Analysis of Creative Accounting and its Impacts on Governments Financial Performance The Case of the Swiss Cantons

Transcription

1 Analysis of Creative Accounting and its Impacts on Governments Financial Performance The Case of the Swiss Cantons Maxime Clémenceau & Nils Soguel Swiss Graduate School of Public Administration (IDHEAP) University of Lausanne Abstract This research aims at empirically identifying a possible impact of creative accounting on public deficits. More precisely, local governments may have incentives to resort to financial tricks in order to hide public surpluses. Such loopholes allow local governments to put expenditure under pressure and to justify higher tax rates than needed. In turn, these high tax rates should generate additional cash-flows that could be used in order to repay debt or to bail out cookie-jar reserves. Considering the second case, money accumulated into these reserves could be used in order to smooth fiscal balance over time. Using panel data relative to the 26 Swiss cantons over the period , we show that creative accounting operations allow to significantly decrease public deficits. Keywords Creative Accounting, Public Deficits, Swiss Cantons, Simultaneous Equations Model with Panel Data. JEL Classification Numbers C23, H62, H72. The authors would like to acknowledge the helpful comments from the participants of the Comparative International Governmental Accounting Research (CIGAR) Network Annual Conference 2013 in Birmingham, of the European Group for Public Administration (EGPA) Annual Conference 2013 in Edinburgh as well as of the Sinergia Workshop in public finance 2013 in Lausanne.

2 Contents 1 Introduction 1 2 Literature review 4 3 Accounts manipulation in Swiss cantons Harmonized Accounting Model (HAM1) Context of account manipulation in Swiss cantons Additional depreciation charges Special funds Descriptive statistics of SFP-balances and creative accounting operations Published SFP-balances Additional depreciation Special funds Adjusted SFP-balances Comments about the use of creative accounting in Swiss cantons Data Dependent variables Control variables Endogenous covariates Empirical analysis Single equation model: methodology and results Simultaneous equations model: methodology and results Conclusion 33 8 Bibliography 37 9 Appendices 42

3 1 Introduction The fundamental objective of accounting is to provide various stakeholders with a true and fair view of the firms or country s financial situation. Nonetheless, accounts may be manipulated through creative accounting, which refers to a process whereby accountants use their knowledge of accounting rules to manipulate the figures reported in the accounts of a business (Amat et al. 1999). According to Koen and van den Noord (2005), creative accounting refers to the more or less unorthodox treatment of operations involving the general government, and add that it may reflect opportunistic accounting. That way, if accounts are effectively manipulated through creative accounting, the objective of fiscal transparency is no longer achieved. In addition, the consequences of such manipulations may be damaging. The current European Monetary Union crisis gives us evidence about the danger of such practices. However, it could be that creative accounting operations could also have beneficial effects on public fiscal soundness in certain circumstances. This latter element is what we will investigate in this research in particular since we aim to assess the impact of some creative accounting operations on public deficits. In most of the Swiss cantons, the subnational level of government, their individual cantonal financial law usually requires them to balance their statement of financial performance (SFP) in the medium-term. In other words, the operating expenses have to be covered by the operating revenues in the medium-term. Swiss cantons are therefore implicitly recommended to embrace counter-cyclical budgetary policy. This means that Swiss cantons may report deficits during slow economic periods, but they have to report surpluses during booms in order to offset past or future deficits. Nevertheless, governments can hardly justify a surplus. It would indeed indicate that taxes paid by citizens were too high compared to the usual public services they received from the government. Conversely, it would mean that governments have not provided enough public services compared to the tax revenues they perceived. That way, claims from citizens or political parties aiming to reduce taxes or to increase expenses may appear from such situations. For this reason, the Harmonized Accounting Model for Swiss cantons and municipalities (HAM1) recommends to budget and to record additional depreciation charges during times of economic growth in order to repay debt or increase the net assets (CDF 1981: 1

