The Pennsylvania House Gaming Oversight Committee (HGOC) held its second hearing of the year on Tuesday, March 28, 2017. The issue under consideration is gambling legislation, notably the legalization of online gaming. The first such meeting took place on on March 2017 where the Senate CERD Committee and the House Gaming Oversight Committee engaged in a robust debate on online gambling activity in the state.

The focus was on general gaming expansion. This public hearing also factored in issues like competitiveness among casinos, local share assessment data, et al.

Major gaming reforms were discussed, including gambling tax proposals for the state of Pennsylvania. The issues of local taxation and online gaming are inextricably intertwined. The HGOC did not explicitly discuss online gambling, but it is the elephant in the room that nobody can ignore for too much longer.

As far as gambling reforms go, all roads point to online gambling. The state of Pennsylvania is waging a much broader battle between proponents of gambling reform, and opponents of online gambling legislation. The debate has reached fever-pitch level, and both sides are jockeying for position during this legislative sparring session.

Back in 2016, the local share tax issue came to a head. Basically, this issue relates to how each casino should make payments to local communities. The Pennsylvania Supreme Court made a ruling that such tabulation was deemed unconstitutional. The Supreme Court gave legislators until January 2017 to resolve the issue.

"The most important reason online gambling revenues need to be taxed at a lower level in Pennsylvania is the existing profit margins. Compared to land-based casinos, online gambling operates at much slimmer profit margins"

But the rush to resolve the crisis resulted in the local share tax issue being pegged onto gaming reform packages that were already in the pipeline. The Senate wanted to deal with gambling legislation issues one by one, not jointly. As such, none of the legislation passed by the deadline.

The issue of taxation and online gaming cannot be ignored. When Senate Minority Leader J Costa introduced SB 524, it came with a 25% sticker tax on online gambling and fantasy sports. That figure is substantially higher than the tax proposed in prior bills where the tax rate was capped at 14%. The bills included the 200-page HB 392 and the Senate bill SB 477. Both bills sought to regulate and legalize online gambling and reinstate local share tax for surrounding communities. 

With respect to SB 477, the GGR revenue would be taxed at 14% for state purposes and 2% to local communities. These projections are broadly consistent with the performance of New Jersey’s legal online casino market This begs the question: What is the right tax rate for online gambling in the state of Pennsylvania? Most analysts agree that 25% is too high for online gambling, and this would destroy the industry even before it has an opportunity to get started.

The most obvious disincentive of high taxation for online gambling is that operators will want to reduce game returns to players. If online slots, online blackjack, online roulette, and online baccarat have return to player percentages between 96% and 99%, those numbers will have to be knocked back for online casinos to be profitable. Pennsylvania is currently at the back of the pack when it comes to slots return at approximately 90%. 

Atlantic City offers a return of 91.5%. Simply put, this means players can expect $0.90 back on every $1 that they spend on slots. If that number is rolled back further, players will be unlikely to plow their money into slots games. Decreasing RTP numbers will initially boost profit margins for online casinos, but players will be turned away over the long-term. This is not viable for the online gaming industry in Pennsylvania.

The most important reason online gambling revenues need to be taxed at a lower level in Pennsylvania is the existing profit margins on online gambling. Compared to land-based casinos, online gambling operates at much slimmer profit margins. The reason for this: Online casinos have much higher RTP percentages. On Play Pennsylvania website it was predicted that Pennsylvania online gambling projections call for 2018 revenue of $230 million, increasing to $364 million by 2022

The tax rate on land-based casinos across Pennsylvania is approximately 54%, but that’s viable given the many ways that profits are derived in the first place. These include hotel fees, entertainment fees, surcharges, dining, low payouts on casino games, and the like. For online gambling, there are none of those additional revenue sources. Online casinos rely solely on their online gambling revenues for profitability. 

When oppressive taxes are imposed, it becomes difficult to operate profitably with such slim margins. Further, online casinos must aggressively market themselves to stay competitive. Advertising budgets will shrink with higher tax rates, and the industry will invariably fold. There are many other peripheral issues to contend with such as payments processing options, security, geolocation technology, and the like. 

As it stands, studies indicate that 77.5% of every $1 earned from regulated online gambling activity in the state of New Jersey is devoured before taxes are imposed. At a 25% tax rate, that would be untenable in Pennsylvania
.

WHY IS ONLINE GAMBLING SUCH A POLITICAL HOT POTATO?

It is easy to make the mistake of believing that legislators are trying to clamp down on online gambling because it is a nefarious activity. Unfortunately, the reason for the fierce opposition to online gambling has nothing to do with morality – it’s dollars and cents.

Lobbyists for land-based casinos which employ hundreds, perhaps thousands of people have tremendous political clout in the state of Pennsylvania and elsewhere. They don’t want to see their industry being upended by virtual casinos that have limited fixed overhead costs with few employees and little connection to the local communities.

For these reasons, online gambling is a risky proposition from a local, county and state-wide perspective. Further, in the absence of strict geo-locational protections, anyone can play at an online casino. The argument is made that a VPN allows quick access to all unregulated online casinos, with no protections offered to players in the state.

Pennsylvania will want to iron out these issues before they consider legalizing online casinos. New Jersey got it right, alongside Nevada and Delaware, and Pennsylvania might be the fourth state in the union to move towards full online gambling regulation in coming months.

Then there is the issue of US Attorney General Jeff Sessions. As a staunch conservative, Sessions has the online gaming community a little spooked. He stated that he would be considering a reversal of the 2011 federal legal opinion vis-à-vis states and the legalization of online gambling. According to David Cookson (Coalition to Stop Internet Gambling), ‘With the fluid situation in Washington, Internet gambling is an unreliable and possibly nonexistent source of revenue.’

As far as federal policy changes go, state-level representatives are not concerned. States have full authority to exercise their autonomous rights to offer online gambling as they see fit. Gambling expansion is currently underway at House and Senate level, and Pennsylvania is anticipating $100 million more in gambling revenue. Among the 12 state casinos, there is uniform opposition to video gaming terminals. 

However, Mount Airy Casino supports online gambling. The governor of Pennsylvania, Tom Wolf wants to be sure that the legalization of online casinos does not in any way adversely affect the State lottery, or the profitability of existing casinos. Much of the property tax relief in the state is derived from slot revenue, and Internet gambling may or may not reduce that.

As it stands, the protagonists and the antagonists have locked horns in this debate, and we are likely to see major developments taking place in coming months.

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