Saturday, 26 August 2017

Federal Group stitches up a deal?

The Joint Select Committee inquiry into Future Gaming Markets recently received a joint proposal from the Tasmanian Hospitality Association and the Federal Group and heard evidence from the two parties.

The proposal highlights most of the economic and financial issues at stake for the inquiry. The following note was submitted to assist the Committee in its important deliberations.

The proposal will perpetuate existing bad public policy. Benefits will accrue to the few existing participants in proportion to the benefits they have already received over the last 20 years. As a way of assisting businesses to grow it is poorly targeted. Allocating perpetual licenses to existing venues for nil consideration will not only give a windfall gain to a privileged few with unsubstantiated  benefits for the wider community, but will tie the hand of future governments if ever they feel a need to make changes.


The end of the monopoly?

The proposal is trumpeted as an end to the monopoly, but in reality it represents only a slight change in the split of the spoils of the government protected gaming business in Tasmania.

The Federal Group has a monopoly gaming license in the State. There are three distinct parts to Tasmania’s gaming business:

·       The monopoly casino operations with EGMs Keno and table gaming.

·       The venues which operate in the community including Federal Group’s Vantage Hotels comprising twelve top performing pubs. Gaming grew after 1997 when the Federal Group extended the reach of EGMs into the community. It needed hotels and clubs as partners. Consequently while casino operations are a monopoly, the EGM industry outside casinos is more akin to an oligopoly, with multiple participants. There are barriers to entry erected by government which determines the numbers of EGMs. The government also determines prices, in this case how much players lose. For all intents and purposes it’s a cosy oligopoly.

·       The monopoly Network Gaming business (part of the Federal Group) which receives all the revenue from EGMs and Keno in the community, pays commission to venues with EGMs and Keno including Federal’s Vantage Hotels, and also monitors and reports all gambling as required to the government.

The dilemma facing the Federal Group is that while there are considerable monopoly profits in Network Gaming, it was one area vulnerable to a competitor if the government opted for a tender process for network operations. The Federal Group was also under pressure from THA and other members of the oligopoly for a greater share of EGM profits for hotels and clubs. Monopoly profits give businesses value but with the exclusive license due to expire as early as 2023 Network Gaming was facing the possible loss of most of its value. A purpose built computer system with no license has little value. The better performing EGM hotels also rely on gaming to underwrite the capital value of their businesses. They too were looking at reduced values as 2023 approached.

It has therefore been proposed to shift most of the profits from Network Gaming either to the two casinos owned by the Federal Group or to hotels and clubs where the Group has a significant interest.  The shift of profits to casinos is a double shift arrangement requiring the government to accept more EGM taxes from hotels in return for cutting EGM taxes in casinos. The major stakeholders, the players themselves, were ignored.

The THA/ Federal Group proposal will see:

·       A continuation of the casino monopoly with higher profits as a consequence of lower EGM taxes.

·       A continuation of the oligopoly for EGMs outside casinos with higher profits shifted from Network Gaming and windfall capital gains as a consequent of perpetual licenses being granted for each venue for nil consideration.

·       The scaling down of Network Gaming. The monopoly profits will be shifted either to the EGM hotel oligopoly where the parent Federal Group is a leading member, or to the latter’s EGM operations in casinos. Network Gaming will provide the network services for EGM monitoring in hotels and will continue to run the monopoly Keno operation.

The Federal Group will continue as the major player in the State’s gambling industry but with a slightly different share.  With THA as a de facto partner it would be pointless for other network providers to tender for the job as network operator even if the government decided it was the preferred path. The suggested network charges set out in the proposal appear to be roughly what a competitive market may charge. This effectively shuts out possible competitors.

The current oligopoly will be strengthened.  Competition post 2023 will be non-price faux competition, like free buses for residents of old persons’ homes and other so called loyalty programs.  

The community concern about the monopoly is not about the monopoly per se but the excess profits protected by government fiat which accrue to a few following a back-room deal when the community were denied access and participation in the division of spoils amongst those few.

The current proposal does nothing to address this concern. Whilst paraded as an end to the gaming monopoly it’s just a slight rearrangement of the existing set-up. The suggestion that the supposed end of a monopoly will lead to better outcomes is largely a bogus claim.  The EGM industry in pubs is, and will continue to be, a government protected privileged oligopoly.

What is the proposed deal for EGMs in hotels and clubs?

Currently EGM player losses are split as follows: Federal Group via Network Gaming 31 per cent, commission to pubs and clubs 30 per cent, tax to the government 30 per cent and GST 9 per cent.