4 13). Indeed, budgeting additional depreciation charges increases operating expenses and so justifies maintaining higher than necessary tax rates. In turn, these high tax rates generate additional cash-flows that allow to repay debt. The HAM1 also states that additional depreciation charges, even if they increase self-financing, may not be used to finance new investments. The additional depreciation charges can therefore be viewed as a budgetary policy tool controlled by the finance minister aiming to artificially deteriorate the balance reported in the statement of financial performance. Additional depreciation charges would then be used in the sole purpose of maintaining fiscal pressure on citizens and to avoid political pressures aiming at increasing expenses. Moreover, according to the HAM1, the creation of reserves, commonly called cookie-jar reserves or hidden reserves, are strictly forbidden. Nonetheless, despite this prohibition Swiss cantons use special funds (that are accruals performing the same objectives as reserves and provisions) in order to artificially increase operating expenses and therefore hide surpluses reported in the statement of financial performance. Based on all the foregoing, we may then formulate the main assumption of this study as follows: By hiding surpluses, creative accounting operations restrain the level of expenses (especially operating expenses) and hold a high tax burden. These creative accounting operations should therefore improve the actual balance of the statement of financial performance, i.e. increasing even more the actual surplus or limiting the actual deficit. Results ensuing from the empirical analysis will thus indicate whether or not creative accounting operations have the expected positive significant influence on the Swiss cantons fiscal soundness. In this research, we consider the balance reported in the statement of financial performance (SFP-balance) to be the difference between operating revenues and operating expenses. Hence, when operating revenues are bigger than operating expenses, we talk about a surplus. And conversely when we refer to a deficit. Then, to measure accounting manipulations as precisely as possible, we have to capture the discretionary nature of additional depreciation charges and special funds. Baralexis (2004) confirms that the main characteristic of creative accounting is the discretionary nature of those operations. Indeed, in the author s point of view, creative accounting is the process of intentionally 2

5 exploiting or violating the GAAP or the law to present financial statements according to one s interests 1. Without leaving behind the legal perspective of the accounting operations, we mostly focus on the economic reality of those operations recorded by Swiss cantons. On these grounds, we consider the total amount of the additional depreciation charges and the special funds as creative accounting operations since they have no economic reality with regard to the IPSAS norms and so deteriorate the true and fair view of the public figures. Both accruals are indeed only and purely accounting gimmicks used by Swiss cantons in order to artificially decrease SFP-balances by increasing operating expenses. Though, from a purely legal perspective, these operations are considered to be acceptable. Using panel data including information related to the 26 Swiss cantons for the period , we estimate two different models in order to test our hypothesis. The first model is a single equation model where the SFP-balance is the dependent variable. Then, we perform a simultaneous equations model where the level of operating revenues and operating expenses is simultaneously estimated. This second approach has the advantage to disentangle the respective effect of creative accounting on revenues and expenses. Finally, five different econometric estimators are taken into account in order to estimate both models. The remainder of the paper is organized as follows. In the next section, we discuss the literature dealing with the notions of creative accounting. In section 3, we first give a short overview of the HAM1, the accounting guideline implemented in Swiss cantons. We then present creative accounting operations that may potentially be used by Swiss cantons. In this same section, we pay careful attention to three items. First of all, we define what creative accounting is in the Swiss context and at the same time we aim at explaining why and how creative accounting is practiced by Swiss cantons. Section 4 is devoted to the descriptive statistics of the SFP-balance and the creative accounting operations. Then, in section 5 is presented the set of variables used in the models. Moreover, we also 1 The GAAP (Generally Accepted Accounting Principles) refer to the standard framework of guidelines for financial accounting used in any given jurisdiction. That way, GAAP are a codification of how firms have to prepare and present their financial statement (revenues, expenses, assets and liabilities). In a large part of jurisdictions, GAAP ensue from the International Financial Reporting Standards (IFRS) developed by the International Accounting Standards Board (IASB). 3

6 present for each independent variable their expected influence on the dependent variable. At section 6, we perform the empirical analysis. The two different models are presented as well as their associated estimation methods. Then, we close the section by presenting results ensuing from the estimated models. Finally, section 7 is devoted to the conclusion. 2 Literature review Over the past forty years, most countries have experienced large public deficits and important debt accumulation. And in most cases, subnational levels of governments have suffered the same phenomenon. Thus, in order to avoid taking unpopular decisions and facing the risk of not being re-elected, governments may be tempted to use some fiscal gimmicks instead of resolving their structural financial problems. Large amounts of evidence support that European Union (EU) countries resorted to accounting manipulations, notably during the run-up for the European Monetary Union (EMU) integration. Milesi-Ferretti and Moriyama (2006) and also Balassone et al. (2007) highlight indeed that EU countries artificially reduced their deficits and indebtedness in order to achieve Maastricht criteria, without increasing their net assets 2. By using a balance sheet approach, Milesi-Ferretti and Moriyama (2006) demonstrated that the change in public debt was strongly positively correlated with the change in government assets. In other words, between 1992 and 1997, EU countries decreased the level of their debt thanks to a reduction of public assets. They then found that this relation disappeared after 1997, after the EU countries got into the EMU. Von Hagen and Wolff (2006) drew the same conclusion. In addition, Balassone et al. (2007) took an interest in showing that EU countries probably manipulated their deficits. In short, they highlight that the reported deficits were not reflected in the change in debt during the run-up for EMU integration. Although they agree that their model is quite simple, they argue that a mere comparison of deficit and changes in debt can help the early detection of inconsistencies in fiscal data. Furthermore, Prammer (2009) explains that some EU countries performed privatizations 2 Some authors argue that this notion should be preferred to both EMU criteria as it reflects the financial health of a country. And also, they argue that this notion is less malleable. 4

