Finding the sweet spot

With the second largest casino gambling market in America, Pennsylvania boasts 12 casinos and approximately $3bn in gaming revenue since 2011. The logical next step for a state with a gaming market of this size is to pass legislation that would legalize and regulate intrastate online gaming.

While Pennsylvania lawmakers have tried for the past few years unsuccessfully to pass egaming legislation, proponents of online gaming were optimistic that 2017 would bear long-awaited legislation in the state. The current legislative effort—which includes several bills introduced in both the House and Senate—marks the strongest push by a state to legalize activity since New Jersey passed its own legislation in 2013. But with several new bills (eg. SB 477, HB 392, and SB 524) featuring a 25% tax rate, Pennsylvania lawmakers are poised to cripple the online gaming market before it even launches. At the currently proposed rate of 25%, online gaming operators will be unable to operate profitably, thereby precluding any long-term economic growth and the associated tax revenues that Pennsylvania hopes to realize.

Should Pennsylvania be successful in passing its own egaming legislation, it will join Delaware, Nevada, and New Jersey as states that regulate online gaming within their borders. While Delaware has imposed a tiered taxation scheme that has yet to be fully realized due to lower-than-expected revenues, Nevada and New Jersey are instructive. Nevada’s online gaming and land-based casino rates are the same at 6.75% for all games (plus possible 1% imposed by municipalities)—and the lowest in the country.

New Jersey—Pennsylvania’s neighboring state—has imposed a slightly higher online gaming tax rate than the land-based casino rate of 6.5%. The current 15% effective tax rate in New Jersey for all online games (plus 2.5% for the Casino Reinvestment Development Authority) is as high as the online industry can sustain. Despite the difference in tax rates between land-based casinos and online games, New Jersey casinos actively advertise and market their online products, demonstrating that the two markets are complementary.

A taxing situation

Pennsylvania’s most widely proposed 25% tax rate for online gaming—a departure from the 14% tax rate previously proposed by state legislators—simply ignores the realities of how online gaming functions. Online gaming operators cannot just “flip the switch” that takes their games online and watch the money roll in. The reality is that online gaming is an extremely cost-intensive venture.

While casinos may be able to handle a 25% tax rate, such an exorbitant tax burden will be off-putting for online operators. Case in point—in New Jersey, approximately 77.5 cents of each dollar wagered online is eaten up by costs plus 17.5 cents per dollar for gaming-related taxes, leaving operators with single-digit revenue assuming operations run smoothly. As such, a tax rate of 25% or higher will make operating in Pennsylvania impossible and would kill the online gaming industry before it even got started.

Even Pennsylvania’s casinos are struggling under some of the highest tax rates on land-based casinos in the world. Pennsylvania’s 54% tax rate on land-based slots have forced casinos to push this cost to consumers, creating some of the worst returns for players in the country. Take, by comparison, New Jersey, which taxes land-based slots at a low rate of 9.25%. Higher tax rates for land-based operators are sustainable for reasons unique to these operations: land-based casinos offer food, drink, hotel accommodations, entertainment, and more, thus making a higher tax rate palatable. Online operators, on the other hand, do not offer any of these amenities, and as such land-based casino tax rates cannot serve as a good guidepost for online operators.

Philadelphia

But some Pennsylvania lawmakers do not buy the argument that online gambling needs to be taxed at a lesser rate than brick and mortar in order for the industry to thrive. Rather, they see lowering the tax rate for online operators as penalizing land-based casinos that have accepted the previous rate and yet continue to be successful. A 2014 gaming study in Pennsylvania, however, found that a lower tax rate is necessary for a viable online gaming industry in the state.

In 2014, Pennsylvania commissioned a study on the state of both land-based and online gaming. This study, completed by Econsult Solutions, found, among other things, that a higher tax rate for online gaming will limit the growth possibilities for the industry, which already has to compete with the lure unlicensed sites that do not have regulation fees and taxes and, thus, do not have to pass those costs onto consumers. The study also found that a higher tax rate is unnecessary to prevent cannibalization of the land-based industry, as online gaming is complementary to land-based casinos, attracting a different demographic than the land-based gamer. The Econsult Solutions study estimated that bringing gaming online could add to the gaming industry overall with potentially more than $90m additional revenue per year.

But if the state ever wants to realize this additional revenue potential, legislators must reach a consensus on a tax rate that embraces the realities of how online gaming operates. The 14% rate originally proposed this year is the highest tax rate that online operators reasonably could sustain. While it is certainly understandable that lawmakers see a high tax rate on gaming as an attractive way to make up for budget deficits, as the land-based industry has shown, a high tax rate will drive out online gaming operators and result in less tax revenue for the state over time.

For those holding out hope that another state will go online in the US this year, lack of consensus among lawmakers on key issues like tax rates will frustrate and complicate those efforts. If Pennsylvania wants to avoid the same type of legislative tiffs that have been keeping states like California out of the running, its lawmakers need to agree on a tax rate this is comparable to its neighboring state of New Jersey. Anything higher will make launching online gaming improbable in the state, defeating the very purpose of passing egaming legislation in the first place: the opportunity for economic growth.