The proposed split is: Federal Group nil, pubs and clubs 51 per cent, the government 40 per cent and GST 9 per cent.

Network Gaming will receive $1.7 million from pubs and clubs to monitor and report to government.

On 2015/16 figures this means Network Gaming will forego $33 million. Federal Group will however benefit from the extra share to the Vantage Group which ensnare about a quarter of hotel and club EGM losses. Furthermore the proposal will reduce EGM taxes in casinos and casino license fees.

Overall the Federal Group will be about $15 million worse off. This reconciles with the figure given to the Committee by Federal Group’s CEO.

Will the government be better off?

No. It will gain from increased EGM taxes in pubs and clubs, lose from reduced EGM taxes and license fees in casinos, but gain from an annual license fee for each EGM of $1000 which is much higher than current fees levied by TLGC.

Overall the government will be in the same position, assuming compliance costs by the Tasmanian Liquor and Gaming Commission don’t increase. They certainly won’t fall with licenses at the venue level. How much they rise is uncertain at this stage.

The players’ position?

Players drew the short straw. There were no proposals to change the house percentage or any other parameters which help determine player losses. Players remain in the same position as those around them haggle over the booty so generously provided. 

Pubs and clubs?

Pubs and clubs will gain an extra 21% of losses which in 2015/16 terms means $24 million. However pubs and clubs will pay an increased annual license fee per EGM to the government and a monitoring fee of $730 per EGM per annum to Network Gaming. This will leave pubs and clubs, $20 million better off. Of this figure about $15 million will accrue to pubs and clubs outside the Federal Group. This latter figure is equal to Federal Group’s reduced annual share.

That’s it in a nutshell, a rearrangement of the oligopoly with pubs and clubs getting a bigger split of the pie post 2023 worth about $15 million pa.

Venue licenses

The joint proponents argued that a tender to allocate licenses “would be very costly and generate considerable uncertainty and massive disruption for all stakeholders”, and instead proposed that existing venue operators be gifted licenses for the post 2023 period.

To spare the community the trauma and expense of a market based solution the proponents have agreed that perpetual licenses be allocated to existing venues.

Should that occur, as we have already noted, pubs and clubs other than those owned by the Federal Group will be better off by $15 million per year. Add in Federal Group’s hotels will give a figure of $20 million per year in extra profits for EGM hotels and clubs. There’s a rough rule of thumb used to value hotels. One dollar on the bottom line will enhance the value of a hotel by seven to eight dollars. Hence an extra $20 million will increase the value of hotels across the State by $150 million. The proposal mentions the average EGM hotel will receive a $1.5 million windfall gain if licenses at the venue level are bestowed. With approximately 100 venues that’s $150 million. That’s the rule of thumb at work, increase profitability by $20 million each year and the value of businesses will increase by $150 million.

It must be stressed the figure of $1.5 million per venue is an average figure. The figure will vary across venues depending on player losses. For example the top performing EGM pub in Glenorchy will receive a windfall gain of probably $4 million via increased capital value of its business. The Dover RSL Club on the other hand will show a minimal increase. The Federal Group will receive an estimated 25 per cent of the statewide windfall of $150 million, other multi venue owners like the Woolworth owned ALH Group, and local groups including the Goodstone Group, Dixon Hotel Group, Kalis Group and the Prescott-Hibberd Group will share 50 per cent of the windfall, while the remaining 25 per cent will go to individual, mostly smaller operators.

The issue at stake here is whether allocating windfall gains to those at the head of the queue is the best public policy approach. Furthermore should those who benefit most from the current arrangement receive the proportionately highest windfall gain? We are not talking about compensation to those affected by an adverse government decision. We are talking about a brand new post 2023 arrangement to replace an agreement due to expire. It’s all very well to minimise transitional costs but should participants receive a windfall gain? Of that magnitude?  The point of a tender is to ensure the benefits of a license would be valued by the market and the sale value would be received by the government on behalf of the community. Federal Group/THA argue gifting licenses to existing EGM hotels and club is a superior way of allocating resources:

“.... this will allow them to make further investments in their businesses.  These investments would have a positive impact on the communities in which these hotels and clubs operate, especially in regional areas that badly need new investments, increased economic activity and jobs.”

