressure cooker that is demographic change.

Frightening scenarios

New Zealand’s fiscal performance has been relatively strong in comparison to many OECD countries, and Treasury have assured us that we do not face an impending fiscal crisis. Nevertheless, our ageing population means inevitable future increases in public expenditure will constrain future tax revenue. Longer term fiscal prospects include some frightening scenarios.

Heading off future fiscal imbalances should be a major priority. Deliberate action sooner rather than later is essential to prevent these problems’ compounding.

Addressing these issues is by no means a piece of cake, but an international examination reveals the various options other countries have implemented to deal with similar fiscal problems.

Many countries around the world have fiscal rules enshrined in national or supranational legislation. As of August 2013, the IMF recorded that there were fiscal rules in some shape or form in use, among 87 countries around the world.

The objective of fiscal rules is to promote fiscal sustainability. This is achieved primarily through numerical limits placed on budgetary aggregates and includes long-term constraints on fiscal policy to correct for distorted incentives of policy makers – like spending targeted by political objectives rather than effectiveness and pressures to overspend. Fiscal rules can also aid in containing the size of government, enhance debt sustainability and support intergenerational equity.

Independent Fiscal Institutions

However, sometimes these rules just aren’t enough.

Fiscal rules are susceptible to weak political commitment, a lack of enforceability and inherent design flaws.

And discontent with the outcomes from reliance on fiscal rules alone has seen a growing global trend in favour of establishing Independent Fiscal Institutions (IFIs) – or Councils.

IFIs exist to support and enhance the efficacy of fiscal rules by improving the transparency and accountability of governments’ fiscal policy decisions. The number of IFIs has surged noticeably in the aftermath of the global financial crisis as well as the ongoing Euro Crisis, as countries scramble to clean up the debris, sort their balance sheets and scrutinise the strength of their rules so as to improve their resiliency towards other exogenous shocks in the future.

While IFIs are still few in number, experience in a handful of advanced economies demonstrate an ability of these institutions to influence the conduct of fiscal policy and improve compliance with fiscal rules. They complement fiscal rules by helping to inform Parliament and the public of spending that fails to deliver value-for-money.

Some of the most reputable IFIs include the United Kingdoms’ Office for Budgetary Responsibility (OBR), Belgium’s High Council of Finance and Federal Planning Bureau, Canada’s Parliamentary Budget Officer, and the United States’ Congressional Budget Office (CBO). These IFIs, while being vastly different in legal form and not without their own hurdles, have proven their credibility, integrity and impartiality over time.

Treasury considered the possibility of establishing spending-limit rules and an IFI here in New Zealand. We further consider the options in our forthcoming report: Guarding the Public Purse: Faster Growth, Greater Fiscal Discipline. The international experience provides important lessons for ensuring that public spending remain focused. This will become increasingly important as demographic changes reduce the country’s capacity to bear wasteful spending.

Co-authored by Dr Bryce Wilkinson and Khyaati Acharya, Guarding the Public Purse: Faster Growth, Greater Fiscal Discipline is to be launched publicly on November 24, 2014 in Wellington. To register for this event, click here.

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*Khyaati Acharya is a research assistant at the New Zealand Initiative, which provides a weekly column for interest.co.nz.