An update on the regulatory reform of the not-for-profit sector

To recall: On 10 May 2011, following preparatory steps such as a Productivity Commission report on its status (see here), and a Consultation paper based on it (see here), the government announced its intention to reform the Not-for-Profit (NfP) sector in Australia (see here for a quick overview of that sector, one of the largest service sectors in Australia and one that has outstanding importance for the social fabric of the country). I have previously blogged on these and related developments (see here and here). There is no doubt in my mind that the Gillard government ought to be lauded for its initiative. It was overdue.

Putting its money where its mouth is, the government has budgeted more than $ 50 million over four years for a range of measures which prominently include the establishment of an Australian Charities and Not-for-Profits Commission (ACNC, see here). The government also established the ACNC Implementation Taskforce (see here) which is charged, during the current start-up year, to build the foundation of the ACNC (including making many of the key personnel decisions).

The ACNC Implementation Taskforce, headed by Susan Pascoe AM (see here) and assisted by David Locke (see here), who is on secondment from the Charity Commission of England and Wales, started its work soon after Shorten’s announcement and has initiated a process now well on its way: four by-invitation-only roundtables towards the end of last year, as well as two discussion papers in November (on the functions and operations of the ACNC, see here) and December (on governance arrangements, see here), will in early February be followed by an ACNC road-show through capital cities (see here for the schedule) before the actual set-up will be finalized in March through June of this year (see here).

There are interesting questions to be asked, also for economists, about the incentive-compatible design of this new organization, as well as the whole design and implementation process itself. It is an interesting question, for example, to determine which interests are to be taken into account. That of NfPs, and/or that of their peak bodies, and/or that of those working in NfPs, and/or that of the government, and/or that of consumers’ of NFP services, or that of the country at large? It is also an interesting question how to take them into account.

The “MudMap” to be found on the ACNC site (see here) illustrates a fraction of the myriad interests that have to be negotiated in the process. My first reaction to this map was, too many cooks have to spoil the broth.  Having followed the process over the last few months (and having participated in one of the roundtables), it seems that the process is well managed and reasonably transparent although it is not clear that to me that it will lead to the optimal outcome, or even a good one. Consumers, for example, seem awfully under-represented. And from what I have observed so far, way too many lawyers and lobbyists seem to get their say too often. It will be interesting to see whether the crew that will be on board in mid-year (when the ACNC is taking over from the Implementation Taskforce) is really independent of ATO and other parties with very vested interests that currently seem to have a prominent voice.

As mentioned, the government has issued two working papers (on the functions and operations of the ACNC and on governance arrangements), with consultation deadlines set for Feb 27 for the former and January 27 (yes, coming very soon indeed 😉 ) for the latter. By and far it seems fair to say that many of insights reflected in the discussion paper are informed by the experience of the Charity Commission of England and New Wales (no surprise here, given David Locke’s prominent role); I am on record having my doubts about this model (see my comment on the Productivity Commission report here). I continue to believe that a hybrid model of compliance – the kind of things that the ACNC Implementation Taskforce is considering implementing and on top of it certification for the few hundred nationally acting not-for-profits – is a better way to go. As detailed in my comment on the Productivity Commission report, there is certainly considerable evidence on the efficacy of some such model.

In the discussion papers that the ACNC Implementation Taskforce has issued, I have read many things that sound right. Yes, it’d be wonderful to have “validated data” (p. 7, discussion paper on Implementation Design) but how do we validate them when the data apparently will be self-reported? And, yes, I like to have an “open data” facility so that researchers can develop their own analytical material (p. 18, discussion paper on Implementation Design). As a matter of fact, that kind of data base would be an effective means for researchers and press and other interested parties to smoke out those that have an insufficient understanding of the fiduciary duty that comes with public monies. It will be interesting to see what exactly this data base will contain. Whatever it is; it will be undoubtedly be self-reported data which are notoriously problematic (see here).

Nevermind that it is currently unclear to what extent this reporting will indeed reduce red tape, and reporting required by other entities. It will take a lot of persistence and negotiation for this data collection to be allowed to substitute for other such efforts. Both the Implementation Taskforce, and its successor, have their work cut out for them.

It is encouraging that the ACNC Implementation Taskforce acknowledges that there is considerable potential for various forms of corruption (e.g., false acquittal of a government grant, or its expenditure on purposes it was not intended for), fraud, mission drift, and so on (see pp. 9 – 10 dp on Governance Arrangements). But again, here, too, the devil is in the detail and it will be interesting to see what effective means the ACNC will end up having and implementing.

The ACNC Implementation Taskforce provides a useful discussion of principles that ought to guide the implementation of appropriate governance mechanisms (pp. 15 – 29). It is heartening to see that it realizes that not-for-profits have multiple stakeholders of which many are unlikely to be properly represented and that therefore “responsible individuals must exercise at least the same degree of care, diligence and skill that a prudent individual would exercise in managing the affairs of others.” (p. 16, no. 87, see also no. 89). All that is fine and dandy, as is the lengthy discussion (and as are the consultation questions) regarding conflict of interest; nevermind the question what exactly constitutes material personal interests, I have to wonder though what the consequences of violations of some such requirement are. My experience in Australia (e.g., being the Treasurer of an owners’ corporation) is that there are lots of well-intentioned laws and regulations and guidelines but they can, more often than not, be violated with impunity because consequences are either not attached to start with, or not imposed, if indeed they exist.