7 and outsourcing in order to reduce public debt. During the same period, Montesinos and Vela (2000) or Benito et al. (2008) pay particular attention to the use of creative accounting in Spain. During the run-up for the EMU integration, Spain principally used Private Financing of Infrastructure and Public Private Partnership in order to maintain the level of infrastructure expenditure whilst achieving the Maastricht criteria. Results also highlight that Spain had recourse to fiscal gimmicks such as the German Method, deferred payments, extension of concession term limits or decentralization of public debt 3. Without qualifying those methods as illegal, authors question whether or not they are strictly legal. According to their point of view, it is the lack of clear accounting standards on how to report those means that allowed governments to do this. It would seem we are therefore in a gray area where there are no specific standards and where concepts need to be (discretionarily) interpreted to provide policy guidance (Shah 1998). From the foregoing, we might assume that it is the political cost of not getting into the EMU that led countries to use creative accounting. Nevertheless, some authors argue that there are fiscal rules, even in Europe, that encourage countries to manage their fiscal balances. Milesi-Ferretti (2004) notes that the incentives to use nonstructural fiscal measures - often described as creative accounting - may increase in the presence of fiscal rules. Then, as pointed out by Buti et al. (2007), creative accounting increased with the introduction of the Stabilization and Growth Pact (SGP), which includes the Maastricht criteria. Initially, fiscal rules were introduced to the public sector both at national and subnational levels of governments, in order to restrain deficits and debt (Bohn and Inman 1996; Feld and Kirchgässner 2008; Bodmer 2012). Nonetheless, various evidence tends to contradict this assumption. Kopits and Craig (1998) warns indeed that states may have the incentive to use creative accounting practices to circumvent these kinds of rules. Evidence of this concern is given by Von Hagen (1991), who reads that U.S. states achieved budget constraint targets with the aid of accounting manipulations. Then, although Luechinger and Schaltegger (2011) demonstrated that fiscal rules significantly allowed Swiss cantons 3 The German method is a method consisting in paying building and interest costs of an infrastructure to the bidder only when the work is accomplished. Therefore, during the building period, the government does not bear neither budgetary expenses or borrowing costs, which allows it to achieve EMU criteria more easily (Benito et al. 2008). 5

8 to restrain deficits, they conclude by mentioning that they cannot rule out that, at least partially, deficits have been reduced through creative accounting operations or windowdressing measures. Finally, Milesi-Ferretti (2004) summarizes as follows: if governments satisfy budget rules by using cosmetics, it implies that, in reality, there is a deficit. Thus, the budget rule would be ineffective to put deficit and debt under pressure 4. However, countries have also legal devices at their disposal allowing them to improve the state financial situation. For instance, U.S. States strongly use Rainy Day Funds (RDFs) in this matter. As described by Grizzle (2010), RDFs are funds in which money is saved when state finances are healthy for use during economic downturns. In other words, Gonzalez and Paqueo (2003) mention that RDFs allow states to smooth public spending over time by saving during booms and using the balance to cover revenue shortfalls during recessions. Some researches show evidence that RDFs allow U.S. local governments to smooth fiscal balances (Gonzalez and Paqueo 2003; Wagner and Sobel 2006; Grizzle 2010). Nevertheless, Pattison (2012) warns that RDFs may be put under pressure by politicians and citizens when they attain a relatively large size. Anthony (1985) suggests indeed that even if deficits are badly perceived, surpluses are not better viewed by politicians and citizens. In the first case, it indicates that the state does not live within its means. Second, a surplus highlights that citizens payed too much in taxes or obtained too little public services. Therefore, it may result from this situation that politicians and citizens claim tax cuts or public expenses increases. However, surpluses are indispensable if states want to save money in order smooth fiscal balance over time. For all these reasons, we may assume that states, local governments or municipalities may also have incentives to use creative accounting in order to hide surpluses. Anthony (1985) shows that the objective of U.S. municipalities is to report a small surplus. A mayor of a Swedish municipality cited by Knutsson et al. (2008) also mention that [his] strategy has always been to hide surplus money into depreciation and long-term financial investments, such as pensions. Otherwise some politicians can be tempted to use the surplus in day-to-day production. [His] intention is to prevent, or limit, the possibilities for 4 This is besides a point to be investigated in this research since Swiss cantons have largely implemented budget rules. In addition, our results will allow to confirm or not the suggestion formulated above by Luechinger and Schaltegger (2011). 6

