Guide to New Zealand Budgeting Practices

Budget allowances

Operating allowance

The operating allowance is the pool of net new operating funding available at each Budget for new policy initiatives or cost increases in existing policy. The operating allowance can be allocated either to expenditure or revenue policy changes. Because most of the operating allowance is usually allocated to expenditure, it is often referred to as an allowance for new spending.

The allowance is set in advance of Budget in accordance with the Government's fiscal strategy, and is usually presented as an annual average amount of net new operating funding available across the four-year forecast period. The graph below shows the average per annum operating allowances from Budget 2003 to Budget 2026.[3]

The operating allowance forms a self-imposed cap on expenditure growth (less any revenue changes). Because most government expenditure does not automatically adjust for inflation, it is generally expected that changes to expenses and new revenue policies are funded from the operating allowance.

However, some notable exceptions where changes to operating expenses and revenue are managed outside the operating allowance include:

• Changes in the cost of debt servicing, the Jobseeker Support benefit or tax revenue (but not tax rates) to help avoid pro-cyclical fiscal policy.[4]
• Impairments and revaluation and other changes due to large assets and liabilities (these items are highly volatile, and are often non-cash).
• Previously forecast growth in expenditure, most notably New Zealand Superannuation.

In addition to creating a cap on expenditure, the allowance approach also incentivises prioritisation. The decision making phase of the Budget process requires Ministers to discuss relative priorities and make trade-offs with the aim of forming a package of high-value initiatives that achieve their priorities. This is why most new spending proposals are considered through the Budget process.

When producing forecasts of future spending, future operating allowances are included to give the most accurate picture. Decisions already made are allocated to the relevant area, while unallocated amounts are shown as forecast new operating spending even though some may be used for revenue changes. This means that for areas where most growth in spending is expected to be funded from the operating allowance, forecasts of future spending do not necessarily reflect the most likely future spend in that portfolio.

This approach can sometimes be a barrier to making long-term strategic investments. For this reason, in Budget 2022, the Government introduced innovative approaches to fiscal management, which spread new investments in the Health, Justice and Natural Resources sectors across multiple Budget operating allowances:

• Two Budgets’ worth of funding for the Health portfolio was agreed through the Budget 2022 process, with the funding impact counted against the Budget 2022 and Budget 2023 operating allowances.
• The ‘cluster’ process piloted in Budget 2022 provided three Budgets’ worth of funding for two groups of agencies in the Justice and Natural Resources sectors. This funding was counted against the Budget 2022, Budget 2023 and Budget 2024 operating allowances.

 

Capital allowance

The rolling multi-year capital allowance was introduced in Budget 2019 and uses a four-year total funding envelope, rather than a single-year allowance. This approach provides flexibility to meet medium-term investment objectives while ensuring the near-term fiscal strategy can be achieved. It improves the ability to take a longer-term view of capital commitments and also increases transparency, by tracking and reporting more clearly the cash impact of initiatives over time.

Budget allowances

 

Funding sources outside the allowance framework

Sometimes, the operating allowance, which is designed to provide a permanent uplift in spending, is not the best tool for allocating new funding – for example in the case of a one-off crisis that requires a time-limited response. This was the case during the first few years of COVID-19 where the costs associated with COVID-19 response were managed against the COVID-19 Response and Recovery Fund (CRRF) – a notional envelope of new funding for operating and capital initiatives – rather than through the allowances. The CRRF was closed as part of Budget 2022.

Further flexibility is sometimes also achieved by establishing other sources of funding. For example, in 2021, the Climate Emergency Response Fund (CERF) was established with funding to match the forecast cash proceeds from the New Zealand Emissions Trading Scheme. The CERF is not tied to a particular financial year and covers both operating and capital expenditure.

The operating allowances graph above relates only to operating allowances, so does not reflect time-limited expenditure agreed through the CRRF or the CERF (or any other expenditure agreed by Ministers to be counted outside the allowances).