Immoral, destructive and prohibited. These are just a few of the words previously associated with the word “gambling” by government officials. Today, however, if one mentions gambling to a legislator in most states, you are more likely to be met with responses like revenue, taxation or balancing the budget.
Indeed, some of the most compelling issues presented by proponents of legalized gambling involve economics. Legalized gambling allows states to generate new revenues without raising taxes and/or implementing major budget cuts. More importantly, legalized gambling can be introduced at a time when the public is unwilling to accept new tax measures. As Gov. Ann Richards of Texas once noted, “It’s a question of money. Either we get it from a lottery or we’ll get it from a huge tax bill.”1
Gambling advocates also argue that the legalization of gambling will generate new funds for public treasuries that can be spent on numerous worthy causes and also create jobs and general economic growth in the community. Moreover, proponents often stress that gambling taxes associated with legalized gambling are politically more acceptable than other forms of taxation because the gamblers themselves pay them voluntarily.
However, like the other topics that have been covered in our series, there are many aspects that must be taken into consideration when introducing taxation structures besides how the jurisdiction plans to spend its potential newfound wealth. This article will address a few of the most important issues.
To begin, when setting a tax structure, even for gambling, a jurisdiction must realize that all industries have demand curves for their products. Typically, the more costly the product is, the less demand there is for the product.2 As a consequence, the more a jurisdiction taxes gambling, the lower the demand will likely be. A jurisdiction must be careful, therefore, not to tax gambling so heavily that patrons resort to illegal gambling or travel to other jurisdictions to gamble. Similarly, a jurisdiction must be careful not to deter legitimate casino operators from investing their limited capital into its market.
A jurisdiction’s tax policy should also be consistent with the purposes for which it legalizes gambling. As mentioned above, given today’s budgetary shortfalls, the purpose of legalizing gaming is likely to maximize tax revenues. Accordingly, a jurisdiction should choose a rate that maximizes the highest return without deterring players and casino operators, which would ultimately be counterproductive to the maximization of tax revenue.3 For example, let’s assume a jurisdiction is contemplating the introduction of one of three tax rates: 6 percent, 10 percent or 20 percent. According to Anthony Cabot in Casino Gaming: Policy, Economics and Regulation, “If the government charges 6 percent, the casino industry can generate $100 in revenue; if it charges 10 percent, the industry generates $70; and if it charges 20 percent, the industry generates $30. Here, both the 6 percent and 20 percent rates generate $6 in tax, and the 10 percent rate generates $7. From a tax maximization perspective, the preferred rate is 10 percent.”4 In contrast, the 6 percent rate would be introduced if the jurisdiction’s secondary goal was to increase employment and, indirectly, taxes; or the 20 percent rate if the jurisdiction wishes to discourage gambling.5
By way of an example, Pennsylvania, which has only nine casinos, topped the nation with about $1.1 billion in tax revenue from casinos in 2009. This take outpaced even Nevada, which collected $831 million from its 260 casinos.6 The incongruity can be attributed to the 55 percent tax rate in Pennsylvania compared to the 8 percent that Nevada takes from its casinos. Pennsylvania Gaming Control Board spokesman Richard McGarvey said Pennsylvania’s high revenue is not surprising: “Our tax is so high because the intention of the gaming law was to bring in tax money.” 7 Indeed, Pennsylvania’s 55 percent tax rate on slot machine proceeds is among the highest in the nation, below New York’s 65 percent and West Virginia’s 57 percent.
However, this is not to suggest that all jurisdictions should simply raise their tax levels. If Nevada imposed a 55 percent tax rate, its market would certainly diminish. As a consequence, the rate at which a government can effectively tax the gambling industry also depends on the type of market in which the industry will exist. For example, in a monopoly, the jurisdiction can often impose higher taxes upon operators than in other markets. The reason for this is twofold. First, the lack of competition allows the operators to pass the cost of taxation directly to the consumer. Indeed, monopoly operators often provide few games at higher odds favorable to the house or institute other costs, such as charging for parking, to maximize profits. Second, operators in monopolistic markets typically have higher margins and can thus afford to pay the higher taxes.
In comparison, operators in a competitive market typically push the tax burden entirely onto patrons. This results in higher prices and lower demand. Specifically, as the tax rate increases, the number of games decreases while the prices that patrons pay increase. Accordingly, too high a tax rate in a competitive market will effectively reduce the demand for gambling in that jurisdiction. Therefore, to be effective, a government’s tax policy should be consistent with the purposes for which it legalized gaming. In other words, the tax should not have any unintended effects on competition or government goals.
