Will be the fiscal rules be met?
The government conducts fiscal policy to meet both its “golden rule”, that over the course of the cycle it should not borrow to finance current expenditure, and its “sustainable investment rule”, that public sector net debt remains below 40 per cent of GDP. The 2003 Pre Budget Report projects a significantly weaker current balance from now on compared to the 2003 Budget projections, while the deficit could breach the Maastricht Treaty’s deficit limit in 2003. On the one hand, the golden rule is expected to be met over this cycle, projected to end in 2005-06, with the current balance returning to surplus at the start of the next cycle. On the other hand, the more pessimistic OECD projections suggest that, although the golden rule would just be met in the current cycle, a sizeable structural deficit would persist. In this case, meeting the fiscal rules in the future would imply revenue or spending adjustments. It would be advisable to start implementing these changes during the current upswing rather than postpone measures and thereby risk reinforcing the downswing of the next cycle. At the same time firm cost control is also advisable. Ensuring a safe margin against the risk of a persistent structural budget deficit may reduce the need for future increases in interest rates.
OECD projections of general government finances
As a per cent of GDP
Source: OECD secretariat.
Should public spending be slowed or revenues be raised?
For many years outlays in health and education were low in international comparison, and raising spending was required to achieve ambitious outcome targets. Real expenditure on health is currently planned to rise at an annual rate of 7¼ per cent until 2007 and on education by 5¾ per cent until 2005. Although there are signs of better service outcomes and improved quality of services, some of these represent a continuation of earlier trends that were visible before the substantial recent spending increases were initiated, and the speed with which the spending increase is taking place is generating cost pressures within the public sector. A more gradual increase in health and education spending could therefore improve the chance of locking in improved performance rather than higher costs. This would also enable the government to carefully pilot and implement various promising innovations – such as Foundation Hospitals, which give hospitals more operational flexibility, activity-based funding mechanisms and Fast Track Surgeries. As an additional benefit, extending the period over which the increase takes place would yield savings to public finances in the short term. All in all, assessing the effectiveness of such a large build-up in public health and education spending will always be fraught with difficulties. The current signs of overheating and overstretching may be more benign than they look. But the “option value” of waiting to ensure best value for money also seems high.
Performance in health care and education
1. Input and output volumes indices reflect a broad set of physical measures (Pritchard, 2003). The broad output index for health care parallels an outpatient treatment which is therefore shown here given its longer time span.
2. Includes nursery, primary, secondary and special education, but excludes further education and universities.
Source: Office for National Statistics, HM Treasury, Department of Health and OECD.
The deteriorating fiscal position also highlights a basic strategic choice in improving health care to a level common in most of continental Europe as well as further raising standards in education: either to accept the corresponding level of taxes and mandatory contributions that are typical in continental Europe, or to expand private funding in ways that do not compromise equity concerns. To avoid large tax rises, users could contribute part of the funding of improving health care and education. An obvious case for this is in higher education, because universities are publicly funded and the private returns are probably the highest in the OECD due to a wide earnings differential between persons with and without university education. Letting graduates pay a larger share of the study costs would be both fair and economically efficient, and the government’s plan to introduce a graduate contribution scheme is both innovative and welcome. It resolves the credit constraints facing students from poor backgrounds by giving a loan to fund increased tuition fees which will have to be repaid after graduation unless the person’s income falls below a minimum threshold. Expanding higher education based on income-contingent graduate contributions, while maintaining the large publicly funded improvements made in early childhood and compulsory education, is the most direct way to achieve equity in access to higher education and education outcomes more generally. In health care, private funding on a large scale is excluded by the government’s principle that access to health care should not depend on ability to pay. However, within this framework there is scope for extending cost-sharing. For example, additional user charges to cover the extra cost of non-generic drugs or charging for missed appointments, can improve incentives, while raising some revenue. Getting incentives right and finding the appropriate level of spending is all the more important in the United Kingdom because the most powerful fiscal pressures as a result of population ageing over coming decades will come from health care rather than pensions.
Expenditure on tertiary education institutions
1. For New Zealand, OECD education data only has information about public spending. Other spending components are estimated based on the Statement of Financial Performance for tertiary education institutions from the cash flow from tuition fees, revenue from services provided, investment income and other sources. Using the same data source to estimate public spending produces results that are consistent with what the New Zealand authorities report to the OECD Education data.
2. Net of tuition fees paid by government.
Source: OECD, Education Database and Statement of Financial Performance for tertiary education institutions in New Zealand.
Can performance targets be better supported by funding incentives?
To get maximum value for the extra spending on public services, continuous improvements in the performance management framework are necessary. The United Kingdom is at the forefront of applying quantitative outcome focussed performance targets in the public sector. These targets have helped drive improvements in public services, created transparency and raised ambitions for service delivery. The framework now needs to evolve further - with fewer targets, which are limited to the main outcomes and key government priorities, with clearer focus on outcomes and with improved metrics. However, targets do not guarantee value for money; they only affect behaviour if service providers have an incentive and feel motivated to meet the targets. Activity-based funding for hospitals, for example, can help reduce waiting times and lengths of stay, and, within the framework of the recently agreed contract, incentive-pay for hospital doctors should be introduced faster and more broadly than currently planned.
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