Fiscal policy is an important part of government operations. Government spending at all levels adds up to around 40 percent of gross domestic product (GDP); it has a major impact on the economy.

The quality of fiscal policy deteriorated during the 1970s and ‘80s. Government spending mushroomed; the tax system became distorted and inefficient with, among other things, excessive reliance on income tax and a punitive top tax rate of 66 percent; and governments ran large deficits which resulted in a heavy debt burden and credit rating downgrades. The parlous state of the government's books was a factor in the economic crisis triggered by the 1984 election. The incoming Labour government did much to improve fiscal policy, especially through sound tax reforms, but it struggled to achieve fiscal discipline and bequeathed its successor a deficit problem that necessitated the spending measures of the 1991 budget. In response to this haphazard record, the architects of the Fiscal Responsibility Act (FRA) – notably finance minister Ruth Richardson – sought to bring a greater focus in annual budgets to issues of fiscal prudence and longer-term strategy.

It is the tenth anniversary of the passage of the Fiscal Responsibility Act. Ten years is a reasonable period of time to assess the strengths and the weaknesses of the legislation, and to consider possible improvements.

The FRA has required a focus on fiscal prudence that has paid dividends in the form of sustained operating surpluses, improvements in Crown net worth and, most recently, an AAA credit rating for Crown foreign currency debt by one rating agency. However, it has not been successful in constraining government spending and the aggregate tax burden. Governments in the 1990s failed to achieve their long-term objective of reducing spending below 30 percent of GDP and subsequent governments have lifted the target to 35 percent. Nor has the FRA imposed any meaningful discipline on the quality of government spending. Contrary to expectations, the FRA has not led to meaningful debate about the value for money of government spending and the link between budget policy and economic growth.

The current government has portrayed itself as a prudent economic manager. This claim is only plausible with respect to its record of maintaining operating surpluses and ongoing debt reductions. Its spending and taxing record has been profligate. The decision to lift the long-term objective for spending under the FRA to 35 percent of GDP effectively sought to appropriate another twentieth of national income for the public sector. In the 2004 budget the government announced additional spending plans totalling a massive $14 billion over the next three years, mostly in forms that would be classified as unproductive. This strategy is inconsistent with the government's stated top priority of increasing the economy's growth rate.

It is quite feasible to envisage a reduction of total government spending in New Zealand from around 40 percent to 30 percent of GDP. In a study for the Business Roundtable, Winton Bates estimated that reducing the most ill-justified government spending by 10 percent could add 0.5 percent per annum to the growth rate for a 10-25 year period.

Since the FRA has been relatively ineffective in curbing government spending growth, an obvious question is whether more explicit disciplines could be introduced. Families are familiar with spending caps – governments need the same. Tax and expenditure limits have the merit of giving politicians extra protection against vested interest groups and may encourage decisions that are more closely aligned with the public interest. Hong Kong, Japan, the Netherlands, Spain, Sweden, Switzerland and the United States have had rules aimed at capping spending. So have many US, Australian and Canadian state governments. US experience suggests that tax and expenditure limits have been effective in constraining spending, and are conducive to economic growth.

Limitations can be self-imposed by a government, or alternatively decided or ratified through referenda. There is also a case for a super-majority requirement for tax increases, because of the risk that a simple political majority may act in a predatory fashion. Such a super-majority provision, which could apply to referenda or parliamentary decisions on tax, has parallels in the Companies Act which requires a major transaction to be approved by at least a 75 percent majority of shareholders.

Tax and expenditure limits ignore base spending which, in New Zealand, adds up to 95 percent of the total. As the Organisation for Economic Cooperation and Development has noted, this spending is not properly reviewed. The key problem appears to be a lack of political will. Assessing value for money is not rocket science. It is simply a matter of demanding convincing answers to basic questions.

Ten years of experience show that the FRA has served New Zealanders well to date, except for the lack of real government spending discipline. Based on overseas examples, tax and expenditure limitation rules backed by citizen referenda and super-majority rules have the best chance of improving spending disciplines.

For more information, contact:

Roger Kerr
Executive Director
Ph: 04 499 0790
Email: rkerr@nzbr.org.nz

David Young
Communications Advisor
Ph: 04 494 9101
Email: dyoung@nzbr.org.nz

Web: www.nzbr.org.nz