There may a possible grain of truth in the argument. It may happen as they say. But it may not.  Even if it does it’s not the optimal solution. The 2003 sole license agreement was predicated on the Federal Group investing in Tasmanian tourism and benefiting the community in much the same way as the current proposal expects. But most of the benefits of that license have been used to buy existing pubs and a bottle shop chain and pay large dividends to interstate shareholders. Even the mandated Saffire project required only six months’ worth of the Group’s cash surpluses. It wasn’t a payment to government for the exclusive license. Federal Hotels still owns Saffire. So will hotels spend as they say? How have they spent EGM profits over the past 20 years? What’s to stop them selling their business, cashing in the windfall gains and requiring the purchaser of the business to use the increased share of player losses to pay the bank loan needed to buy the business rather than invest in improving the business? At best it’s a hit and miss public policy approach. At worst it’s a shameless grab for a handout.

Federal Hotels’ twelve EGM hotels in the Vantage Group will be ripe for sale if perpetual EGM licenses became a reality. The last three additions to the stable have cost over $40 million in total, which when combined with the other nine plus the mooted windfall gain from individual venue licenses means the pubs will be worth $200 million. Without EGMs the value would be around $60 million. It must be remembered the Federal Group owns only one quarter of EGM pubs on a value basis. That gives some idea of what the current battle to win the hearts and minds of government is really about. The government can hardly insist, as a pre condition, the Federal Group not sell its hotels thus preventing it from riding off into the sunset with saddlebags stuffed with proceeds from cashing the windfall gains?

Wouldn’t it be better for the government to extract more in taxes each year and directly target where assistance may be required?  To tourism infrastructure maybe? Drysdale training? To benefit other businesses including non-EGM hospitality businesses?  To other government services starved of cash? There is absolutely no basis for pretending as the proposal does, that the best way forward for communities is to provide windfall gains to EGM operators so they may invest in their businesses.

The Federal Group expressed a view on this matter in its 1993 submission to the LegCo inquiry into extending EGMs into the community.

Claims of substantial economic benefits through the development of expanded facilities in hotels and clubs may be overstated. It is generally acknowledged that Tasmania is over supplied with licensed premises. In this situation, revenue from machine gaming in many instances would be applied to debt reduction or hoteliers’ profits rather than improved facilities...”

One aspect of the proposal to allocate licenses to individual venues is that they be perpetual licenses. To allocate perpetual licenses resulting in large windfall gains to existing proprietors for nil consideration, and expose the government to pay future compensation if altered policy affects the profits of license holders would be reckless public policy.

Asserting the grant of perpetual licenses will unleash a new round of investment in new facilities reflects a naive view. What occurs when a new asset is created like a perpetual license is that financiers and investors will be attracted by the lure of making returns from a license protected by government. Take the case of taxi licenses. Once upon a time a taxi license was a permit to drive a taxi. Over time a separate taxi license was created and a system of license holders, operators and drivers evolved. License holders, often absentee investors, gradually took an increasing share of taxi revenue at the expense of operators, drivers and consumers. This made the taxi industry vulnerable to an alternative model like Uber. What will happen if perpetual licenses are granted to EGM venues is the value of hotels will be placed out of reach of smaller operators. A system where gaming operations in venues will be leased out to larger gaming operators is a distinct possibility. License holders will want a return on their investment just as taxi license owners have done, to the detriment of consumers and communities. It’s fanciful to assert that all license holders will plough their returns back into the community. There’s no evidence from past practices across industries that this is likely to occur.

Guiding principle five put forward by the government states the “duration of any license should be commensurate with among other things the level of investment necessary to underpin the delivery of the gaming operation.” We are currently over the post 2023 EGM cap in number terms, hence no further investment is required for gaming operations and any maintenance or enhancements can surely be funded from ordinary profits, just like any other activity for any other business.  The government’s guiding principle provides no support for giving licenses for nil consideration in the hope license holders may invest and grow their businesses. The proposal is public policy nonsense.

Employment aspects

The afore mentioned 1993 Federal Group submission to the LegCo inquiry also set out a case study of EGMs in the two casinos. The wage component for EGM operations was 5.53% of player losses. This assumed the house percentage from EGMs was 15 per cent. Currently the house percentage is 10 per cent. Adjusting for this gives a current wage component of 8.3 per cent of player losses. This is similar to the figure of 7 per cent in a previous submission by the writer and by the Dixon Hotel Group. Given the 2016 player loss figure from EGMs in pubs and clubs was $114 million this means the number of FTEs involved in gaming in pubs and clubs is around 200. Of course employees carry out a multitude of tasks, but the specific gaming wage component is only around 7 to 8 per cent of player losses

