Guide to New Zealand budgeting practices

Fixed nominal baselines

One of the most important features of New Zealand's Fiscal Management Approach (FMA) is fixed nominal baselines. Fixed nominal baselines means that the amount of funding an agency receives each year (the baseline) does not automatically increase to adjust for inflation. Instead agencies are expected to absorb price increases; in effect this acts as an annual efficiency dividend on Government expenditure.

A small number of specific forecast items are excluded from this approach, such as legislative entitlements where it would not make sense to ask an agency to absorb an increase in demand for a benefit or subsidy that there is a legal obligation to provide.[1] In these cases, the increase in the cost of the policy is forecast and built into the profile of the appropriation. Examples of this include welfare benefits, which are adjusted for inflation, superannuation which is indexed to the average weekly wage, and some education spending which is adjusted for demographic changes.

For the majority of expenditure, however, appropriations are ‘fixed’ and a specific policy decision is required to make adjustments. Funding increases are sought through the Budget process, where increases have to be met from a limited pool of funding allocated for new spending and traded off against spending proposals in all other areas of Government. These pools of new funding are called the allowances. Allowances are set during the strategic phase of the Budget process and are set at a level which allows the Government to achieve their broader fiscal objectives.

Nominal GDP is the total value of output from the economy in current prices. When growth in Government expenditure is greater than growth in nominal GDP the share of GDP attributable to the Government is increasing. When growth of nominal GDP is higher, the opposite is true.

We can see from the graph below that core Crown expenses have risen, and are expected to continue to rise faster than inflation, but have been declining as a share of GDP. This suggests that on average, departments will receive funding over and above the increases in costs they face from inflationary pressures, assuming the allowances are used for new spending (e.g., not tax reductions). This increased funding may be used to fund new initiatives, or meet drivers such as growth in the population. For agencies that do not receive a funding increase it is expected that they can cover increased costs with improvements to efficiency.

This approach means that the government applies a high level of scrutiny to new spending. In order to receive funding for cost pressures,[2] the burden of proof rests on agencies to demonstrate that they will not be able to deliver services effectively within existing funding levels. The government must then trade off increasing spending on existing programmes against any new policies.

Other approaches are used in other countries. For example, in Australia the majority of spending is indexed to Consumer Price Index (CPI) or one of a number of wage cost indices. Departmental spending (which constitutes about 6% of total government spending) is then adjusted for an annual efficiency dividend, usually at a rate of about 1.2-1.6%.

Notes

  • [1] As outlined in Cabinet Office Circular (18) 2, forecast items require Cabinet to agree a specific metric for determining costs based on an external variable and that there are strong policy grounds for excluding the item from the fixed nominal baseline approach, i.e., legislative entitlements are not all treated as forecast items. Permanent legislative authorities (PLAs) are treated as forecast items.
  • [2] ‘Cost pressures’ refers to the pressure on agencies arising from increases in volume (demand for a service) or price (cost of a service).
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