Brian Fallow: Reining in Government spending

Resentful that the tax-man is making out like a bandit in the current boom and the rest of us are missing out?

a study commissioned by the business roundtable and published under its imprimatur offers a solution, advocating a real per capita freeze on government spending that could only be over-ridden by a 75 per cent voter majority.

in restraining leviathan, a review of the fiscal responsibility act 10 years after it was enacted, economist bryce wilkinson found that, by and large, the act had done a good job of stabilising the fiscal position - warding off a debt spiral, in other words. But it had done little to discipline government spending.

and that is the key, wilkinson argues, to lightening the tax burden without which talk of returning to the upper half of the oecd is just "a fraud on the electorate".

the act brought greater transparency and (in principle) accountability to fiscal policy by requiring governments to spell out their targets for the operating balance and debt.

the present objectives are driven by the debt target, which is to slowly reduce gross government debt so that it falls below 20 per cent of gross domestic product by 2015.

the target for the operating balance is to run surpluses over the economic cycle sufficient to meet that debt target and put away enough in the cullen fund to partially defray future nz superannuation costs.

since the act came in we have had operating surpluses for 10 years in a row while net public debt, which peaked at 51 per cent of gdp in 1992, has fallen to 11 per cent.

associated with that, central government spending has fallen from around 40 per cent of gdp at the end of the 1980s to below 31 per cent, its lowest level since the late 1970s.

that is despite the fact that in real per capita terms discretionary government spending (which excludes interest and unemployment costs) has been rising for 10 years.

but these positive outcomes cannot just be credited to the fiscal responsibility act.

strong economic growth has helped - the growth dividend, the roundtable would argue, from the reforms of the 1980s.

but wilkinson says it is highly implausible that the growth in per capita gdp over the past 10 years, which averaged 2. 5 per cent a year, can be sustained on current policies.

looking forward, a more realistic indicator would be trend growth in labour productivity, which in the view of most forecasters is 1. 5 per cent a year - if we are lucky.

to lift it to 2 per cent would require significant change, wilkinson says, and is unlikely

in the present permissive fiscal framework.

the oecd favours supplementing deficit and debt targets with an expenditure target, on the grounds that the former can be met too readily by higher taxes which impede economic growth.

the present regime allows governments to treat the extra tax revenue in periods of strong economic growth as free cashflow that they can spend at will to buy votes from favoured constituencies.

one way of curbing that tendency and forcing governments to focus on reducing wasteful spending, he says, would be to adopt a tax and expenditure limitation (tel) rule.

"voters know about spending caps from their personal lives. They understand the need to prioritise. "

provision could be made for such rules to be set aside when necessary, but a super-majority (say 75 per cent) for voting to do so is likely to be desirable if the rule is to be effective.

in the united states, a majority of the states now have some form of tel rule. The differences between them provide a basis for researchers to draw some tentative conclusions about what works and what does not.

if you go down this route it seems to be a good idea to limit spending as well as tax. Otherwise you are liable to get low-quality spending anyway but funded by user-charges, debt or asset sales.

what should the limit be?

limiting the growth in government spending to inflation plus population growth (that is, holding it steady in real per capita terms) seems to be most effective, wilkinson says.

"it is clear from experience in new zealand and the united states that an income-related limit allows governments to spend freely and unwisely during economic booms, and that such spending is difficult and painful to reverse during recessions. "

if tax revenues in one year exceeded the limit, the excess would be returned to taxpayers the following year.

what would happen during a recession? wouldn't the revenue base shrink and spending have to fall as well?

well, yes. "spending interests will see this as a negative feature," wilkinson concedes.

"yet if a tel rule is to be successful in pressuring governments to review base spending, it has to bite at some stage in the economic cycle. It may be that it is easiest to focus a government's mind on reassessing value for money in spending during a recession. "

the proposal would follow the colorado model in requiring a referendum for increases in tax, spending or debt that would otherwise violate the tel rule.

and it favours requiring a 75 per cent majority for tax increases.

"at any point in time there are around 1. 1 million adults drawing a core benefit [including the accommodation supplement]. In 2002 there were 2. 7 million registered on the electoral roll. Clearly those on benefits have a conflict of interest when voting on a proposal to raise taxes. "

at this point, one might think, the proposal is in deep waters indeed.

wilkinson says it is a key virtue of a tel that it shifts the power to increase taxes and government spending from politicians to voters.

but we have a representative rather than a direct form of democracy and for 360 years parliament has had the exclusive right to raise and lower taxes.

it is a right written in blood, not ink. It is the very core of parliament's sovereignty and it is unlikely to legislate it away.

colorado, which comes closest to the sort of tel wilkinson favours, ran into a fiscal crisis in 2001-02 following the dot. Com crash.

it has had to raid trust funds and cut spending on higher education, health care and state jobs.

but wilkinson says that was because only about a third of the state budget was discretionary.

"in contrast, in new zealand central government can readily cut wasteful base spending if it wishes. "

if the notion of limiting the growth in government spending to inflation and population growth sounds familiar, it may be because don brash advocated it in a speech to the national party's annual conference last year.

but that was before he became leader of the opposition.

it remains to be seen whether his caucus is quite that far to the right of centre.