Guide to New Zealand budgeting practices

Operating allowance

The operating allowance is the pool of new operating funding available at each Budget. The allowance is set in advance of Budget in accordance with the government's fiscal strategy. It is usually presented as an annual average amount of funding available across the four-year forecast period. The graph below shows the operating allowances from 2003 to 2022.

The allowance is a net amount allocated for new policy initiatives or cost increases in existing policy. It may be allocated either to expenditure or revenue policy changes. Given that the bulk of the allowance is usually allocated to the expenditure side, it is often referred to as an allowance for new spending.

The allowance forms a self-imposed cap on expenditure growth (less any revenue changes). As discussed above, baselines do not automatically adjust for inflation, so all changes to expenses and revenue are funded from the operating allowance. All new policies and almost all increases in the cost of existing policies are funded out of the Budget allowance.

The starting presumption is that all new expenditure counts against the operating allowance. However, some notable exceptions are:

  • Changes in the cost of debt servicing, the Jobseeker Support benefit or tax revenue (but not tax rate) to help avoid pro-cyclical fiscal policy.[3]
  • 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. Note that changes to these forecasts are charged against the allowance.

As the chart below shows, the operating allowance for Budget 2022 is $5.9 billion per year in perpetuity, meaning that each year of the forecast period (2022/23 to 2025/26) Ministers have $5.9 billion to allocate (or a total of $23.6 billion across the forecast period).[4] This increases the total baseline, as shown in the bottom row of the figure below.

Each year another operating allowance is available for allocation, meaning that by 2025/26 a total of $16.4 billion a year of new funding will be allocated to baselines, as can be seen by stacking the four rows below.

Budget 2022 and future operating allowances

Budget 2022 and future operating allowances

In addition to forming a cap on expenditure, the allowance approach is also useful for incentivising prioritisation. The decision making phase of the Budget process, which takes place from December to April, requires Ministers to discuss relative priorities with the aim of forming a package of high value initiatives that achieve their priorities, as set out in the Budget Policy Statement. It is preferable that all new spending proposals be considered through the Budget to ensure consistent prioritisation.

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 we 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 has been 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 provides three Budgets’ worth of funding for two groups of agencies in the Justice and Natural Resources sectors. This funding is counted against the Budget 2022, Budget 2023 and Budget 2024 operating allowances.

Further flexibility is sometimes also achieved by establishing other sources of funding. For example, in 2021 we established the Climate Emergency Response Fund (CERF) with funding to match the forecast cash proceeds from the New Zealand Emissions Trading. The CERF is not tied to a particular financial year and covers both operating and capital expenditure. Budget 2022 included a package of initiatives responding to the climate crisis which were counted against the CERF.

Another example of a funding source outside the allowance framework is the COVID-19 Response and Recovery Fund (CRRF). This fund was a temporary tool created to manage operating and capital costs associated with the COVID-19 response and recovery. It was closed as part of Budget 2022.

Notes

  • [3] Pro-cyclical fiscal policy is either, expansionary (increased spending or tax cuts) fiscal policy in a boom or contractionary (reduced spending or tax increases) during a trough or recession. This is generally avoided in order to better manage the economic cycle. For example, if unemployment rises in a time of economic recession and the government were to charge this cost against the operating allowance it would crowd out other spending which could risk exacerbating the downturn.
  • [4] Budget initiatives are often announced as an amount of operating funding 'over four years'.
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