Better accounts, better democracy

Publication | 03-01-2018

In the 17th century, the Netherlands led the world in accountancy. And it enjoyed a Golden Age. But today? The previous President of the Netherlands Court of Audit, Saskia Stuiveling, who died on 20 April 2017, once observed that “Thorbecke’s House”, as the Dutch State is often called in honour of the 19th century statesman largely responsible for the constitution, had more than a passing resemblance to M.C. Escher’s house. Taxes end up in a “no man’s land” where it is almost, if not completely, impossible to check how they are spent. What was once a well ordered and organised system, she argued, had slowly deteriorated into a confusing and complex muddle. If taxpayers are to be confident that they are getting “value for money”, the State needs to introduce modern, transparent and understandable accounting rules. Many countries in Europe and the private sector are working on new rules, but what steps is the Dutch government taking? Anyone who thinks accounting rules are dull and of no relevance to democracy is in for a surprise. It is wrong to think no one benefits from them. Better accounting rules are an investment in transparency and trust.

They touch upon the very essence of democracy and as such are important to everyone. In the past ten years, for example, the Directorate-General for Public Works and Water Management has twice run up deficits of billions of euros and had to put off maintenance work, without the shortcomings being evident in the official figures. The maintenance backlogs led to a further deterioration in the highways and waterways and to unpopular traffic measures. Poor bookkeeping was one of the causes.

The former Minister of Finance, Jeroen Dijsselbloem (PvdA labour party), and the Court of Audit set up a committee to advise on accounting rules. It recommended that a new and better accounting system should be introduced in steps. The minister left it to the new government to follow up the recommendations. What’s happening now?

The question is both politically and democratically relevant, because better bookkeeping makes for better decisions that benefit everyone. This is not an unnecessary luxury in a time of growing financial scope and rising expenditure. Better bookkeeping is also necessary to keep a closer eye on public funds. The total tax revenue of 300 billion euros is spent by many organisations and is budgeted and accounted for in many different ways. How taxes are spent can be difficult to audit, another reason to improve the rules.

There is also a third, more pressing reason. Borders are breaking down, economies and states are becoming more interwoven. The Netherlands has had the same geographical borders since 1830, but the border between what we can decide upon and what others can decide upon has shifted. The European Union is considering the introduction of new, uniform accounting rules. What is the Netherlands’ stance in this debate?

The situation is historically interesting because the Netherlands has a reputation to hold high. The Low Countries once led the world in modern accounting. The Golden Age was known for its careful expenditure and the meticulous checks and balances. Four hundred years ago, Prince Maurice, Simon Stevin and Johan van Oldenbarnevelt were pioneers in the field of accounting.

I was subtly reminded of this by a joint improvement project initiated by the Austrian parliament, national audit office and government. “During your Golden Age you led the world in financial accounting and modern bookkeeping,” I was told. “Now, you’ve been left behind and even seem to be absent from the international debate.”

The Dutch East India Company (VOC), for example, was set up in 1602. It was the first company in the world to issue tradeable shares. Van Oldenbarnevelt, State Advocate, made it possible for everyone to invest directly in the company. Revolutionary! Before then, the public had entrusted their money to Administrators, who represented the investors’ interests. The Administrators bore all the risks while the anonymous investors were sheltered from any losses. The innovation of the joint stock company was to spread risk by means of shares.

The Dutch Republic not only encouraged innovation, it also created a direct link between the business and the investing public. This prompted a debate as from 1622 about the use of money. A group of discontented participants in the VOC published Nootwendich discours (“Necessary Discourse”), calling on the Administrators to account for their actions in the previous 21 years. They demanded an insight into how their money had been spent and how the Administrators had run the VOC. Some Administrators were filling their own pockets and only later paying out dividends to the participants. The lack of transparency, in combination with suspicions of mismanagement, fostered mistrust and public resistance.

Modern bookkeeping was introduced into the Netherlands at about the same time. The Tuscan monk Luca Pacioli (1447-1517) had laid the foundation with the publication of his book, Summa de arithmetica, geometria, proportioni et proportionalita (“Summary of Arithmetic, Geometry, Proportions and Proportionality”). His double entry system of bookkeeping recorded every financial transaction twice, once as a debit entry and once as a credit entry.

In the Dutch Republic this method was first used in the State’s accounts. Bookkeeping had previously been little more than a means to record transactions in order to remember which merchant had to deliver money or goods to whom. The idea of using the accounts to calculate profit or loss, to allocate it to specific activities and to reflect on the return on an investment was a novelty.

In the first half of the 16th century, double entry bookkeeping became a key element in the ars mercatoria, the art of trading, in the cities of the Dutch Republic. Its gradual acceptance by a broader public began in the south of the country. Not only merchants but the entire elite of the governors and aristocrats learnt to use Pacioli’s innovation.

