The ‘Lower’ Tax Rate For PA Online Gambling Vs. Bigger Tax For Casinos Is A Red Herring

March 16, 2017
The ‘Lower’ Tax Rate For PA Online Gambling Vs. Bigger Tax For Casinos Is A Red Herring

During last week’s joint online gambling hearing in Pennsylvania, two state senators continually claimed that the lower tax rate imposed on online gambling revenue would cause the state’s casinos to shift their focus toward online play to the exclusion of physical gambling.

These concerns were voiced by Sens. Robert Tomlinson and Lisa Boscola. They were also brought up by Parx Casino Chairman Bob Green and CEO Anthony Ricci during their testimony, with Ricci stating:

“I find it impossible to assume that a brick-and-mortar casino paying 59 percent in taxes will not lose significant business to an online operator paying 15 percent in an open, unprotected market.”

This concern — which was Tomlinson first raised back in 2015 — relies on the dubious assumption that online gamblers and land-based gamblers are one in the same. It also demonstrates a fundamental misunderstanding of the land-based and online gambling business models.

Online and land-based gambling have different overhead and margins. Even the assumption that online and live gamblers are cut from the same cloth were true (it’s not and here’s why), the notion that casinos would disregard land-based operations in favor of online simply doesn’t pass the smell test.

Atlantic City proves the obverse

We need look no further than the tax situation in New Jersey and Atlantic City to put this argument out of its misery.

Pennsylvania taxes slots at more than 50 percent and is considering a tax rate of 15 to 20 percent on online gambling. That’s the reason for the cannibalization concerns.

But in Atlantic City, the reverse is true. Land-based casino revenue is taxed at 9.25 percent, while online gambling revenue is taxed at 17.5 percent.

If higher taxes on land-based gaming would cause Pennsylvania casinos to shift their focus online, it stands to reason Atlantic City casinos would do the opposite. They don’t.

Atlantic City casinos plaster online advertising all over their properties and on radio and TV. This might seem counterintuitive to Tomlinson and Boscola. But it makes perfect sense when you disregard the highly flawed assumption upon which their house-of-cards argument is built.

The tax rate has little to do with it.

A tax rate disparity already exists in PA

Maybe it’s a Pennsylvania thing and we can’t compare Pennsylvania to New Jersey?

OK, I’ll humor that idea, but it doesn’t change anything.

If the significantly lower tax rate would incentivize casinos to focus on online gambling at the expense of land-based gambling, why aren’t Pennsylvania’s casinos pushing table games on their patrons instead of slot machines?

After all, Pennsylvania slot revenue is taxed at a hefty 54 percent. The tax on table games is a mere 16 percent — after a two-percent increase last year.

Most readers either know or can quickly work out why highly taxed slots generate far more revenue in Pennsylvania than table games, despite the tax difference.

  • Gross slot revenue in 2016: $2,360,184,122
  • Gross table game revenue in 2016: $853,238,055

Even though the casinos kept 86 cents of every gross revenue dollar generated at their gaming tables in 2016 ($733,784,727), the 46 cents of every gross revenue dollar generated through slot play amounts to much more money: $1,085,974,496.

And that’s gross revenue, not net revenue or profit.

Margins don’t only come from tax rates

Tax rates aren’t the only determining factor of a game’s potential to generate revenue or its profit margin for the casino. A dollar pumped into a slot machine doesn’t generate the same revenue as a dollar bet on a roulette table.

Slots and table games have different overheads, and therefore vastly different profit margins. That is why there are such disproportionate tax rates. Employee wages, maintenance, space considerations, the speed of the game and the house edge are just some of the factors in play.

Online and land-based gambling have different overheads too.

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There’s not much meat on the online bone

As Chris Sheffield told a Pennsylvania committee in June 2015, during his time in the European online gambling space, “a four percent tax rate in Gibraltar left us with a 15 percent margin.” (Sheffield is formerly of BetFred and now the senior vice president and managing director of interactive gaming at Penn National.)

At the same hearing, Richard Schwartz of Rush Street Interactive told the committee its analysis showed a tax rate of 15 percent would leave Pennsylvania online operators with margins of five percent. (The final rate is likely to be in the 17 to 20 percent when all taxes are factored in.)

This analysis lines up very closely with what Atlantic City casinos are hoping to achieve while dealing with a 17.5 percent tax rate (15 percent to the state and a further 2.5 percent to the Casino Reinvestment Development Authority). The target EBITDA (earnings before interest, tax, depreciation, amortization) is also around five percent.

That’s the target, mind you. Few online operators in New Jersey are believed to be hitting these targets. Online gambling isn’t just flipping a switch and watching the money roll in.

During its most recent earnings call, Betfair noted that after three-plus years in the market, Betfair Casino New Jersey is just approaching the break-even mark:

“… Betfair Casino New Jersey… is now operating at the breakeven EBITDA after a couple of years of startup losses.”

Where does the money go?

Here’s a rough idea of what happens to the money generated by an online gambling operator in the Atlantic City market:

  • 17.5 cents go to taxes
  • 20 cents go to player reinvestment (player promotions and retention costs)
  • 18.5 cents are eaten up by payment processing, KYC, geolocation costs and platform and content royalties
  • 24 cents is spent on advertising
  • 2.5 cents is gobbled up by other regulatory fees
  • 12.5 cents goes to general and administrative needs, including staff

This adds up to online operators in New Jersey having an EBITDA of … five percent!

And remember, that’s assuming everything goes smoothly.

It’s possible to save in some areas, particularly if it’s a large operator generating nine figures of revenue annually (which won’t exist in New Jersey or Pennsylvania). But even in those instances, the best-case scenario is something along the lines of a 15 to 20 percent EBITDA.That might be attainable by the top 10 operators in the world.

Advertising is critical online

The number that really jumps out from above is the nearly 25 percent of revenue online operators spend on advertising. But as one industry source explained it, “Advertising for online is like capital investment for brick-and-mortar casinos. It’s not a nice-to-have; it’s a must.”

This is why even the biggest operators, with revenues exceeding a billion dollars a year, still use 20 to 30 percent of their revenues for advertising.

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