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. The graph below shows the operating allowances from 2003 to 2017.

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.[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. Note that changes to these forecasts are charged against the allowance, see under Forecast changes and in-year revisions.

As the chart below shows, the operating allowance for Budget 2018 is $2.8 billion per year in perpetuity, meaning that over the forecast period (2018/19 to 2021/22) Ministers have $11.2 billion to allocate.[5] Each Budget a new operating allowance is available for allocation, meaning that by 2021/22 a total of $10 billion a year of new funding will be allocated to baselines.

Budget 2018 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 particular 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. For example, forecasts of future health spending in the economic and fiscal updates do not include any allocations from future Budgets, however, particularly in the case of the health portfolio, it is likely that it will receive increases each Budget.