The Minister of Finance recently submitted (in Dutch) the Sustainability of Public Finances Act (Hof Act) to the Dutch House of Representatives. The objective of this act is to ensure that the Netherlands meets the EMU standard of a budget deficit of no more than 3% (the EMU deficit) in order to avoid fines. The legislative proposal is intended to ensure that the central government and local and regional authorities (provinces, municipalities, water boards) all devote the same effort to achieving this EMU standard. This could obstruct investments. We believe that public-private partnerships (PPPs) could provide a solution.
Because the European Union can only impose fines on Member States if they exceed the EMU deficit, while at least in the Netherlands various local and regional authorities can be in part responsible for incurring the actual fine, the national government wants more control over the spending patterns of those local and regional authorities. The core of this is that all local and regional levels of government are also restricted to a maximum EMU deficit. Originally, the Minister wanted this to apply separately to all local and regional authorities, but protests brought about an amendment, as a result of which a maximum EMU deficit will apply to every level of local and regional government (all of the provinces collectively, etc.).
Problem: accounting technique obstructs investments
Although the intentions with the Hof Act are admirable and apparently conducive to public finance, the legislative proposal could be a severe obstacle for necessary investments, even when funds are available for those investments. This is because the Hof Act, based in part on European rules, departs from a different accounting method- the cash accounting system - than the method applied by the lower government bodies, the accrual accounting system. The difference between these systems is that the cash system prescribes that the expenditure in a given year may not exceed the revenue in that year. The accrual system prescribes that costs be included in the budget once an obligation is undertaken, even if the obligation will only actually be performed - and paid - in another year.
And that is what can pose a conflict with the EMU standard in the Hof Act, which will also apply to local and regional authorities. The crux of the matter is that the actual expenditure is what applies in calculating the EMU deficit, not the costs budgeted. An example: if a municipality reserves a budget for the construction of a new city hall over a number of years, a sum is reserved in the budget for that purpose for a number of years without this causing an EMU "surplus". If the municipality subsequently constructs the city hall and uses the sums reserved for that purpose, the use of those reserved funds constitutes an expenditure to be included in calculating the EMU deficit. If the municipality’s revenue is insufficient in that year, it may not be possible to construct the city hall in that year because the investment would cause the EMU deficit ceiling to be exceeded. Although the amendment to the proposal applies to a maximum EMU deficit per level of local and regional government, this does give municipalities more room to consult with other municipalities (which will not be exceeding the EMU deficit in that year) in order to arrive at a credit balance by coordinating the investments, but that road is uncertain and may cause delays. Moreover, municipalities will be subject to their own EMU reference framework, enabling municipalities to take this into consideration in their accounting, probably making it difficult to make shifts.
Although the Hof Act could obstruct sizeable investments, using PPPs with integrated contracts will often provide a solution. In contracts of this type, using our example of a new city hall, the costs of the project are borne by the private party, while upon realisation the municipality pays a periodic availability fee to the private party for the duration of the building’s life cycle. These constitute relatively small payments over many years that will generally fit into the annual budget so that the EMU balance is not affected. Making reservations for the investment will then also often be unnecessary. What is more, experience has shown that PPPs significantly reduce the total life-cycle costs.
Would you like to know whether a PPP can solve - for example - the Hof Act issue for your project? Please contact our Public private partnership team.