9 expansion in different services and at the same time strengthen the long-term financial situation. Then, Pilcher (2011), who pays attention to local governments of the state of New South Wales (NSW) in Australia between 2003 and 2006 also indicates that they have incentives to smooth fiscal balances over time. The author assumes that it can generally be done thanks to discretionary accruals and mentions that such an objective may particularly be achieved by playing with depreciation charges. More precisely, Pilcher and Van Der Zahn (2010) suggest that local governments of NSW use unexpected depreciation to artificially decrease financial performances. Then, Stalebrink (2007) also advances that Swedish municipalities could use capital depreciation to manage reported financial performances 5. In his view, Swedish municipalities would increase capital depreciation during good economic periods, and they would do the opposite to dampen deficits 6. 3 Accounts manipulation in Swiss cantons In this section, we first provide a concise overview of the accounting guide used by Swiss cantons, i.e. the HAM1. We then present accounting operations with which Swiss cantons may play in order to manipulate their financial figures. We also deal with the reasons why Swiss cantons may have incentives to manipulate fiscal balances. 3.1 Harmonized Accounting Model (HAM1) One of the most important particularities of the HAM1 is the implementation of accrual accounting instead of cash based accounting. Accrual accounting has been preferred because it is supposed to increase transparency inside the administration, which should increase the manager s accountability and improve organizational performance and resource allocation. Furthermore, accrual accounting allows to better identify the full costs of public policy. Hence, it must be noted that the HAM1 is deeply inspired by an economic 5 At the same time, the author indicates that Swedish municipalities resort to large asset write-offs when deficits are expected to occur. Thus, his findings reveal that the public sector also has incentives to perform big bath accounting. 6 Capital depreciation mentioned by Stalebrink (2007) are the equivalent of depreciation charges of the administrative assets recorded in the HAM1. 7

10 approach of public finance. That way, this economic perspective goes in the direction of the true and fair view of the financial status currently targeted by the IPSAS norms 7. Nevertheless, although the HAM1 largely relies on IPSAS norms, it also allows Swiss cantons to have a more political vision of public finance. Indeed, the HAM1 offers the technical opportunity to create hidden reserves. That way, two opposite visions of public finance, namely the political vision and the economic vision, pitch each against each other into the HAM1. In spite of this tradeoff between both visions, the content of the HAM1 is relatively similar to that proposed by the IPSAS norms. Indeed, the HAM1 also includes a statement of financial performance (SFP) and a statement of financial position, i.e. a balance sheet. Whereas the former statement provides information about the cash flows from operating activities, the latter informs about the canton s net assets 8. The SFP-balance is a crucial element as it determines the change in cantonal net assets. While a surplus reported in the statement of financial performance increases the net assets or decrease the indebtedness, a deficit decreases the net assets or increases the indebtedness. As the SFP-balance determines the change in debt, the political debate (from the budget preparation to the closing of accounts) is principally focused on this item. Consequently, the finance ministers aim at putting the statement of financial performance under pressure in order to restrain operating expenses and therefore the indebtedness. That way, operations of creative accounting will tend to be focused on the SFP-balance. Indeed, by manipulating the statement of financial performance, finance ministers also influence the level of debt. One must then remember that the HAM1 is based on accrual accounting. Thence, some accounting elements impact the liquidity while others are only book entries; they are accruals. As the accruals may be more easily manipulated, they may be used to influence the statement of financial performance and thus, indirectly, the level of debt. 7 Figure 1 below shows a graphical representation of the statement of financial perfor- The IPSAS (International Public Sector Accounting Standards) norms are recommendations, published by the IPSAS Board, intended for the presentation of accounts in the public sector. They are based on the IFRS (International Financial Reporting Standards) and on the IAS (International Accounting Standards). The IPSAS norms apply to every public entity (central government, subnational level of government and municipality), with the exception of public firms that principally have a commercial activity. 8 The net assets, also sometimes called equity, is the difference between the assets and the liabilities of a canton. 8

