An Evolving Perspective on the Gaming Industry

Thank you for that kind introduction and for the invitation to be with you today. For the second year in a row, not only do I get the opportunity to address state legislators — one of the industry’s most important stakeholders — but I also get to escape the Northeast in January for warmer climates. So for both reasons, it’s a pleasure to be here.

For those of you unfamiliar with my organization, I’d like to briefly explain what the American Gaming Association is and give you an overview of the industry we represent. The AGA is the national trade association for the commercial casino segment of the gaming industry. Our primary mission is to represent our industry on federal legislative and regulatory issues. Our membership consists primarily of publicly held casino companies listed on the New York and NASDAQ stock exchanges, including most of the operators you’re probably familiar with, such as Caesars, Harrah’s and MGM MIRAGE, along with major slot manufacturers, such as IGT, Bally’s and WMS — although with all the mergers taking place the total number of companies is shrinking fast. As Harrah’s CEO Gary Loveman recently said, pretty soon we’ll be having our board meetings in a Volkswagen!

The commercial casino industry, which operates 443 casinos in 11 states, generated over $27 billion in gross revenues in 2003. Of that amount, we paid more than $4.3 billion in taxes to state and local governments. We also provided more than 350,000 direct jobs with salaries of over $11.8 billion. While we only represent the interests of commercial operators, a lot of our companies are involved in other aspects of our business, such as racinos and Indian casinos, which I’ll discuss a little later in my remarks.

Last year, I talked to you about the need for cooperation between the industry and state legislators built on a better understanding of our business and how it works. With this appreciation, the industry can fulfill its economic promise while you can fulfill your commitment to the citizens of your states.

That is still a goal we should share and strive to achieve. But as Winston Churchill once said, “My views are a harmonious process which keeps them in relation to the current movement of events.” While this might be an excuse for changing his mind, I think it also says that it’s important to periodically re-examine our priorities, particularly with an industry changing as fast as the gaming industry.

In the past year, we’ve seen two mega-mergers, the approval of up to 60,000 slots in Pennsylvania, the opening of four racinos in New York, the significant expansion of Indian gaming in California and — much to Sen. Geller’s delight, I’m sure — the approval of a referendum that authorizes local voters to determine whether or not slots can be allowed at existing racetracks in his home district in Broward County and in neighboring Miami-Dade.

As you may recall, the speech I made to your group last year focused on taxes. Since then, because of an improving economy, fewer states faced budget deficits, and no state raised taxes on commercial casinos in 2004. However, a precedent had already been set. Sen. Geller recently told me about a speech Eugene Christiansen gave to your group. Gene summed up the impact of spiraling casino tax rates this way: A 10 percent tax rate will get you a Bellagio, a 35 percent tax rate will get you a Holiday Inn, and a 70 percent tax rate will get you a slot barn — in other words, no capital investment, no economic development, few jobs and little if any increase in tourism.

I’d like to take a moment and share with you the impact of setting or raising tax rates at levels that force our companies to create slot barns instead of Bellagios. In Illinois, what did the state get when it raised the top tax rate from 35 percent to 70 percent? Seven hundred employees were laid off, and another 600 jobs went unfilled. Hundreds of millions of dollars in planned construction projects were either put on hold or canceled altogether. Revenues in FY2004 were down $88 million, with casinos in neighboring states reaping the benefits. Ultimately, the tax hike brought in less than half of what was projected — and payments to local governments actually went down by more than $8 million from 2002 to 2003.

This should not come as a surprise to anyone. As I mentioned earlier, the major companies I represent are publicly held, listed on the New York and NASDAQ stock exchanges. They are responsible to their shareholders and must get a fair return on investment.

In New York, where the effective tax rate for racinos is close to 80 percent, investment in capital improvements has been minimal. To give you a sense of the disparity between a high-tax market like New York and other more reasonable jurisdictions, the budget for capital improvements is $15 million at Saratoga Raceway, $10.5 million at Finger Lakes and $8 million at Buffalo Downs — in contrast to more than $100 million at a typical riverboat casino and upwards of $1 billion at major destination resorts. The total amount spent on capital improvements in each of these New York racinos is equivalent to what we might spend on just a restaurant in a moderate tax environment!