Simon Stevin (1548-1620), a protestant who probably left his hometown of Bruges in Belgium out of fear of the Duke of Alba’s Council of Troubles, was a driving force in its adoption. Stevin studied in Leiden and was active as an engineer. Along with the father of international law, Hugo de Groot, he built and improved windmills in many places. Even before Galileo, the two carried out an experiment from the top of the tower of the Nieuwe Kerk in Delft to refute Aristotle’s theory that heavier bodies fell faster than lighter bodies.

Stevin always wanted to combine theory and practice. He tutored Prince Maurice (1567-1625) in applied mathematics and explained how the new bookkeeping method would help him improve the management of his considerable estates and always show exactly how much his estate managers should have in cash. He showed the relationship between stock levels and farm harvests. And he explained that fraud would be easier to detect. Stevin wrote it all down in his Vorstelicke bouckhouding op de Italiaensche wyse (Royal Bookkeeping in the Italian Manner). While Stevin was working on this book in 1604, the States General established a committee to improve the bookkeeping of the five Admiralty Councils. As holders of the national purse strings, the States General wanted to know whether they were getting value for money. The improvements they made to the Admiralties’ bookkeeping system had exactly the benefits that Stevin had predicted. They increased insight into the stocks in the arsenals and on board the ships. The Admiralties were able to make more efficient use of their stocks and expensive stores and combat fraud more efficiently.

The Admiralties thus had a better understanding of the stores in their armouries: their contents could be read from the accounts, and with this information they could take the right decisions on the use of the fleet. By using a standard bookkeeping method, the Admiralties also improved their purchasing position: they knew who could provide a product at the lowest cost and it was more difficult to favour a preferred supplier.

Their accounts were transparent and comparable. Thanks to superior bookkeeping, the Dutch Admiralty was better informed about what it owned and how many weapons it held. According to some historians, this bookkeeping innovation explains why the little Republic managed to outmuscle its much larger neighbours. It made the seemingly inefficient federal republic more efficient than London, Paris and Madrid.

The moral of the story is that good bookkeeping is a boon to both decision-making and accountability. The information generated by a properly kept set of accounts improves an organisation’s operations and enhances its efficiency and effectiveness. Decisions can be fully thought-out in advance and refined in response to changing circumstances. There are therefore fewer unpleasant surprises afterwards. The benefits can be enjoyed both in the private sector, where investors want to know what happens to their capital, and in the public sector, where taxpayers want to know if they are getting “value for money”.

Better bookkeeping is therefore not a technical nicety but a matter of fundamentals. It is a question of transparency that paves the way for the effectiveness and efficiency of public administration. It goes to the heart of the public sector.

So, back to the present. My Austrian counterpart was surprised by the Netherlands’ reluctance to walk in step with many other European countries. There is something different about the public sector. In contrast to the situation in the Golden Age, many experts believe the Dutch government’s bookkeeping is out of date. The ministries’ books of account might be in order, with more than 99 per cent of expenditure being regular, but what is the point of accurate and reliable figures if they only tell half the story? The government’s accounts do not present the full financial picture to parliament.

The cause of this lies in the way the government keeps its accounts. The accounts tally the incomings and outgoings in a particular year, plus future expenses that the government commits itself to during that year, such as capital expenditure and approved grants. The accounts are similar to a student’s records of what comes in and what goes out during a particular month and the dates on which the tuition fees are due.

This method of bookkeeping produces only limited financial information: there is no complete understanding of the actual costs or of the ministries’ financial position. The accounts do not present all the relevant financial information concerning the decisions taken or their financial consequences –­ the income and expenses as well as the receipts and expenditures. Furthermore, the accounts do not disclose the value of assets owned by the ministries or by the State as a whole.

This method begins and ends with the moment on which money is actually received or spent. If the Ministry of Defence buys 37 fighter aircraft, the cost is entered in the budget and accounts of that particular year only. The aircraft are not recognised in the accounts during the rest of their economic life, which might be dozens of years. Yet the cost of operating and maintaining them is related to their economic lives. And what if the aircraft are flown for longer than initially intended, for example on unforeseen peace missions? Must they be replaced earlier because their actual lives are shorter than their budgeted lives? What do the aircraft actually cost in that year? This information is needed before a decision can be taken, but it cannot be informed from the accounts.

Accounts that do provide this information produce better political decisions and strengthen accountability. The accounting rules are therefore critical. An MP wanting to take a decision on the procurement of a frigate that must be in service for dozens of years needs to know the actual cost of building and maintaining the necessary infrastructure before deciding whether to spend money on maintenance or on more roads and railways, or on the tax authority’s IT system.