11 mance according to the HAM1. The closing of the statement of financial performance highlights the cash flows from operating activities. This last indicator is defined as the sum of the SFP-balance (here a surplus) and the depreciation charges. The cash flows from operating activities refers to the financial means at the cantons s disposal to finance new investments. Figure 1: Statement of financial performance (SFP) Referring to our problematic, by increasing depreciation charges, the cash flows from operating activities remains constant while the surplus is reduced. That way, by concealing the surplus reported in the statement of financial performance through depreciation, a canton maintains its investment capacity and, at the same time, avoids political claims aiming at reducing taxes or increasing future operating expenses. This latter demonstration provides a first oversight with regard to the stakes that Swiss cantons have to cope with when they close the books. More detailed information about these stakes are given in the following subsections. 3.2 Context of account manipulation in Swiss cantons The use of creative accounting in Swiss cantons is strongly tied to the fiscal policy recommended by the HAM1 and implemented in most cantonal financial laws. The 4th article of the model of law concerning the canton s finances contained in the HAM1 proposes that the statement of financial performance must remain balanced in the medium-term (CDF 1981: 72). This means that deficits should be allowed during downturns, but that 9

12 these deficits would need to be compensated with surpluses in a period of 8 to 10 years, during periods of economic expansion (CDF 1981: 66). Without saying so explicitly, the HAM1 advises cantons to embrace a counter-cyclical budgetary policy. Such a budgetary policy aims at intensifying the level of public expenses during periods of bad conjuncture, so as to stimulate economic activity. On the other hand, it is necessary to decrease public expenses during a period of economic expansion, so as to produce surpluses. This will then allow the cantons to settle their past deficits (Martin 2009). In other words, the canton is required to use surpluses to offset past deficits and by so doing it will avoid deteriorating the net assets. Nevertheless, as previously mentioned, it is extremely risky for governments to feature a surplus. Indeed, if a surplus occurs, it actually means that the fiscal pressure was too strong compared to the services provided. Or, put in a different way, it means that the services were too weak compared to the state s tax revenue. Because of this, political pressures aiming at reducing surpluses can appear. Whereas left-wing political parties might want to increase operating expenses, right-wing parties would be more willing to decrease fiscal pressure (Tellier 2006). Both cases would however result in the surpluses to fade away. That way, in the Swiss context, a canton would not be able to keep its net assets without resorting to creative accounting (e.g. without using additional depreciation charges). 3.3 Additional depreciation charges In order to be successful in balancing the statement of financial performance in the medium-term, the harmonized accounting guideline recommends applying additional depreciation charges. Comparably to ordinary depreciation charges, these are depreciation charges of assets 9. Unlike the ordinary depreciation charges that have to be reported each year because of the law, the accounting handbook for Swiss cantons reads that additional depreciation can be budgeted during economic expansions in order to pay off debt (CDF 1981: 13). 9 The additional depreciation charges represent a different book entry than the ordinary depreciation charges, although they are both depreciation charges of assets. 10

13 Additional depreciation charges are thus only used to artificially decrease surpluses. Recording additional depreciation charges allows Swiss cantons to maintain a high fiscal burden on citizens and to put operating expenses under pressure. At the same time, the additional depreciation charges increase the cash flows from operating activities, which decreases the canton s need to borrow and so contains the debt increase. In other words, additional depreciation charges allow Swiss cantons to artificially increase the operating expenses and so justifies maintaining higher than necessary tax rates. In turn, these high tax rates generate cash-flow that allows to repay debt. The additional depreciation charges are therefore a policy tool controlled by the finance minister aiming to artificially increase operating expenses and deteriorate the SFPbalance. The additional depreciation charges would then be used in the sole purpose of maintaining fiscal pressure on citizens and to avoid political pressures aiming at increasing operating expenses. It would ultimately be a tool helping local governments to maintain a structural surplus in the medium-term. Consequently, it must be concluded that the additional depreciation charges have no economic justification as they do not account for an asset impairment loss. Therefore, as they have no economic consistency with regard to the IPSAS norms and lower the true and fair view of the cantonal financial situation, we consider them as a creative accounting operation. 3.4 Special funds The manipulation of additional depreciation charges, however, is not the only tool that Swiss cantons have at their disposal to hide surplus. In fact, although they are strictly forbidden by the HAM1 (CDF 1981: 37), cookie-jar reserves could be created, particularly through the resort to special funds. The (CDF 1981: 13) reads that special funds correspond to the total or partial allocation of specific [operating] revenues to particular tasks. Special funds are normally created only in sectors where a causal relationship can be established between the task to be fulfilled and the direct payments obtained by the beneficiaries (e.g. a parking fee or tax). In addition, it would be best to keep special funds to a minimum, in order to preserve surpluses to face overall excess of [operating] expenses. Indeed, deficits and debt should be covered by net assets or additional depreciation 11

