The Auditor-General says the state government has hoarded hundreds of millions in funding budgeted for the early childhood sector, while high fees keep many families from sending their kids to childcare or preschool.
The opposition says that means disadvantaged children who would benefit the most from early childhood education are the ones most likely to miss out.
The Auditor-General's report, released on Thursday, says that in the four years up to 2014-2015, the government spent $350 million less than was budgeted for early childhood education, including holding back $227 million in funds received from the federal government.
Meanwhile, in 2015, only 77 per cent of children in the year before school were enrolled in the minimum standard of 600 hours of early childhood education (15 hours per week), well short of the government benchmark of 95 per cent. The report blames poor targeting of funding.
NSW childcare and preschool fees are the highest in the country, where the government invests less in early childhood education than any other state: $202 per child, compared to $357 in Victoria, $598 in Tasmania and $644 in South Australia, according to the Productivity Commission.
Labor's early childhood education spokeswoman, Kate Washington, said the Auditor-General's report was "damning".
"Seeing that 77 per cent of kids only in NSW are accessing 15 hours or more of preschool each week, which is well below every other state and territory in Australia, and far below the benchmark. We know it comes down to the basic thing that preschool and long-day-care fees are the highest of any other state or territory, and that's due to the lack of government investment in early childhood education.
"The government has underspent its own budget money for the past four years by $350 million ... Why aren't they spending the money they've budgeted so they can start addressing the problem that has been identified in this report?"
Minister for Early Childhood Education Leslie Williams said early childhood sector spending had increased over the past three years by 14.5 per cent, and blamed federal government funding uncertainty for the unspent allocation.
"Differences between the budget and forecast are due to the timing and variations of Commonwealth National Partnership funding paid to the state," she said in a statement.
"The Auditor-General's report confirms that reforms delivered by the NSW Government have resulted in improvements – however we recognise there is still more to do."
Leanne Gibbs from the Community Childcare Co-operative said there is a wealth of evidence that shows participation in early childhood education improves wellbeing and life outcomes across the board more than almost any other single factor, and NSW was bucking international trends in not investing heavily in it.
"It's one of those things that everybody agrees on that it's essential and imperative," she says. "What we really need to change the performance they're identifying is more money from the NSW government. That would take the fees down ... which would then provide greater access for children."
There were some improvements: in 2015, 99 per cent of children in the year before school were enrolled in some type of education program, up from 82 per cent in 2013. And the number of disadvantaged children enrolled also increased from 18,125 in 2013 to 24,214 in 2015.
The Department of Education said many of the report's recommendations were already under way including a new community preschool funding model and a $40 million investment in long-day-care services targeted to children with greater needs.
States are responsible for preschools funding and the federal government for funding long day care and other childcare through family and centre subsidies. In 2015, 62 per cent of early childhood education enrolments in NSW were in long day care.
The report slammed the federal government for acting as an "impediment" to improving the system, given its funding "has been short-term, often received late, and difficult to predict in advance".
