Chye-Ching Huang: Spending cap based on failed idea

Opinion

The spending cap proposed by the National-Act confidence and supply agreement is a bad modification of a failed idea tried by the Colorado in the US.

In 1992, Colorado adopted in its state constitution a rule that state and local spending and revenue growth would be limited to the sum of the population growth rate, plus inflation. The measure was called the Taxpayer Bill of Rights (Tabor).

As intended, Tabor eviscerated Colorado's government: as a share of Colorado's economy, government spending and revenues fell by almost 30 per cent between 1992 to 2005, outpacing the trend in other states. The effect on public services was dramatic and unappealing.

Between those years, when the rule was in full effect, Colorado fell from 24th to the 50th ranked state in the United States in the share of children receiving their full vaccinations. In the early 2000s, Colorado couldn't afford to vaccinate against diphtheria, tetanus and whooping cough, so temporarily suspended its requirement that schoolchildren be fully vaccinated.

Colorado fell from 23rd to the 48th ranked state for the percentage of pregnant women receiving adequate access to prenatal care. Large education budget cuts had school districts increasing class sizes, moving to four-day weeks and turning off heating during winter.

The Act Party has labelled Colorado's spending cap a success and argues adopting a version of it would boost New Zealand's economic growth. But that is the one thing that Colorado's Tabor did not do: economic studies find no evidence that Colorado's spending cap helped its economy grow.

Indeed, Colorado business leaders successfully campaigned in 2005 to suspend Tabor and to make it less rigid. It was making impossible the government investments in education and infrastructure needed to support business growth.

The spending cap outlined by Act and National's new confidence and supply agreement seems to be based on a version discussed by Act before the election, which mitigates some of the worst elements of Colorado's rule. The cap can be overridden in some circumstances, and certain types of spending will be exempt (otherwise the rule would prolong and deepen recessions by requiring large spending cuts during economic slumps).

But it retains key harmful components of Colorado's failed experiment, especially tying capped spending to population growth and inflation. This guarantees that spending subject to the cap will not be able to keep pace with the needs of New Zealand's growing economy and ageing population.

Treasury estimates that from 2009 to 2050, New Zealand's population will grow by around a quarter. The number of people aged over 65 is projected to grow by six times that much. Over-65s have greater needs of government than other groups: while they are just 12 per cent of the population, they receive about a quarter of government spending.

Yet the formula promoted by Act takes no account of how the needs of a growing elderly population will squeeze spending that is subject to the cap. So to comply with it, government will be forced to choose: either cut real levels of services to the elderly, or cut other types of spending subject to the cap, such as education and policing.

Colorado's experience shows it is impossible to avoid this choice by delivering the same services more efficiently. It simply wasn't possible to achieve big enough efficiency savings to outpace the spending cap.

The proposed spending cap would also encourage governments to smuggle spending through the tax system. For example, instead of giving subsidies to film production companies as grants, the government can structure the grant as a tax break, which are exempt from the cap. All sorts of spending can be converted into tax breaks, making the tax code complicated and inefficient, and making what government spends public funds on much less transparent.

The confidence and supply agreement says that a spending cap will help to address New Zealand's "current fiscal problems". The presumed "problems" are short-term deficits (driven by the recession and - on Treasury's figures - expected to disappear by 2014/2015 anyway) and a projected steady increase in debt relative to national income over the long term.

But designers of Colorado's Tabor were frank about the fact that its primary purpose was not to reduce debt or deficits, but to shrink government. To solve the debt problem, New Zealand can do so much better than to recycle an extreme and failed American policy.

Other balanced paths to sustainable public debt levels exist. Just one example, consistent with the goal of greater fiscal discipline, is the "pay-as-you-go" principle, which requires that new spending increases and tax cuts are offset by revenue increases or spending cuts of the same magnitude. We can also demand that our politicians engage in sensible, multi-party discussions on the need to tackle debt, and try to reach a broad consensus.

Rigid and poorly designed fiscal rules tried by the United States, such as Tabor, or the federal debt ceiling, just lead to manufactured crises and unproductive partisanship.

Chye-Ching Huang is a senior lecturer with the University of Auckland Business School's department of commercial law.