14 charges. Furthermore, special funds may, however, be used to provide funds for future tasks so that ulterior political decisions can be rapidly implemented (CDF 1981: 70). Nonetheless, when the goals for the special funds no longer exists or cannot be reached, governments will then have the responsibility to cancel them (CDF 1981: 69). Then, one must notice that special funds increase the canton s nets assets. This is the reason why we consider those funds as a good device to accumulate cookie-jar reserves. Suppose that the SFP-balance is higher than expected when a government is closing their books. The canton can increase the amount allocated to special funds in order to hide excess operating revenues. This operation will simultaneously increase operating expenses, reduce the SFP-balance and increase the canton s net assets. Furthermore, conversely to additional depreciation charges, the operations on special funds may also be used to increase the SFP-balance. Indeed, by withdrawing money from special funds, it also allows Swiss cantons to artificially cover a deficit. Swiss cantons mostly discretionary bail out those funds without a causal relationship between the task to be fulfilled and a direct payment obtained by the beneficiaries. Moreover, those funds may be bailed out without any economic reality behind such an operation. For these reasons, we assume that special funds are manipulated and used as a cookie-jar reserve or Rainy Day Funds, which is against the HAM1 recommendations 10. Then, as the use of special funds does not match with the HAM1 recommendations and that, most of time, the use of special funds has no economic consistency, we consider those accounting operations as creative accounting. 4 Descriptive statistics of SFP-balances and creative accounting operations In the current section, we present the data relative to the Swiss cantons financial situation as well as the data referring to the creative accounting operations. More precisely, published SFP-balances of the 26 Swiss cantons are hereafter presented as well as the 10 Indeed, the creation of cookie-jar reserves is prohibited by the HAM1 since the net assets has to be used as a general reserve (MCH1 1981: 13). In other words, the use of special funds by Swiss cantons may be assimilated to the use of reserves and provisions by private firms that aims at concealing their benefits. 12

15 total amounts of additional depreciation charges and special funds. Finally, we conclude by displaying the adjusted cantonal SFP-balances that are the published SFP-balances without the creative accounting operations. Then we must note that the figures presented below are expressed in real terms per capita. Working with real values allows us to control for inflation. As an individual deflator for each canton does not exist, we work with the implicit Swiss GDP deflator to obtain real values 11. Swiss cantons are relatively heterogeneous, in particular in terms of financial size. Therefore, in order to take this heterogeneity into account and to make clear comparisons, accounting data in this paper is presented per capita. 4.1 Published SFP-balances Table 1 below displays the published SFP-balances of the 26 Swiss cantons during the period In this study, we define the SFP-balance as the difference between the total amount of operating revenues and expenses. We therefore do not concentrate on the capital revenues and expenditures. To do this, we use the data for the cantonal operating revenues and expenses that are computed and provided by Swiss cantons. Figures are presented in real term per capita. For each canton, the table shows the average published SFP-balance for the considered period, the standard deviation, the minimum and maximum values and the years during which the canton recorded a deficit. Finally, since not all cantons introduced the HAM1 the same year, N indicates the number of years since the canton s implementation of the new harmonized accounting guideline 12. Cantons are ordered according to their average published SFP-balance, from the highest surplus to the highest deficit. 11 Source: Swiss Federal Statistical Office (SFSO). (deflator 2010 = 100%) 12 Note that the cantons of GE and ZH adopted IPSAS norms in 2009, and the cantons of BL and NW in

16 Table 1: Published SFP-balances per capita ( ) Canton N Mean Std. dev. Min Max Deficits BS ZG FR GR SZ LU OW SG VS UR SH BL TG NW ZH AI GL TI AR AG JU SO VD BE NE GE Mean Source: Swiss canton s accounts and own calculations The first thing we notice when observing the table is that cantons appear to have a mean surplus of CHF from 1980 to Over this period, Swiss cantons have achieved 9 years of deficits, on average. The canton of Basel-Stadt (BS) is the one that gathered the greatest surplus of CHF per capita. Over the 16 years during which BS applied HAM1, the canton found itself with 13 years of excess operating revenues. On the other end of the spectrum, Geneva (GE) recorded the largest deficit over the whole period, worth CHF per capita. Furthermore, it closes its annual accounts approximately every second year with a deficit. Let s however note that GE is a special case. Placing just above Geneva (GE), the canton of Neuchâtel (NE) wrote down a mean deficit of CHF, almost half that of Geneva (GE). The next interesting fact is that 21 cantons out of 26 end the year with a surplus on average. However, these surpluses are fairly heterogeneous. In fact, the canton of the Jura (JU) recorded excess operating revenues close to 24 times smaller than Basel-Stadt (BS). In contrast, only 5 cantons 14

