Slaughtering The Cash Cow


The business of NSW Lotteries Corporation is up for sale at arguably the worst time in decades to privatise any government agency, let alone one that is a cash cow.

Few would argue that selling gambling products is a core function of government. Then again, history shows that voters have been happy to buy government-issued lottery tickets in the knowledge that profits would be spent on hospitals or on visionary infrastructure like the Sydney Opera House.

Last financial year, NSW Lotteries generated profits before notional tax of around $56 million, but that is not the whole story. It also paid "tax equivalents" of $13 million plus $307 million in gaming duty to the NSW Treasury. Last year’s audited accounts report total cash payments to the consolidated fund of $356 million.

The plan is for government to continue to receive the gaming duties, which is supposed to reassure the public that this largest segment of the revenue from Lotteries continues to flow. Yet the question arises: will the rate of gaming duties remain at least at the current level? One way for NSW Treasury to sweeten the deal for potential purchasers — and to increase the headline price — would be to commit to reducing the rates of gaming taxes in future years. At a minimum, a purchaser of NSW Lotteries would want to be assured that the gambling taxes would not increase — and would prefer they were quietly reduced in a year or so. The documentation on this topic will no doubt be drafted very carefully.

Even if the NSW Government retains revenues from duties on lottery products, the sale price would have to be hefty to compensate for the loss of a stable cash flow for the next 30 years (the term of the proposed sale). One thing seems clear: whatever can be raised from a sale in 2009 is likely to be about half of what could have been raised before the global financial crisis.

The main theme of many commentaries on current proposals to sell NSW government assets is that the Government needs cash to fill a hole in its budget — a hole that has supposedly opened up because of the need to spend heavily on infrastructure, a need which has (supposedly) only just been recognised now.

Yet such observations overlook the fact that Australian governments no longer prepare budgets and report their financial results on a cash basis. Rather, they prepare budgets and record financial results on an "accrual" basis.

In broad terms, under accrual accounting the privatisation of government businesses would involve the substitution of one asset (the business) in exchange for another asset (cash).

If the proceeds from sale of an asset were equal to its value on the Government’s books, the sale would have no impact on projected budget results. In practice, however, the Government’s books reflect the values of individual assets and liabilities, and don’t attempt to value these assets as "businesses". So it may well be that sale proceeds would exceed book values. Hence the difference between sale proceeds and net assets could be reported as a profit on sale, which could then correctly be recorded as part of the budget results.

This may provide a clue to the real rationale for the planned sale of NSW Lotteries — and other NSW proposals for the sale of rights to trade in electricity or to operate prisons.

The latest balance sheet of NSW Lotteries Corporation shows net assets of $59 million. Of total assets of $297 million, cash and financial assets amount to $224 million while liabilities of $238 million include $75 million in unclaimed prizes. Once sold, surplus cash could be stripped from the corporation leaving it in work out mode (until unclaimed prizes can be passed over to Treasury as unclaimed moneys). The main assets to be sold with the lottery business would be computer equipment and software, currently in the books at a modest $14 million. So the rest — virtually the whole of any sale proceeds — could be booked as a gain for the general government sector.

Had the Iemma Government sold the State’s electricity assets, as it had proposed last year, then there would have been a different accounting result. The property, plant and equipment of the three generators (Eraring, Macquarie, and Delta) were in the books at June 2007 at $6.7 billion. The three distributors (Energy Australia, Integral and Country Energy) held infrastructure assets with a book value of $12.7 billion (some of which were to be retained). There were suggestions that the likely sale proceeds would be $20 billion. Then it was $15 billion, and falling. If the electricity privatisation had been "successful" (if that is the right word for the sale of assets providing basic services to the community) then the likely surplus against book value would have been minimal. Indeed, if sale proceeds had been less than book value, they could have contributed to a recorded budget deficit.

Which brings us to the Rees Government’s "Plan B". The Iemma proposals to sell electricity infrastructure assets were opposed by a reported 84 per cent of the electorate. The latest plan is to sell "trading rights" over the electricity generated by the state-owned generators. Since those "trading rights" have never before been counted as an asset of government, the transaction is likely to produce an accounting gain that could be treated as improving the budget result.

This suggests that the latest privatisation plans have more to do with cosmetic accounting and efforts to "manage" budget results than with a hard-nosed assessment of priorities. Of course, this is nothing new (recall the Greiner government’s efforts to manage budget results via a series of "special dividends" from Sydney Water in the 1990s).

But why try to manage budget results in this way? The economy is experiencing reduced growth. In times like this, there’s nothing wrong with a budget deficit, particularly if government borrows to invest in infrastructure.

Any argument that the state needs to sell assets to produce a budget surplus in order to preserve the state’s AAA credit rating should be disregarded on several grounds. The financial impact on the state of a downgrade would be minimal. Voters are treating these arguments with greater scepticism — after all, a downgrade hasn’t prevented Queensland’s Bligh Government from being re-elected. Credit rating agencies are somewhat discredited after their track record in giving AAA ratings to thousands of packages of subprime loans and CDOs.

But there are also technical reasons to be sceptical about the Government’s strategy. Most finance professionals would agree that investment risk is closely associated with volatility of cash flows. If the NSW Government sells off its electricity or lottery businesses it would mean a loss of stable revenue streams and would make the state more dependent on volatile stamp duties from property sales.

Of course, asset sales might prop up the budget in the short term, on an accounting basis. Treasurer Eric Roozendaal is on the record as stating that the proceeds will be spent on "front line services". That sounds suspiciously like spending on recurrent expenditure, not capital works. And it raises the question of where will the money come from in subsequent years.

If the NSW Lotteries business is sold, then the state will have lost revenues currently at around $60 million per annum, and maybe more. Meanwhile, many people are asking: why don’t we have another Opera House-type lottery to fund investment in a metro system?

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