The THA was asked about the employment effects should EGMs be removed from hotels and clubs. The answer was a loss of 1,000 jobs.  Presumably this means 1,000 FTEs and includes Federal Group pubs. That’s what a THA member’s survey found. Ignoring the possibility that such a survey lacked scientific rigour where answers tend to be skewed when responders’ livelihoods are under threat, which jobs will go? For starters the 200 gaming FTEs. That leaves 800 others. From the food and bar areas ? Can’t be from anywhere else? If FTE wages are $40k per year that’s $32 million less wages in hotels’ food and bar departments. In the bar area wages are around 20 per cent of turnover and for food about 35 per cent. Let’s say 30 per cent average across the two departments. Applying this percentage, a loss of wages of $32 million implies reduced food and bar revenue of $106 million.  The high risk and problem gamblers contribute almost half the EGM losses but little in the way of extra food and bar sales. On the other hand the low risk social gamblers spend a lot more on food and drink compared to their gambling outlays. So for the loss of 1,000 jobs to be valid, the latter category of players would need to cease patronising hotels. Where will they eat and drink? What will they do with the extra cash? Spend it elsewhere? Hide it under the bed?  In addition aren’t there patrons who might return to hotels if EGMs are removed? Peter Hoult for one gave evidence on the 15th Feb he doesn’t go to pubs with pokies. There’s bound to be others.

There’s no evidence that the job losses from changes to EGMs in hotels, resulting from either increasing the tax rates or transitioning them out of communities, will be as catastrophic as the claims from those operators who will be most affected have suggested. Of course there will be adjustments problems particularly by those with disproportionately high level of gaming revenue who have benefited most from the current arrangements. If change of any description is ruled out because those who will benefit most from the status quo may be affected, we would never see any change. Ever. Weren’t there adjustment problems for non EGM businesses when EGMs were first introduced into the community?

The industry knows much more about employment than it has so far admitted. The committee endeavoured to get more details of Federal Group’s EGM employment numbers but were fobbed off by the Group’s Dr Hanna who proffered the disingenuous explanation that Deloitte’s modelling did not provide sufficient breakdown to be able to answer the question. Regardless of what Deloitte may have fed into its model which is based on ABS statistical categories which businesses don’t use as part of their management systems, every hotel owner knows employment numbers in each department in each venue. It’s basic management accounting information.  Deloitte took management information from Federal Group, fed into a model based on ABS statistical groups and when asked about the original data Dr Hanna in effect said the model only provided aggregate information. It was a gobsmacking answer. The dog ate his homework.

Gambling taxes generally

The writer has previously raised the need to be clear about the rationale for gambling taxes, whether to raise government revenue (arguably it isn’t) or for distributional reasons, for example to redistribute excess profits and windfall gains back to the community. When analysing the appropriateness of taxes it is useful to have some understanding of tax theory particularly the concept of tax incidence and also the broader public policy principle of horizontal equity.

Legal versus economic incidence

This is essentially the difference between who pays a tax and who actually bears the cost. The two sometimes coincide, but often they don’t.

GST for instance is paid by most businesses. It’s a legal requirement. The legal incidence of the GST falls on business shoulders. But the real burden of the tax falls on the final consumer. This is the economic incidence. This may appear little more than a question of semantics but it is important when arguing for or justifying a particular tax.

EGM taxes are similar. The Federal Group is the legal taxpayer, but the burden of the tax is with the player. The gambling industry needs to give up the pretence it pays gambling taxes. The players do. The economic reality is that the government provides a highly protected environment to conduct gambling operations and allows the industry to retain most of the player losses. The industry maintains gambling taxes are an impost. This is wrong. They are a benefit bestowed on venues by governments.

Businesses are mere agents for the collection of GST. It is not theirs. Similarly the gambling industry members are agents for the government/community in respect of gambling losses. It’s not a question of how much they pay but rather how much the government allows them to retain.  The question as to how much they retain should, in part at least, be decided by the principle of horizontal equity.

Horizontal equity

The principle of horizontal equity requires similarly situated individuals to be treated equitably. Not equally but equitably. If one sector of the hospitality industry has been provided a highly protected environment to operate it gets preferential treatment compared to another operating outside the protected zone where market forces will differ. One cannot treat the two equally because they operate in different areas but one can treat them equitably. That’s why a market based solution was proposed by the government to bring a bit of equity back into the system, which Federal Group/THA now propose to sidestep, ostensibly to avoid costs and hassles.

Horizontal equity is for all intents and purposes the same as the level playing field concept which one often encounters in public policy discussions.