17 reported an average deficit between 1980 and Other than Geneva s, these canton s deficits are relatively homogenous. It is worth noticing that the difference between the smallest surplus and the smallest deficit is of CHF per capita, which is a substantial gap. This again proves to us that the cantons financial health can differ greatly. Finally, the SFP-balance levels do not only vary across cantons, but also strongly fluctuate over time as indicated by the standard deviation as well as the maximum and minimum values. 4.2 Additional depreciation The variable measuring the total amount of additional depreciation charges can be expressed as: Depreciation t = ADC tr P t where ADC refers to the total amount of additional depreciation charges, t to the year t, r is the figure recorded in the cantonal statement of financial performance and where P is the canton s population. We use the population as denominator in order to take into account the cantons heterogeneity in terms of size. Table 2 shows the total amount of additional depreciation in real terms per capita over the period ranging from 1980 to This table indicates, for each canton, the mean over the period, the standard deviation and the minimum and maximum values. Then, N indicates the total amount of years during which each canton applied HAM1 and the column Years report the number of time that additional depreciation charges have been used between 1980 and Finally, Swiss cantons are ordered according to the average amount of additional depreciation charges, from the largest amount to the lowest one. 15

18 Table 2: Additional depreciation charges per capita ( ) Canton N Mean Std. dev. Min Max Years UR ZG NW GR OW AI SZ BE BL SH SO VS GE TI GL AR LU VD TG JU FR AG ZH BS SG NE Mean Source: Swiss cantons accounts and own calculations First of all, the table above shows us that over the whole period and considering all cantons, the figures recorded in the accounts are on average CHF per capita. Furthermore, 23 Swiss cantons record additional depreciation charges. This first overview therefore confirms our belief that Swiss cantons resort to additional depreciation to hide excess operating revenues. There are however large differences between cantons in this matter. Indeed, whereas the canton of Uri (UR) records on average CHF per capita, the canton of Zürich only lists an amount of 2.58 CHF per capita. The canton of Uri (UR) seems to be an extreme case since the second canton recording the largest amount of additional depreciation charges - the canton of Zug (ZG) - only lists CHF per capita. Then, the total amount recorded as additional depreciation charges decreases more or less gradually from CHF - the canton of Nidwald (NW) - to 2.58 CHF - the canton of Zürich (ZH). In addition, 3 out of 26 cantons do not exhibit any additional depreciation over the entire period. Basel-Stadt (BS) and Saint-Gallen (SG), 16

19 however, are the ones who write down ordinary depreciation charges which are much higher than the amounts forecasted. We can therefore assume that these cantons use ordinary depreciation charges to reduce SFP-balances. It would allow Swiss cantons to be much more discreet in their accounts manipulation. Remember that the goal of creative accounting is for fraudulent operations to be undetectable, or at least as concealed as possible. Then, we may assume the canton of Neuchâtel (NE) does not use additional depreciation charges due to its financial situation. Finally, in addition to great variations across cantons, the large standard deviations indicate there is also a strong temporal variability. Naturally, we can come to the same conclusion when observing the maximum and minimum values. This latter information would therefore provide evidence that the use of additional depreciation charges would depend on the business cycle, as expected. 4.3 Special funds The variable measuring the total amount of special funds can be expressed as: F unds t = ASF tr W SF tr P t where ASF refers to the amounts allocated in special funds and where WSF represents the amounts withdrawn from special funds. Then, t refers to the year t, r is the amount reported in the cantonal statement of financial performance and where P is the canton s population. We use again the population as denominator in order to take into account cantonal heterogeneity in terms of size. Table 3 presents the amounts saved into special funds in real terms capita, from 1980 to This table indicates, for each canton, the mean over the period, the standard deviation and the minimum and maximum values. Then, N indicates the number of years during which each canton implemented HAM1. Lastly, Swiss cantons are ordered according to the average amount of special funds, from the largest amount to the lowest. 17

20 Table 3: Special funds per capita ( ) Canton N Mean Std. dev. Min Max GL BL FR SG VS OW BS SH TG GE NE AR BE TI AI VD ZH NW GR UR SZ LU SO AG JU ZG Mean Source: Swiss cantons accounts and own calculations The first thing to notice in the table above is that every single canton without exception has used special funds during the considered period. On average, the amount accumulated each year by Swiss cantons represents CHF par capita. This first revelation suggests that Swiss cantons use special funds to conceal excess operating revenues. However, there are disparities between cantons: whereas the canton of Glarus (GL) recorded a total amount of CHF per capita between 1980 and 2010, the canton of Zug (ZG) reported an amount of CHF per capita. Interestingly enough, it must therefore be noted that some cantons withdraw more money than they bail out special funds. In addition, even though there is a gap between the canton of Glarus (GL) and the canton of Basel- Stadt (BS), the amounts saved as cookie-jar reserves through special funds gradually decrease until the canton of Schwyz (SZ). Finally, by paying attention to the standard deviation as well as to the minimum and maximum values, we may also notice a strong temporal variability. We therefore reach the conclusion that, as assumed, the use of special 18