Overall, I fear that we might end up with a lot of new wordage and reporting requirements that will have little bite when all is said and done.

I would not mind being wrong on this one.

 

Three cups of tea and other nasty habits

The philanthropic press in the USA (e.g., here) — and not only it (e.g., here) — is currently abuzz about accusations levelled against Greg Mortenson, former mountaineer turned successful book author turned philanthropic entrepreneur and co-founder of the Central Asia Institute (CAI).

For a quick primer, see here.

The CAI has raised tens of millions of dollars and claims that it has built and/or supported over 170+ schools and school library projects and provided education to over 68,000 children, including 52,000 girls, in the remote regions of Pakistan and Afghanistan where few education opportunities existed before CAI did all the good deeds it reports having done (see here.) But did it? And did Mortensen benefit in unseemly ways from the considerable donations that CAI managed to attract?

It is not clear at this point what exactly the truth is but a class-action suit has been filed that alleges fraud, deceit, breach of contract, racketeering, and unjust enrichment on the part of Mortensen and CAI.  See here for the gory details. The evidence that has emerged so far suggests that there is something to the accusations and that, at the minimum, Mortenson and CAI played fast and loose with the facts.

Whatever the evidence turns out to be, this affair is of the high-visibility kind and hence very likely to have already damaged the reputation of the not-for-profit sector in the USA as such; it has rightly generated more questions about the efficacy of the monitoring solutions that the not-for-profit sector in the USA adopted a few years back under the threat of legislative action. See here. I would be very surprised indeed if Senator Grassley — who back then single-handedly prodded the not-for-profit sector in the USA to take action — will not have some further questions to ask about this latest indication of the not-for-profit sector’s inability to monitor itself. And I am sure he will ask them very publicly.

It is, of course, an interesting question whether a similar development could take place in Australia. The Mercy Ministeries, albeit on a much smaller scale, is an example that, yes, it could. See here.

A set of recent experiments of colleagues in Australia further illustrates the potential for abuse well. In “Economic and Intrinsic Motivations for Dishonesty: An Experimental Study”, Friesen & Gangadharan, senior lecturer at the University of Queensland and professor at Monash University, respectively, conducted two incentivized lab experiments
with students. In their “Theft experiment”, their subjects were asked to find in given tables pairs of two-digit numbers that would add up to 100 and to then report anonymously how many of the 20 matrices they had been able to “solve” this way; their pay was the self-reported number of correct decisions and the pay was real cash provided by the experimenter. In their “Reporting experiment”, subjects were asked to make potentially hazardous “production decisions”. The probability of hazards could be reduced at a cost to the “producer” under conditions of compulsory and voluntary reporting of “accidents”.

(Before you read what the results were of those experiments, you might want to predict them.)

In the Theft experiment, one third of subjects took more money than they were entitled to; of that third, one quarter took all. In the Reporting experiment, nearly everybody was dishonest at some point. (Note that in the compulsory treatment that requires outright lies.) Less than ten percent of the subjects always reported an accident! Reporting occurred more often in the compulsory treatment than in the voluntary.

Dependent on your belief in human nature, these results may be surprising but they should, in any case, provide some food for thought: If in an environment where relatively little is at stake you see such massive cheating, what can you reasonably expect in an environment where lots is at stake and hence the temptation to misbehave is correspondingly so much greater?

Another interesting “experiment” was recently reported by the IRS of the USA which on June 2008 revoked summarily the tax-exempt status of no less than 275,000 nonprofits that failed to file reports for three years in a row. In numbers of existent entities that action shrunk the US Third Sector overnight by more than 20 percent. See here.  These numbers are truly stunning and illustrate the utter lack of accountability and transparency of the sector in the USA. I am almost certain that Senator Grassley will have many a question to ask about these developments. As well he should.

These developments also suggest that how important it is for the nonprofit, or third sector in the USA and Australia, to catch up with its attempts to become accountable and transparent so that developments like the ones mentioned at the outset cannot possibly happen again. The Australian Third Sector is not accountable and transparent and current discussions on how to change that sorry state of affairs are curiously uninformed by discussions and events elsewhere; it is particularly noteworthy that the changes currently discussed in Australia have quite some similarities with the failed US system of self-reporting and self-monitoring.

I have written about the problem of the lack of accountability and transparency of the not-for-profit sector in Australia, and the insufficient current attempts to reform it, elsewhere (e.g., here), so simply leave it at that for here and now.