The principle of horizontal equity is also relevant when assessing whether EGM tax rates in casinos should be less, whether the casino EGM operator should pay the Community Support Levy (CSL) and whether the tax rate on Keno should be so much less than the tax on EGMs.

Horizontal equity is a useful starting point when assessing competing proposals. A government may choose to depart from a rigorous application of horizontal equity, for example, if it perceives there may be skill or knowledge spill over effects into the rest of the economy. This doesn’t occur with gambling as others have testified. It displaces existing activity and generates less employment than most other business activity. It’s made worse in the Tasmanian case because of the large leakage of profits via dividends to interstate shareholders.

There hasn’t been any evidence of which the writer is aware that gambling deserves special treatment because of the extra benefits it brings compared to other activities.

Ironically Anglicare and others who wish to see EGMs removed, implicitly adopt the horizontal equity approach. As they submitted in evidence, they view spill over effects as negative, with social costs exceeding economic benefits, so rather than give the EGM industry extra support, government endorsement and protection should be withdrawn.

Using a yardstick is essential when judging different proposals. How else is it possible to compare the various assertions?

Hypothecation and the CSL

Federal Group’s CEO doesn’t recognise the CSL as a separate impost but rather a hypothecation of gambling taxes by government. The CSL for pubs is not a levy per se but rather extra tax payable by pubs compared to casinos. Governments can deem any amount it wishes as a separate levy. This argument was advanced when the CEO was justifying why casinos shouldn’t have to pay the CSL even though it’s locals who incur almost all the losses.

The CEO has a point about hypothecation. The CSL is in reality a tax. However horizontal equity deems casinos should pay the same rate as hotels. The Federal Group CEO argued for lower EGM taxes in casinos so as to align them with other regional casinos in Australia thereby making them competitive nationally. Yet the Tourism Industry Council of Tasmania was unequivocal in evidence to the inquiry there is no link between gambling and visitation to Tasmania. It’s questionable whether horizontal equity should be interpreted as narrowly as Federal Group’s CEO has done, to mean all casino EGMs pay the same rate of tax across Australia or whether it should be interpreted to mean casino EGMs should pay the same amount of tax as hotel EGMs throughout Tasmania leaving both treated equitably compared to all other hospitality operators in Tasmania.  The government’s woolly guiding principles and proposed policy positions are of no assistance.

The views of Federal Group CEO given in his verbal submission suggesting the CSL was a hypothecation rather than a separate levy appeared to be contradicted by the written proposal which supports a continuation of the CSL derived from hotel EGM losses only. If it’s a hypothecation by government and not a separate levy why is the Federal Group/THA trying to tell the government how to spend the money? It’s been a long running bone of contention with the THA’s General Manager that some local governments want EGMs removed from their areas yet welcome spending pursuant to the CSL. It’s seen as hypocritical. With a better understanding of tax theory the THA might appreciate CSL spending comes from the pockets of punters not industry. Rather than erect a plaque in the local sports ground to celebrate the generosity of industry, it is just as easy to argue the plaque inscription should offer an apology to the community as the facility was all that could be afforded from the miserable two per cent returned to the community from the CSL.

The end of the tender process?

If the joint proposal gains favour there won’t be enough room in the small Tasmanian market for another network provider to monitor EGMs in competition with Network Gaming and hence a tender process is pointless.

Furthermore there’ll be no need to tender licenses at the individual venue level as all venues will take up the licenses if offered.

Hence the hotel oligopoly and the casino monopoly will be able to keep secret full details of the profitability of their government protected EGM operations. However some details have come to light. The wage component of gambling is quite low compared to other areas of hospitality. The network cost to monitor and report EGM transactions is only $730 per EGM per year which is why the Federal Group was able to surrender some of its excess profits. Keno monitoring costs must be even lower and given there are far fewer Keno terminals than EGM machines and a considerably lower tax rate,  the profits from Keno must be significant. Why shouldn’t the principle of horizontal equity apply? It’s a government sanctioned monopoly acquired for nil consideration?

Rather than signalling an end to a monopoly, the proposal is simply a reorganisation of the existing arrangements. The Federal Group will continue as part of the arrangement but with a different share. It will remain as the largest hotel owner and as provider of network services via its subsidiary Network Gaming. The proposal will see the continuation of existing Keno arrangements, a lowly taxed, highly profitable monopoly which like the fabled goose continues to lay golden eggs.

The proposal is a business as usual plan. It represents bad public policy.
(Disclosure: The writer has an interest in a tourism venue with EGMs)

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