21 funds largely depends on the cantonal economic situation. 4.4 Adjusted SFP-balances In the previous subsections, we exhibited the published SFP-balances levels and the two main creative accounting tools that Swiss cantons mostly use in order to hide surpluses. In this subsection, we are displaying the adjusted SFP-balances, i.e. the published SFPbalance without the creative accounting operations. Table 4 presents the adjusted SFP-balances in real terms per capita from 1980 to This table indicates, for each cantons, the mean over the period, the standard deviation, the minimum and maximum values and the numbers of years during which Swiss cantons reported a negative adjusted SFP-balance (deficit). Then, N indicates the number of years during which each canton implemented the HAM1. Finally, Swiss cantons are ordered according to their average adjusted SFP-balance, from the largest amount to the lowest. Table 4: Adjusted SFP-balances per capita ( ) Canton N Mean Std. dev. Min Max Deficits UR BS ZG GR OW FR NW SZ GL BL VS SH LU SG AI TG TI AR ZH AG BE JU SO VD NE GE Mean

22 The first thing to note when paying attention to table 4 is that, from 1980 to 2010, the Swiss cantons reported an average adjusted SFP-balance of CHF per capita. Over this period, Swiss cantons have reported on average 9 adjusted deficits. Then canton of Uri (UR) is the one that reported the largest adjusted surplus with CHF per capita. On the other hand, the canton of Geneva (GE) recorded the largest adjusted deficit. Furthermore, over the considered period, 19 out of the 26 Swiss cantons closed the books on average with an adjusted surplus. Nonetheless, these adjusted surpluses are relatively heterogeneous. Indeed, the canton of Zürich (ZH) recorded excess adjusted operating revenues that are on average close to 10 times lower than Uri (UR). Conversely, 7 cantons reported on average adjusted deficits between 1980 and Finally, the standard deviation as well as the minimum and maximum values highlight that adjusted fiscal balances vary over time. 4.5 Comments about the use of creative accounting in Swiss cantons At this point and to conclude this section, some extra clarifications concerning the resort to creative accounting by Swiss cantons may be formulated. First of all, it must be noted that additional depreciation charges and special funds seem to be effectively used in order to artificially reduce and smooth cantonal SFP-balance over time. The comparison of table 1 and table 4 provides such evidences. Indeed, whereas the average published SFP-balance is CHF per capita, the same indicator becomes CHF per capita when we exclude the creative accounting operations. Moreover, the standard deviation as well as the minimum and maximum values are systematically larger when considering the adjusted SFP-balances, i.e. the published SFP-balance without creative accounting operations. Secondly, results tend to demonstrate that, with few exceptions, cantons publishing the lowest SFP-balances are the ones that, proportionally, record the most creative accounting operations. Although this may seem surprising, these findings make sense. If we consider a canton that accumulates large SFP-surpluses over the years, it will have some freedom to reduce taxes or to increase operating expenses without deteriorating its future financial situation. On the other hand, a canton with a weak financial situation will have less 20

23 leeway. Consequently, if the surpluses are smaller and less frequent, the canton will be more likely to hide surpluses and to bail out the cookie-jar reserves. 5 Data In this section, we introduce the model covering the influence of creative accounting on the cantons SFP-balance. First, we present the set of variables we use in this research. We then present both models (single and simultaneous equations models) and the econometric estimators used to test the hypothesis previously formulated. 5.1 Dependent variables For the single equation model, we use Balance, i.e. the cantonal SFP-balance as dependent variable. We define the cantonal SFP-balance as the difference between the total amount of operating revenues and expenses. The variable Balance may therefore be either a surplus or a deficit. However, note that the total amount of additional depreciation charges, allocation as well as withdrawal from special funds are excluded from the SFP-balance calculations. In other words, we use the adjusted SFP-balance as dependent variable. We use the information available in the 26 cantons statement of financial performance to compute this variable. Once again, the variable is expressed in real terms per capita. Then, for the simultaneous equations model, the two dependent variables are the total amount of operating revenues (Revenue) and the total amount of operating expenses (Expense). Again, the additional depreciation charges and the amounts allocated into special funds have been excluded from the operating expenses and the withdrawals from special funds are excluded from the operating revenues. 5.2 Control variables We control for other variables influences on SFP-balance so as to isolate the effect of the variables that interest us. Note that we use the first lagged value of the variables Depreciation (Depreciation(-1)) and Funds (Funds(-1)) to capture the impact of the 21