Clues sometimes have to be found in the small print of schedules and annexes when information is kept out of the standard budgeting and accounting documents. Ministers must and regularly want to use the available budget for the same purpose in subsequent years. The accounting system, however, is concerned with expenditure in the current year. The money is no longer available after that year. In practice, budget reserves, cash shifts and year end margins have to be used to carry money forward to future financial years. Why does the government use an accounting system that relies on such stopgaps? Why are we still using opaque, makeshift techniques that often lead to misleading implications?

The introduction of an accrual accounting system would improve the quality of democracy. It’s what the experts advised the then finance minister, Jeroen Dijsselbloem, to do last spring. Such a system would strengthen parliament’s ability to approve the budget. In my opinion, it would also re-enthuse public confidence in democracy. An accrual system does not consider only the expenditures and receipts in a particular year but also, and especially, the long-term income and expenses arising from a decision. It strikes a balance between the short-term and long-term liabilities. It also discloses the value of assets such as buildings. And it keeps track of annual receipts and expenditures, so that deficits or surpluses are known. This is all relevant to taxpayers.

Such modern accounts would keep track of more relevant information, link money to outputs and better inform the public and politicians of State expenditure – in advance so that parliament can take a decision and afterwards when the accounts are submitted.

Taking this step would have another benefit: it would reduce the no man’s land as it would be easier to follow the tax euros as they pass through schools, care providers, municipalities, provinces and water authorities, which have already switched to accrual accounting.

Different systems are being used in the public sector to account for goods and services that are paid for with the tax euros collected in The Hague and then spent throughout the country. This muddies the view of public money. The financial information presented by the government cannot be linked to the information presented by other organisations. There is not enough insight into the “money in the field” The figures produced by schools and universities cannot be compared with those produced by the Ministry of Education, Culture and Science; similarly, figures from the care sector cannot be compared with those from the Ministry of Health, Welfare and Sport. The figures are produced using different accounting principles.

Studies by the Netherlands Court of Audit have found that the provincial authorities received better information about road maintenance from members of the provincial executive than members of either house of the States General did from the responsible minister. Ironically, provinces and municipalities are required by national regulations to keep accrual accounts but the regulations themselves are not applied at national level.

The differences between central government and the other authorities create problems. Not only do we want to compare the figures, we also want to draw conclusions, for example on the social impact of public money. So there must first be an understanding of the money and then an understanding of the social outputs.

The National Air Quality Cooperation Programme (NSL), for example, receives funding from both central government and local authorities. Subject to certain conditions, central government provides funding to the provinces that is then passed on to municipalities. But the central government, provinces and municipalities do not keep uniform accounts of for the money they spend to improve air quality.

The Minister of Infrastructure and the Environment in the second Rutte government therefore had only a limited insight into how much money was being spent on the NSL in total. There was also no overall understanding of the measures’ effectiveness in improving air quality. It is therefore uncertain whether the same results could have been achieved with less money or whether the same amount of money could have had a greater impact on air quality. Such information is necessary to make political decisions.

And how are the public to find out? Which MPs must they turn to for information? How can they decide who to vote for when they’re in the voting booth? It is in the country’s democratic interests to improve the consistency of the accounts. They go to the heart of the public sector.

Again, this is not a question of technique. It is a matter of principle. It is about parliament’s ability to approve the budget, the democratic foundations of every parliament and every local, provincial and national authority. If the rules are unable to clarify the financial information, both the decisions taken in advance and the accounts rendered afterwards will be inadequate.

This warning was also voiced in the final report issued by the mediator tasked with forming a new government last summer. The former vice-chairman of the Council of State, Herman Tjeenk Willink, asked the intriguing rhetorical question, “What legitimacy does a public administration have when only the most gifted members of the public can know what is going on, and then only with the greatest difficulty, and those for whom the democratic rule of law was intended cannot.”

 Apart from being a management tool, accountancy is a communication channel between the manager and the supervisor and between the ministers and the House of Representatives. Communication relies on language, and language relies on words having specific meanings that are known to both the speaker and the listener. Various parties use the information an organisation shares to form an opinion on the organisation’s performance. The information provided by organisations must therefore be comparable if we are to form an opinion on them. Consistency, standardisation, is a precondition for information that can explain an organisation has performed and enable us to form an opinion on the effectiveness and efficiency of the government’s actions.

The private sector already recognises the importance of uniformity. The financial and economic crisis has strengthened the sense of urgency. Uniformity is important to society. Strict agreements on how you present what you have achieved make it possible to learn and make better decisions. Demand for comparable figures is higher than ever before now that so much information is readily available digitally.

The private sector has agreed on a uniform language to prepare and compare annual reports. International Financial Reporting Standards (IFRS) are used by all listed companies. Uniform reporting is important for all shareholders, and today’s investors are far more critical than those in the VOC. It is for good reason that the private sector accounting method is based on the accrual system, with a balance sheet and an income statement to provide an insight into an organisation’s financial position and the profitability of its activities. The IFRS lay down how the documents must be prepared. By law, their use is strictly checked by independent auditors. Unlisted companies must report in accordance with the Generally Accepted Accounting Principles (GAAP) of the country in which they are established.

