[toc]The latest piece of online gambling and gambling reform legislation out of Pennsylvania largely mirrors those that have come before it, with a few critical differences.
Most notably, SB 524 — submitted by Senate Minority Leader Jay Costa — proposes a 25 percent tax rate on daily fantasy sports and online gambling. This stands in stark contrast to the two previously submitted bills that called for a 14 percent rate.
While numerically, an 11 percent disparity might not seem like a huge jump, Costa’s suggested rate would likely prove crippling to the nascent industry, hamstringing it before it could find its wings.
And here are a few reasons why.
#1 – Online casino margins are slim to begin with
Pennsylvania’s land-based casinos can stomach a 54 percent tax rate on slots. Why? Because land-based casinos have multiple means of generating revenue, all of which are presumably taxed at substantially lower rates.
Food, beverage, and hotel stays are good examples. Throw retail expenditures in there as well.
However, online gambling sites only have one way to stay afloat, and that’s via gambling. If a business’s sole path to profitability is hindered by oppressive tax rates, its margins will invariably suffer.
Which maybe wouldn’t be so bad if online gambling margins weren’t already quite thin to begin with. But the reality is that regulated online gambling operators also face costs that don’t impact land-based venues as heavily.
For instance, aggressive advertising spend is crucial to the success of online casino and poker sites. Granted, land-based casinos spend heavily on advertising too. But they have the built-in advantage of being physical entities that passersby will see.
Online gambling sites are hidden behind a digital wall.
Thus, spreading awareness can prove an expensive challenge. Not to mention, online sites generate significantly less revenue than their land-based counterparts. This means that every dollar spent on advertising has that much greater of an impact on margins.
There are also extraneous costs to contend with, including payment processing fees, geolocation costs (unique to online gambling), affiliate fees, and miscellaneous regulatory costs.
And that’s forgetting about payroll for staff, and promotional costs.
Anecdotal evidence suggests that 77.5 cents of every dollar generated via regulated online gambling in New Jersey is eaten up prior to taxes. Simple math reveals that if the same truth holds in Pennsylvania, a 25 percent tax rate would be untenable.
#2 – High taxes = inhospitable player environment
If online gambling operators are operating in the red, they’re going to seek ways to turn that around. One of the most immediately impactful ways of doing so is by lowering game returns.
That’s exactly how Pennsylvania’s land-based casinos have countered the 54 percent tax rate on slots.
Currently, Pennsylvania offers slot players one of the worst returns on their dollar of any state in the country, roughly $0.90. For comparison sake, that’s about 1.5 cents less than the slots at nearby Borgata in Atlantic City return.
Online casinos are known for boasting higher returns on slots than their land-based counterparts. As an example, on New Jersey online gambling sites there is an influx of slots that return 95 percent or higher.
Should Pennsylvania impose a 25 percent tax on online slots, we suspect returns will fall more in the 90 percent range. Which means that a gambler who deposits $100 would lose their money twice as fast on average.
This could have far-reaching consequences. One fear is that online-only players aren’t going to feel quite as compelled to visit land-based properties if they keep getting destroyed gambling online.
And whereas online casinos can hide slot returns from players, they can’t necessarily do the same for their video poker and table games, where the rule sets and payout tables are on full display. The savvy, young online gambler is likely to see these poor games, and forgo their online gambling ventures in favor of another activity.
Furthermore, under a 25 percent tax rate online casinos may feel forced to cut back on their reinvestment programs. This means less lucrative cross-promotions, and therefore less incentive for players to transition from live to online.
What results from these cost-cutting measures is that margins increase temporarily. But the long-term growth prospects of the industry are weakened.
#3 – Online poker wouldn’t stand a chance in PA
Online poker margins are already razor thin, and a high tax rate certainly won’t help matters.
Consider that in other ring-fenced and highly taxed regulated markets, such as Italy, Spain, and France, online poker revenue has been trending downward for years.
Smaller operators were effectively pushed out of the market. Operators noted that these markets are unsustainable for online poker. And the larger operators that stayed put were forced to offset the high costs of regulations by rolling out unfavorable rake schedules.
Unfortunately, poker players are more sensitive to high costs than other gamblers. This is one of the reasons why the European ring-fenced industry has struggled.
Italy and Spain tax online poker at 20 percent, and boast populations of 60 million and 47 million, respectively.
Based on these figures, it’s clear that Pennsylvania would be an even more inhospitable climate for online poker. The tax rate would be five percent higher, and operators would service a much smaller population of 12.8 million.
New Jersey taxes online poker at just 17.5 percent. But even that has proven too high for operators to offer the same rake tables found on dot-com sites.
And liquidity has suffered for it. Average cash game traffic (according to PokerScout) is now struggling to stay above 300 concurrent players. Revenue is barely eclipsing the $2 million monthly barrier.
All of which begs the question: Given the history of highly taxed and regulated markets, would online poker operators even try in Pennsylvania under a 25 percent tax rate? Probably not.
Even if they do, are players who currently play on unregulated sites really going to trade for legal sites where the cost of playing poker is that much higher?