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What’s the right tax rate for online casinos?

By Aaron Stanley, CDC Gaming Reports

The Pennsylvania legislature appears to be on its way toward the eventual approval of a package that would legalize online gambling, but the rate at which online casinos should be taxed remains a firm point of contention.

The bill proposed by Pennsylvania’s Senate seeks to tax online casino revenues at 54 percent, a rate at which operators and i-gaming proponents have balked at. They argue that the rate is absurdly high and would drive away any and all private investment.

The Senate bill would tax online poker, however, at a more reasonable 16 percent. The House version would tax all online gambling at 16 percent, per Online Poker Report, a figure more in line with New Jersey’s 17.5 percent clip.

The million dollar question, in this instance, is what is the ideal rate at which online gaming should be taxed to maximize revenues while making the activity worthwhile for private operators?

“The honest answer right now is that nobody knows, and because this is all so new everybody is just taking a shot in the dark,” Clyde Barrow, a professor at the University of Texas – Rio Grande Valley. “New Jersey was very conservative in their approach in trying not to kill the golden goose.”

Mattias Stetz, chief operating officer of Rush Street Interactive who previously worked in European online gaming for a decade, says he has seen tax rates ranging from 5 percent to 56 percent across jurisdictions.

“There’s no way to make money on a 54 to 56 percent tax rate,” he explained.

Barrow notes that states that legalize gambling in some form typically prioritize either generating tax revenue or jobs and economic development. States like Massachusetts, with its forthcoming Wynn Boston and MGM Springfield resorts, have taken the job creation approach, whereas Pennsylvania’s goal has always been to maximize tax revenue in order to help keep budget deficits down.

Understanding Pennsylvania’s mindset helps explain why some in the state senate think a 54 percent rate is a good idea – after all, it’s the same rate at which land-based casinos are taxed. And these senators aren’t pushing online gaming because there’s an overwhelming public clamor to gamble and play poker on the internet, they’re pushing it because they need the money – badly.

The state must cover a $2 billion shortfall from the just concluded fiscal year, and it faces mounting deficits as the new one begins. Standard and Poor’s, the credit rating agency, put Pennsylvania on alert Thursday, saying the state is demonstrating “financial mismanagement” and is at risk of another downgrade if it fails to address the budget problem.

While a 54 percent rate on the surface sounds like it would generate a bounty of new tax revenues, it would quickly run into the Laffer Curve phenomenon – which holds that the more an activity is taxed, the less that activity occurs. The end result is that overall tax revenues generated from that particular activity are less than if it were taxed at a lesser rate.

Some Pennsylvania lawmakers have sought to avoid this by having the state lottery run the online gambling operations rather than private operators.

“A lot of it depends on how much of the capital investment and administration is under the jurisdiction of the state as opposed to private vendors,” said Barrow. “If the state is running it through the lottery, you might be able to get away with a tax rate that high. If they’re expecting this to be run through the existing private casino facilities, then I think it’s too high.”

Stetz said that U.S. states should look to Europe’s ready-made case studies for guidance on how and how not to tax online play.

“We don’t have to project – we can just look at what has happened in Europe,” he said. “You have Estonia at 5 percent, you have Belgium at 11 percent, you have the UK at 15 percent, Romania at 16 percent, Denmark at 20 percent, Spain somewhere around 34 percent and France at 56 percent.”

Stetz reckoned that the sweet spot for successful online gaming markets has tended to fall in the mid-teens range, and he emphasized that excessively high tax rates in Europe have had the adverse effect of driving play away from the legal and regulated space toward the underground market.

“I can tell you right off the bat that France is not successful. It’s impossible to know how big the black market is in France, but the estimates I’ve seen are that over 70-75 percent of all the gaming happening in France is happening through illegal sites,” he said. “Spain is another country where operators came in and are giving back licenses.”