Home Economics, Not Politics: A Regulatory Roadmap for the 21st Century

Economics, Not Politics: A Regulatory Roadmap for the 21st Century

Thirty-three years ago, I began full-time research into the regulation and impacts of legal casino gaming, a pursuit that continues through the present day with no end in sight. One of the first people I met with way back in the winter of 1982 was New Jersey Casino Control Commissioner Martin Danziger, a veteran federal regulator and astute observer of regulatory practices and trends in various industries.

It was the dawn of gaming regulation, as New Jersey was in the process of building a regulatory system and Nevada was working toward developing a regulatory system to oversee what had largely been an under-regulated industry up until that time.

Danziger warned of what he viewed as an inevitable evolution: Regulators and the regulated would grow closer together, to the point where the regulators would grow fiercely protective of the industry that they oversaw.

He saw this as both inevitable and bad, inimical to the public interest. That was 33 years ago. We now know two things:

He was absolutely right. It was inevitable, and it has occurred.
He was absolutely wrong. It is not inimical to the public interest.
At the time he made those remarks, and at the time I began my life’s work as a student of gaming regulation and impacts, the world was different. Today, it is taken for granted that gaming licensees—both operators and suppliers—have met stringent tests to demonstrate their good character, honesty and integrity.

Today, it is taken for granted that gaming companies could reach out to Wall Street and the financial community to attract affordable capital investment.

Neither of those were true back then. Virtually every gaming licensee in the United States—at the individual and corporate level—has demonstrated the requisite level of suitability. Both regulators and investors know this and have adopted a higher comfort level as a result.

That higher comfort level means that a variety of requirements once viewed as essential and immutable is neither. Once upon a time, every gaming and non-gaming employee had to be licensed, as did every gaming and non-gaming supplier. That is no longer necessary.

But what of the issue of regulators becoming defenders of the industry? Why is that not a major cause of concern?

I submit that what has occurred is a confluence of interests. Inevitable, yes, but also benign and—as it turns out—rather helpful. The interests of the state and the interests of the industry are parallel and should be parallel. When the industry thrives, the state benefits in various ways from tax revenue to employment to tourism promotion and so forth.

When legislators and regulators adapt to encourage more investment and growth that is not cause for hand wringing. In most cases, that is cause for hand clapping.

That does not mean that effective regulation is not necessary. It is. States need to ensure that their rules can still address any worst-case scenario, that no licensee can be too big to regulate and that the rules governing good character, honesty and integrity remain intact and immutable.

Indeed, the regulated entities themselves leverage their licenses and regulation as competitive tools, in some cases as necessary barriers to entry against potential competitors who are less willing to play by the rules.

Regulators, by and large, are appointed, not elected. But elected officials need to understand their core role in this process: They must set standards, including necessary post-employment restrictions, on those who are appointed. And those appointees must be free to operate independently of the political process.

The most effective statutes, and the most effective regulations, are useless unless you appoint support people who meet the absolute highest standards of integrity. That was true in 1982. It is equally true in 2015.

But what of the issue of gaming saturation? How do states address that? Can it be addressed or should states simply sit back and watch their industries compete to the point of exhaustion and economic collapse?

I submit that it can be addressed and must be addressed.

Hidden beneath the issue of saturation are related issues that must be recognized and confronted:

The establishment of tax rates on gaming revenue is the most powerful weapon in a state’s arsenal.
Historically, states establish tax rates—as well as their overall gaming policy—on political considerations, rather than on sound economic grounds.
Tax rates and regulatory policies that were set when an industry was established are going to be less viable over time and must be adaptable.
These are separate issues but they must be addressed in tandem. In most states, gaming tax rates are far too high. In certain markets, this is far less of an issue than in others. In markets where there is significant population density and little competition, operators can overcome the handicap of high tax rates.

But other markets—and arguably most markets—cannot, particularly when they face new competition, and must grapple with old tax rates, which were set in another era.

How were those tax rates established in the first place? Did lawmakers sit down with economists and consultants and map out an optimal rate designed to attract capital investment and advance multiple public policies? Hardly.

Why do some states have tax rates north of 50 percent, while others are south of 15 percent? It is not economics at either end of the spectrum. Indeed, New Jersey has a rate of 8 percent, which seems quite low by any reasonable standard.

Five years ago, I authored a peer-reviewed white paper on tax policy. As part of my research, I interviewed my mentor Steven P. Perskie—who was a member of the state Assembly in 1976 and 1977 and is widely hailed as the architect of the Casino Control Act—to provide the thought processes that guided the decision to set the rate at 8 percent. He responded with the following written comment:

“In researching the drafting of the bill introduced in 1976, after the (New Jersey) referendum passed, we found that the highest (combined) tax on gross revenues was 7.5 percent (in Nevada). For principally political reasons, we therefore set the initial rate for New Jersey at 8 percent. We assumed that this would inoculate us from any argument in either direction (that the tax was too high or too low), and indeed we never had to defend that decision. We didn’t, at that time, make any effort to calculate the revenue estimates for the state, as we had no idea (and, as experience would show, we had no idea) what we would be dealing with.”

Such efforts at political inoculation did not end in 1976 and arguably continue to this very day. However difficult it may be, states should tilt away from political considerations and confront economic realities. States have to examine—and continually re-examine—their policies, including their tax rates, to ensure that their policies are in sync with their policy goals. A high tax rate is not compatible with a goal of maximizing employment, nor is it compatible with a goal of promoting tourism.

A high tax rate limits the ability of an operator to choose different business models. A high tax rate can only work with a business model based on local convenience. That inevitably means that a casino can only capture a limited number of adults and a limited amount of discretionary spending.

The result is that high tax rates will not work in markets that are approaching saturation.

I must issue one additional caveat: Low tax rates do not automatically translate into economic success. If they did, Atlantic City would be thriving today, as would Reno.

Tax rates are a critical piece of the puzzle, but they make up only one piece. If there is one essential ingredient for success, it is this: capital investment.

States must work in tandem with their industries to determine what else is needed to attract capital investment, which must be deployed properly to grow the market demographically and geographically. That is how you deal with saturation.

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