Yet another consideration when setting a tax regime is that the taxes should be adequate. Adequacy means that the amount of the tax meets government expectations in legalizing casinos and that there is a balance between the need to generate more funds to meet an expanding government budget and the need for stability in periods of decline.8 In the best of worlds, tax revenues increase to meet new government needs in times of economic growth but remain steady when the economy experiences a downturn. One technique for achieving this balance is to incorporate a stable tax, such as property tax, which has relatively little variation based upon economic decline or growth, with a more volatile tax that depends more heavily upon economic conditions, such as gross gaming revenue tax.9 The former allows the government to recover the costs of regulating the industry while the latter allows the jurisdiction to capitalize on additional revenues when the industry is burgeoning.
The notion of reliability also should be considered when devising a tax regime. Specifically, jurisdictions often plan ahead for anticipated sums of revenue from reliable levies that have shown themselves to provide stable yields year after year. If a jurisdiction is not careful, however, it may miscalculate estimated tax yields, giving rise to the occasional fiscal crises.10 For instance, gambling once was thought of as being recession proof. Yet the current financial crisis has proven this to be incorrect, and gaming jurisdictions have experienced large revenue declines. As a consequence, jurisdictions that have recently legalized gambling or are exploring the possibility of legalizing gambling need to have realistic expectations regarding estimated tax yields. Otherwise the jurisdiction is simply setting itself up for a budgetary shortfall.
Another basic concept for a jurisdiction’s reflection is that taxes should be simple and easy to understand. In other words, “taxes should be intelligible to the taxpayer.” 11 For instance, if a tax system confuses the taxpayer, then it is more likely to result in inaccurate tax reporting, disputes, litigation and the loss of taxpayer acceptance. Complex tax systems also may allow some taxpayers to evade the intention of the law by using unintended loopholes to reduce their tax liability.12 An illustration of an extremely simple tax is a flat fee structure. Here, the amount due and when it is due are easy to determine. An example of a complex tax system, on the other hand, is charging a percentage fee on net revenue.13 Here, the complexity stems from the need to define gross revenue as well as appropriate deductions from it. Accordingly, in instituting a tax system the jurisdiction must strive to make its system manageable, thereby reducing the possibilities for confusion, disputes and unintended loopholes.
In light of the above, when a jurisdiction first looks to tax its emerging gaming industry, it will usually start by taxing the casinos only (as opposed to the patrons, etc.). The reason for this is that casinos handle the majority of the money and are the easiest to tax, as they are subject to the jurisdiction’s close regulatory scrutiny. Typical examples of taxes that a jurisdiction may levy against casinos include excise taxes imposed for the privilege of operating gaming establishments, gross revenue taxes, net revenue taxes, property taxes and unit taxes, the latter being based upon, for example, each gaming table or gaming device located within the casino.
To conclude, tax rates are often thrown around without context. For example, a 30 to 40 percent tax rate is music to everyone’s ears when it comes time to balance the budget, but while some gaming jurisdictions may be able to support that high of a tax rate, others cannot. More importantly, the underlying policy goals may not be met with such a high tax either. Each jurisdiction, therefore, needs to look closely at its own policies, intentions and gaming market in order to decide the correct tax regime to complement it. Simply imposing a high tax rate in the hope of maximized profits may deter casinos and players from a jurisdiction and ultimately be counterproductive to its goals as well as the success of its gaming operations.
1 Thompson, William N., “Legalized Gambling,” pg. 43, Santa Barbara, California: ABC-CLIO (1994) citing to Gaming and Wagering Business September – October 1991.
2 International Gaming Institute, Univ. of Nevada, Las Vegas, William F. Harrah College of Hotel Administration, “The Gaming Industry: Introduction and Perspectives,” pg. 97, John Wiley & Sons Inc. (1996).
3 Cabot, Anthony N., “Casino Gaming: Policy, Economics and Regulation,” pg. 444, Las Vegas, Nevada: UNLV International Gaming Institute (1996).
6 “Pa. gambling tax income outpaces Nevada,” Ventura Country Star (July 26, 2010).
8 Supra note 3, at 448.
10 Supra note 1, at 43.
11 Groves, Harold M., “Financing Government,” pg. 16, New York: Holt, Rinehart, and Winston Inc. (6th Ed. 1964).
12 Supra note 3, at 442.