Matthew Robertson 10.30am
If I asked you to describe a generic duck, you would probably say it had a white covering, yellow feet and a beak.
Let’s imagine that there are rules for what a duck is and that those rules are the above. By this definition a dog covered in white with painted orange feet and a beak planted on it would be classified as a duck. Everyone knows it is a dog but the rules state that it’s a duck.
This illustrates how misguided playing by the rules can be. It is from ‘The Smartest Guys in the Room’, a book about the rise and fall of Enron. I will not go into the intricacies of the Enron scandal but it was their ability to manipulate the rules that led to their downfall, in particular accounting ones.
You don’t need to be a comedian to know that there are many ways individuals and companies can use tax rules to minimise their liability but there is less understanding of how national governments can ‘bend’ the rules to show a better position.
International companies adhere by International Financial Reporting Standards (IFRS), the main bedrock of these standards is a principal called ‘Accruals Accounting’ where economic events are recognised by matching revenue to expenses at the time in which the transaction occurs. As opposed to when it was paid or received.
Governments are not obliged to use accruals accounting and so are more susceptible to manipulation and because they do not have the same audit regulations, there is a lack of transparency. It is this lack of transparency that allowed the Greek government to hide its liabilities which were only revealed when the new government came in. In austere times the incentive to reduce the deficit is higher than ever.
One of the key methods to reduce a reported deficit is to keep liabilities off government books. The IMF mentions that when Eurostat (the statistical office of the European Union) went through Greece’s accounts, it reclassified transport and other companies as belonging to the general government and so increased Greece’s reported debt by €18.2 billion. It is not clear whether the difference would have been a deciding factor in allowing Greece to join the common currency area but it is clear that false reporting allowed the government to borrow more than it should.
Which is why I have been interested in the latest release of Whole Government Accounts (WGA) which were published on July 12th for the year ending 31 March 2011. As described by the Treasury:
'WGA is based on EU adopted International Financial Reporting Standards (IFRS), the system of accounts used internationally by the private sector, as adapted or interpreted for the public sector context, and is similar in presentation to private sector accounts. It complements the National Accounts figures, produced by the Office for National Statistics (ONS), by providing a set of financial statements based on standards familiar to users of private sector accounts.'
The release of the accounts to 31st March 2011 is only the second set of financial statements of this kind and so this is the first time that a comparison can be made between 2009/10 when Labour were in power and 2010/11 when the coalition came in.
The biggest number that hit me was that government borrowing and financing increased £126bn which reflected the need for higher borrowing whilst tax receipts fall short of public spending. Because of this, debt interest increased by £13bn to £44bn in the year. Despite the rhetoric of trying to tackle the deficit, these figures show how little was achieved in this respect in the first year of the coalition.
Most of that analysis has been well documented in the financial press but what about the dogs dressed as ducks?
The biggest differences between the government accounts and the WGA relates to public service pensions and Private Finance Initiatives (PFI).
Note 1.47 in the WGA:
"WGA is prepared on an accruals basis in accordance with accounting standards. It takes into account all future pension liabilities from the service already provided by past and current public servants. Therefore, WGA net liabilities include the net public service pension liability for public sector pension schemes. “
“There are similar differences between the WGA net deficit and the National Accounts current deficit in relation to: interest on pension liabilities of £47 billion which is included in WGA but not National Accounts.”
The other big difference is in the treatment of PFI, WGA records more PFI contracts as liabilities of the public sector than the National Accounts do. This is primarily because of the inherent subjective way of measuring PFI contracts. The main objective of PFI contracts was to transfer risk from the public sector relating to the operation of certain assets. Naturally, there will be judgements involved in determining the balance of risk and reward from each contract. One of the criticisms of New Labour was that they changed the calculation of comparing PFI to public sector procurement so that the risk assessment became far more subjective and arguably easier to manipulate.
The WGA tries to overcome this difficulty by recognising PFI contracts by judgements on the balance of control, as the subjectivity of control is a lot less than the subjectivity of risk.
The WGA accounts are far from perfect and they do not provide a complete assessment of the UK government’s fiscal position. It is not beneficial that the March 2011 accounts have only just been released and there will be probably be a number of adjustments once these figures have been audited. But they are an attempt at providing a greater level of transparency and to subject government to the same accounting rules that worldwide corporations adhere to.
The measurement of government success should never be restricted to how it performs on accounting/financial measures, a problem inherent in GDP statistics. But there has to be a consistent and reliable basis on which to judge how much money a government can raise and spend.
The UK is the first to try and attempt to consolidate the whole of the public sector on an accruals basis and it will be interesting to see how this will be received internationally. After all, no one wants to see a dog dressed as a duck.
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