The situation in the public sector is neither as uniform nor as transparent. The rules in the semi-public sector, including care and education institutions, are based on GAAP but have many sector-specific exceptions. The same muddle is found at the municipalities and provinces: the rules are set by central government but exceptions are permitted under specific regulations. So what is the situation in central government?

The question is whether the variations will bring us closer to or take us further away from the goal of informing all interested parties of how public and private funds are spent. It must be possible to follow the funds distributed from The Hague to every corner of the country in order to form an opinion on their use. Members of parliament are not the only interested parties; school governors, hospital managers and critical taxpayers must also be able to form an opinion without having to repeatedly swot up on the details or master all the exceptions specific to a particular annual report. People approach the accounts in a variety of guises, sometimes as shareholders, sometimes as governors, often as taxpayers but always as critical citizens. Are citizens expected to know and understand all the dialects of the reporting language?!

Uniformity is even more important in a world where borders are breaking down and international relationships are growing in importance. Anyone going their own way and making up their own rules is perversely promoting the lack of comparability and will not be understood or trusted. This will happen in both the public and the private sector. Shareholders will not invest in a company that presents obscure and incomprehensible figures that cannot be compared. So why should the Dutch public accept such a situation?

This brings us back to the crux of the matter. Central government should start applying accrual accounting rules and the associated uniformity in the public sector now! The international standards applied by listed companies are being adapted for use in the public sector. The IFRS are being rewritten as International Public Sector Accounting Standard (IPSAS).

Progress, you might think. Were it not that Brussels, the capital of the European Union, is working on its own version, the European Public Sector Accounting Standards (EPSAS). EPSAS will not be a lingua franca but a separate dialect spoken by the public sector in the EU. And like many other things in the Union, they could become compulsory in the member states at some point in the future. But the accounts would present not only the cash expenditure but also the costs and financial position. Only the Netherlands and Germany currently work with what experts call an outdated, “mediaeval” cash accounting system.

So are things about to change in the Netherlands? What benefit does a cacophony of accounting dialects have for the international community? What language will the Netherlands speak? A compulsory switch to an EU system based on IPSAS is a real possibility but the door is still open to one of many dialects of the EPSAS language.

In November 2017, the European Council of Finance Ministers, Ecofin, requested a detailed assessment of the pros and cons of EPSAS. The European Commission will base the assessment on four scenarios, ranging from the EU-wide compulsory implementation of EPSAS to more eclectic, voluntary adoption. Ecofin will take the final decision.

The new Minister of Finance in the Netherlands, Wopke Hoekstra (CDA, Christian democratic party), must therefore engage in a national and an international debate. What is the added value of an EU/EPSAS dialect if we already have an international language in IPSAS? Why does the regulation permit dialects? If the ultimate goal is uniformity, aren’t dialects illogical as they will limit opportunities for transparency?

If the Netherlands is to have a meaningful voice in the European debate, it must first understand what its own principles are. When he was finance minister, Jeroen Dijsselbloem was advised to introduce accrual accounting in steps but this advice has still not been acted upon. The historical irony is that the Netherlands was once at the forefront, nowadays it does not have a national stance but is none the less taking part in the international decision-making.

In summary, an accrual accounting system would help the politicians reassure the public that their money is being spent economically, efficiently and effectively. Accounting systems are being discussed in Europe but not in the land of Prince Maurice, Johan van Oldenbarnevelt and Simon Stevin. Nearly all EU member states have adopted accrual accounting. The Netherlands stands alone with Germany. Why? A better system is an investment in transparency and trust, which is worth committing to in and of itself. It cannot be ruled out that, just like 400 years ago, accrual accounting will improve public accountability and promote innovation and prosperity.

What is the Netherlands Court of Audit?

The Netherlands Court of Audit is an independent institution located on Lange Voorhout in The Hague, dating in its current form from 1814. It audits the regularity and efficiency of government expenditure. Expenditure must be made in compliance with applicable regulations and the money must be spent to achieve its intended purpose. The Court is increasingly auditing the effectiveness of government policy. The Court’s Board is made up of three members. Arno Visser has been its President since 2015. The Court employs a staff of 270.

Arno Visser (51) is the President of the Netherlands Court of Audit. A year ago Elsevier Weekblad published his essay, Are you getting value for your taxes? Before being appointed President of the Court of Audit, Visser was a member of the municipal council of Almere (2008-2013) and a member of the House of Representatives on behalf of the VVD liberal party (2003-2006). Born in The Hague, he studied theoretical and comparative literature at the University of Groningen. As a member of the municipal council he was responsible for, among other things, the finance portfolio.