How is it that the ACT Government can sell buildings and other assets to the private sector, lease them back and be better off? If the Government is better off, how can the private sector make a profit? And if the private sector can make a profit by owning and leasing the buildings, why is it not possible for the public sector to do the same thing? Alternatively, Why not just raise a loan, rather than flog off the silver?
On its face, selling and leasing back does not make sense. Either the ACT Government is just pulling a swifty by selling the family silver to pay the grocery bill or the private sector is being taken for a ride.
But there is another element to this story. It was referred to by the Under-Treasurer, Mick Lilley, during Estimates Committee hearings last week. The crucial element is the effect of federal income and company tax on the private-sector entities that buy the assets and lease them back.
A crude, hypothetical example, illustrates what happens. Assume an interest rate of 10 per cent. The ACT Government sells a $100 million building to XYZ Ltd and leases it back for $7 million. This gains it $10 million a year in interest. So the ACT Government is $3 million up. XYZ Ltd borrows the $100m at a cost of $10 a year. It receives rent of $7 million a year. But its $10 million interest bill is tax deductible, so it gets $4 million a year from the Federal Government. That leaves it with a profit of $1 million a year.
The overall result is that the private sector gets a $1 million a year profit and the overall public sector (ACT profit less Federal loss) gets a $1 million a year loss. Differences in interest rates, changes to out-goings and other details do not change the fundamental picture. In short, every time the ACT Government does an asset sale and lease back it is cost shifting to the Federal Government and giving the private sector some profit.
There may be some incidental gains because the private sector can generally manage assets better than the public sector, but that need not necessarily be the case.
It is very sharp practice by the ACT Government and in the short-term makes sense and money for the people of the ACT. But the Federal Government is not going to put up with this indefinitely. It will simply reduce the amount it grants to the ACT by the amount it is losing in tax by the ACT’s privatisations.
This is another example of the deep strife our tax system is getting into.
There are several major defects.
One is that the Feds raise much more than they spend and the states do not raise enough of what they spend. So the states are dependent on the Feds for grants and do not have to wear the full political responsibility for raising revenue.
The boffins call this “”vertical fiscal imbalance”.
It results in states cost shifting to the Feds. In health, for example, they make emergency departments hell-holes so people go to their GP and the Feds pick up the tab through Medicare. They restrict hospital pharmacy services so people have to go outside and the Pharmaceutical Benefits Scheme picks up the tab.
Another problem is competitive federalism. When one state cuts a tax the others have to follow or lose all the business to the low-tax state. This means state tax bases are too narrow. So is the Feds tax base. It means we tax too few things. As a result the tax on any individual transaction tends to be high, so high that it is worth avoiding.
(Incidentally, the ACT’s $100 million is small beer compared to the tax implications elsewhere. The privatisation of Telstra has a huge hidden tax cost if the companies and individuals who buy shares borrow the money, as is likely, and claim tax deductions against the interest. But that is another story.)
Accrual accounting is supposed to show the true costs of everything government does, but the system shows only direct-cause, calculable costs to the ACT’s coffers. It does not show costs to the Federal Government purse which in the long-term will result in lower federal grants. Nor does accrual accounting assess long-term costs in the community at wide which in turn might affect government costs.
For example, tobacco and gambling provide good sources of revenue which would tend to make governments reluctant to discourage the activity being taxed. That has certainly been true in Victoria recently. The long term costs of gambling is not accounted for.
Conversely, accrual accounting (or indeed any accounting) does not and cannot show the long-term gains of certain spending … say on pure research, education, roads and so on. Moreover as the gains might be mostly to people outside government … people getting services … and they do not have a direct benefit to the government bottom line, those gains can be ignored by policy makers dependent on accrual accounting alone.
Any form of government accounting is bound to have deficiencies, particularly as the government and non-government sectors are so intertwined. The danger of accrual accounting in isolating the actual economic cost of everything government does, is that it might ignore uncertain long-term gains from today’s spending. It is a valuable tool to work out costs of some things that might otherwise go unnoticed. But it should be a slave not a master.
The ACT’s $100 asset sale and lease-back plan, however, indicates the contrary. Sure, the ACT Government is making a profit. But is anyone better off other than the new owner of the asset who is milking the Feds with a tax deduction?