Delaware gaming tax policy not to be emulated

If it ain’t broke, don’t fix it. That seems to be the mantra for gaming taxation policy in the great state of Delaware, at least if the goal is to squelch any incentive among the state’s operators to innovate, market their products and generate new revenues.

Delaware last month became the 14th state to legalize fantasy sports, affording both FanDuel and DraftKings the opportunity to resume offering games within the state after the state attorney general sent cease and desist letter to both operators last summer.

Like it has done with both its online and land-based casinos, Delaware will tax fantasy sports operators at a suffocating clip – a $50,000 annual license fee plus 15.5 percent of gross revenues.

We know from basic economics that the more the government taxes a particular activity, the less that activity occurs. Accordingly, such a tax structure will without a doubt prohibit any fantasy sports operator not named FanDuel or DraftKings from doing business in the state, and it probably means that even the Big 2 will pay minimal attention to the market.

Put it all together and we can confidently conclude that the state’s $400 million fiscal deficit will not be remedied by fantasy sports taxes.

To anyone who has followed gaming tax policy in Delaware recently, this shouldn’t be a startling observation.

Nearly five years into its online gaming experiment, the state’s internet casinos remain on life support because of a provision that requires that they be taxed at a rate of 100 percent until a statewide revenue threshold of $3.75 million is met.

To date, annual igaming revenues have yet to even approach that mark, meaning that no operator has made any money offering these online games in Delaware. Fiscal year 2017 – the best year on record – generated $2.7 million gross revenues, well shy of the threshold.

This is why nobody is talking about a thriving Delaware online casino marketplace.

Compare Delaware’s performance to New Jersey, which has begun to fulfill its potential as an igaming market. New Jersey has a population of 8.9 million. Delaware has a population of 950,000. Both came online at the same time, so it seems fair to assume that Delaware should produce 10 percent of what New Jersey does over a given period.

In May 2017, New Jersey topped $21 million in monthly revenues for the first time ever. Delaware, which had its strongest month of the fiscal year in May, generated just $302,000 – roughly 3 percent of New Jersey’s haul.

The First State’s heavy-handed approach to tax policy also extends into the land-based space, where its three racinos are struggling to compete against newer, fancier and better-located properties in the mid-Atlantic region.

After state taxes and required racing purse allotments, Delaware casinos keep just 66 percent of the table games revenues and 42 percent of slot revenues generated.

This stranglehold, gaming executives in the state say, has throttled their ability to compete and attract customers in an increasingly competitive regional marketplace.

To be fair, every industry group regardless of sector will always argue that they are being overly taxed. But Delaware casino operators have a more legitimate argument than most.

Dover Downs Gaming & Entertainment, the state’s only publicly-traded casino, reported a profit of just $32,000 for the second quarter, a 96 percent decrease year-over-year. The company has posted quarterly losses four times in the last two years. Shares of Dover Downs are trading around $1 for the past year on the New York Stock Exchange.

The company’s total revenues for the quarter were down 6 percent to $43.3 million in total revenues, with gaming revenues and hotel occupancy rates decreasing in tandem.

Company officials insist that their product offerings and customer service commitments are not the problem. They say their limited efforts to attract high-end players are succeeding and that its customer service ratings are high, but that the restrictive tax regime is limiting the company’s ability to draw in new customers.

“We’re continuing to press our case to the current administration that more marketing resources are needed in order to improve the Delaware casino industry’s competitiveness,” said
Denis McGlynn, chief executive officer of Dover Downs on the company’s second quarter earnings call.

McGlynn added that reducing gaming tax rates provide funds for marketing and capital expenditures which could help attract a wider range of players. The company noted that it wouldn’t be able to just cut expenses to dig its way out of the muck.

“We did a pretty good job of keeping expenses down in the quarter, but the lower volumes and the extremely high gaming tax rates obviously impact our margins and our gaming margins were about 4 percent for the quarter,” said Timothy Horne, chief financial officer.

New Governor John Carney’s administration seems receptive to the casinos’ concerns, particularly as they are some of the largest job creators in the small state. But given the tax rate he signed into law on fantasy sports operators, it appears he may have other priorities.

“It may be a hard sell to convince Delaware it needs to accept lower taxes to keep the facilities open: Pennsylvania casinos pay an effective 55 percent rate (includes contributions to the PA Race Horse Development Fund). Maryland Casinos pay an effective rate of 67 percent!” wrote Thomas Niel, a contributor to Seeking Alpha, an investing publication.

“At 57% combined tax and purse contributions, Delaware’s rate is not onerous compared to the competing jurisdictions.”

All told, when the soon-to-be-realized legal fantasy sports regime takes effect in Delaware this month, there will be no need to scratch our heads in wonder when it fails to live up to expectations.

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Aaron Stanley
https://www.clippings.me/aaronstanley