Addressing Not-For-Profit Sector accountability and transparency

The Australian Third, or Civil Sector, is one of the largest industries in the country. According to a 2010 Productivity Commission (PC) report (see here) it consists currently of 600 000 not-for-profit organizations, of which the Australian Bureau of Statistics considers about 60 000 economically significant (e.g., employing paid staff, or otherwise a candidate for taxation). Over the past decade the sector’s contribution to GDP has doubled and it is currently estimated to be at least 4 percent per annum, i.e., well in excess of $40 billion. Nearly 5 million volunteers add an estimated $15 billion in unpaid work. The Third Sector is a key ingredient of civil society.

The Australian Third Sector is also covered by a pathetic hodgepodge of regulation. In the words of the PC, “the current regulatory framework for the sector is complex, lacks coherence, sufficient transparency, and is costly to NFPs [Not-for-Profits]” (PC 2010, XXIII) yet, the Australia does not have standards of recommended practices for charity accounting such as England or Wales, or New Zealand, or the USA and Western European countries for that matter. Fundraising is de facto unregulated. Essentially, donors and state have little idea what happens to the considerable amount of private or government donations (concessions). That’s not a way to instill public trust and confidence in a sector whose livelihood depends on it.

The problem has long been known and a sizable cottage industry has documented the lack of accountability and transparency of the Third Sector in Australia. Over the last 15 years (starting with the 1995 Industry Commission report) five significant federal inquiries have addressed the regulatory mess that the Third Sector represents, and dozens of talking heads — mostly lawyers, advocates, and bureaucrats — have given their opinion on literally thousands of pages of final and draft reports, thousands of submissions on the draft reports, transcripts of hearings, scoping reports (the latest one, drawing on the PC 2010 report, issued in January 2011, see here.

Apparently, to judge from a clip in the SMH this past weekend, the federal government is now determined to install a national not-for-profit regulator to cut the red tape in the sector: Labor, we learn, “will reportedly put aside $53.8 million over four years in Tuesday’s budget to establish the independent Australian Charities and Not-for-profits Commission from July 1 next year.” (see here)

Welcome news that is on the one hand.  One the other hand, I fear the problem of accountability and transparency of the Not-For-Profit Sector will not be solved this way. If other countries’ history is any guide, it will take some big scandals to focus the government and the sector on what it means to be accountable and transparent.

I see two key problems:

First, few seem to have a good understanding what exactly the purpose of regulatory reform in this area ought to be, and can be. A couple of weeks ago I attended yet another workshop organized by the Australian Centre for Philanthropy and Nonprofit Studies at QUT. It was telling that in the last of two days of sessions, the participants were scrambling to answer what seemed a naive, and maybe was meant to be a devilishly simple, question: why do we need regulation in the first place? It took a while for the – in other countries widely accepted
— answers to come forth: to promote public trust and confidence in the charitable sector, which requires that fundraising is done properly, that money is going to cause, that accountability and transparency are such that donors (private and public) can verify that money will be spend the way NFPs say it would be spent. The problem is, none of these things can be easily regulated. Partially because regulation that tries to ensure these kind of things needs enforcement which is expensive. Very expensive indeed.

Second, few — specifically the dozens of talking heads that dominate the debate currently — seem to have a good understanding of available working models. Much of the focus seems to be on the Anglo-American model but this model — based as it is on obligatory annual (self-) reporting — is known to have its share of problems and will, in any case, take years to be implemented here. What, unfortunately, continues to be ignored in the Australian discussion are the very effective certification agencies that exist in a number of West-European countries such as Germany, the Netherlands, Switzerland, or Austria. In all these countries,
(self-) reporting requirements are way behind those in, say, the England, or the USA. Yet, these certification agencies have been rather successful in generating public trust and confidence in the sector, or at least its nationally working flagships (which albeit representing typically 5 percent of the sectoral firms account for more than 8o percent of assets and revenues. Importantly, most of these certification agencies make due with surprisingly small budgets. Shoe-string budgets indeed of a couple of millions at most of which typically at most a third comes from Public subsidies. Yet another interesting example is the New Zealand Charities Commission which — having been established only in mid-2005 — has within a couple of years managed to establish a Charities Register which has 24/7 up-to-date information on more than 25,500 registered charities (see http://www.charities.govt.nz) and which is moving towards a model that through its actions (e.g., complaints forms on its website) quickly towards a model that seems to draw on some of the lessons that can be learned from the certification agencies in Europe.

So, while it is commendable that the federal government does something, the way it apparently wants to go about reforming the Not-For-Profit Sector seems ill-advised, wasteful, and predictably ineffective. It is a policy that seems not based on the considerable evidence that is out there on available alternatives, and ultimately insights from economics about the incentive incompatibility of self-report mechanisms.

The Wallis Report, the Cooper Review, and the limitations of Behavioral Economics

In a recent special session on Superannuation at the Australian Conference of Economists, David Gruen — an economist working for the Australian Treasury and one of the authors of the Cooper Review (see here) reflected on the intellectual paradigm shift that informed its deliberations and recommendations (see here). Continue reading “The Wallis Report, the Cooper Review, and the limitations of Behavioral Economics”