Operating Surpluses

In most regards the New Zealand reforms go further than those of any other country in breaking with conventional practice. One major exception, however, is that New Zealand still is more locked into annual financial control than are some of the other countries that have reformed their public sectors. New Zealand does not permit departments to carry over unused operating funds from one financial year to the next. Australia and Sweden, by contrast, permit departments to retain unused funds and to pre-spend a small portion of the next year's appropriation during the current year. To guard against the hoarding of money, they limit the amount that can be carried over to the next year.

The differing concepts of reform discussed in chapter 2 lead to different practices on unused appropriations. The managerial model views retention of savings as an incentive for managers to be efficient; the contractual model may see it as a breach of the agreement between the government and the affected department. From a managerial perspective, when a department loses the money at the end of the fiscal year, it has a strong incentive to spend the entire appropriation, whether or not it needs the funds. This is not a difficult task for resourceful managers who can find all sorts of good uses for the money. Permitting departments to hold on to the funds may assist them in meeting unanticipated demands on future budgets, while easing some of the rigidities inherent in the annual budget and appropriations cycle.

The contractual approach begins with a different premise, that unused funds are not savings but a surplus. The Public Finance Act states that, except as agreed between the Minister of Finance and the Responsible Minister for a department, no operating surplus should be retained at the Department. The PFA defines an operating surplus as "The amount by which departmental revenue exceeds the expenses of a Department". This provision has a simple rationale: the surplus belongs to the Crown, which provided the funds in the first instance, not to the department, which produces the outputs. If spending departments were allowed to unilaterally retain surplus funds, they rather than the government would decide what to do with the money. This decision should be made by the owner, not by the spenders.

Whatever the theoretical basis of this position, its application has several adverse side effects. Barring departments from retaining unused money shortens the budgetary perspective of managers, abrades relations between departments and the Treasury, and fosters a "use it or lose it" attitude in the departments. Moreover, it does not distinguish between a surplus that is due to efficiency savings or one that results from failure to complete all planned work. Whatever the cause, every unspent dollar reverts to the Crown.

Departments have a variety of tactics that enable them to spend just about all of the funds in the year for which the appropriation was provided. As year-end approaches, they can spend projected operating surpluses by purchasing equipment, shifting funds among output classes, undertaking minor building repairs, spending on discretionary activities such as employee training, and accelerating some payments. Adept managers can take advantage of accrual accounting rules to use surplus funds. One chief executive explained how his department has exploited accrual accounting to spend all available funds. His department takes the position that if it has met output targets for the year, any operating surplus is due to the performance of its managers. Hence the surplus is distributed as performance bonuses. Even if it is paid out early in the next financial year, it may be expensed in the year the bonus is earned.

There may be nothing wrong with managers spending just about every dollar they have, except that it calls into question the pristine logic that operating surpluses belong to the Crown. These surpluses exist because the funds are saved by managers; they tend to be small because current rules give managers little incentive to save.

To its credit, Treasury does not penalise underspending departments by lowering baseline expenses. When a department has an operating surplus, its baseline for the next several years is maintained at the same level as if the money had been spent. In such instances, however, the government may demand more outputs in future years without providing additional funds.

It would be sensible for Treasury to explore means of permitting the limited carryover of operating surpluses. If the rules were liberalised, Treasury would have to deal with a slew of issues, such as: should the amount or use of carryover funds be limited? Should departments retaining operating surpluses be expected to produce more output in the next year? Should they pay a capital charge or earn interest? These and other technical issues have to be addressed, but they should not stand in the way of giving managers the right incentives to use public funds efficiently.

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