In Rhode Island, the effective tax rate of 60 percent has put the racinos there at a competitive disadvantage with casinos in neighboring Connecticut, which are taxed at less than 25 percent. The lower tax rate has encouraged capital investment, which has created vastly superior properties in Connecticut and more spending by Rhode Island and Massachusetts residents at Connecticut casinos than at the more convenient Rhode Island racinos — which they have to drive right past to get there! The spending is not insignificant; Rhode Island and Massachusetts residents spend more than $1 billion a year at Connecticut’s two Indian casinos, Mohegan Sun and Foxwoods.

Despite these lessons, some state legislators, particularly in the eastern United States, continue to focus on the racino model with a tax rate in the “slot barn” range. To give you an idea of how far this segment of the industry has come in a short period of time, let me share a few statistics with you. The number of racinos has grown from just six in 1994 to 23 today — that’s a 283 percent increase in just 10 years!  — and they now operate in seven — but soon to be nine — states. The industry employs more than 11,000 people, generating over $2 billion in revenue and distributing in excess of $765 million to state and local governments in 2003. This is on top of the amounts I cited earlier for commercial casinos.

I recognize that when examining revenue options, legislators consider the racino model more politically palatable since it’s often done in the name of preserving the racing industry, and it limits expansion to locations where gambling already exists. And yes, it will bring some economic benefits. But, as I just described, imposing high tax rates will not maximize economic and social benefits — for either the industry or the state.

High tax rates have led some in our industry to declare that they will now limit their investment to states with a stable, predictable tax environment. Terry Lanni, the chairman and CEO of MGM MIRAGE, one of the largest casino companies in the world, joked that maybe his company should move to Mississippi after Gov. Haley Barbour announced that he was “against raising anybody’s taxes, period.” More recently, MGM MIRAGE has said that it would focus all of its domestic investment and development plans on Nevada, New Jersey and Mississippi, where they have “reasonable taxes and understand our industry” as opposed to other jurisdictions, where the company did not foresee any big growth or investment opportunities.

Commercial casinos have sought other opportunities for growth as well. One of those areas has been in management contracts with Indian tribes. While some commercial companies have been active in Indian Country for a decade, a host of new ones have joined them in recent years. For example, Caesars has been working with the St. Regis-Mohawk Tribe in New York to develop a casino in the Catskills. Numerous commercial casino companies signed management contracts with tribes after they negotiated compacts with then-Gov. Gray Davis of California. Station Casinos, previously just a Las Vegas locals casino operator, now runs a casino in California near Sacramento; longtime tribal partner Harrah’s operates a casino in southern California; and Caesars has entered into management contracts with tribes to build casinos there as well. Until recently, Donald Trump managed a casino in southern California, but his tribal partners, the Twenty Nine Palms Band of Mission Indians, told him last month, “You’re fired!”

The broader expansion strategy also has played out beyond our borders. In fact, major U.S. casino operators see the greatest opportunities overseas, primarily in Asia and the U.K. A report by Credit Suisse First Boston called Macau the fastest-growing market in the world and already third in size behind Las Vegas and Atlantic City. The new Sands Macau is helping to fuel that growth, and Wynn Macau has yet to even open. Malaysia, Singapore, South Korea, Taiwan and Thailand also are considered potential markets. In the U.K., while the government initially projected that up to 40 new casinos would be developed following gambling deregulation, a government decision last month scaled back those plans. However, that country still figures prominently in the business plans for many of our companies, including Harrah’s/Caesars, MGM MIRAGE, Ameristar and Isle of Capri.

Losing the opportunity for economic growth and jobs is not the only unintended negative consequence of the racino model. Michael Pollock, who analyzes industry trends, recently observed that an increase in purses at tracks may have revitalized certain aspects of racing, but they are now seeing diminishing returns. In other words, slots are accounting for an increasing percentage of total purses while wagering at the track has not increased proportionately. At the outset, no one asked if there should be a limit on the amount that should go toward purses. Now, some are starting to look at more creative ways to use the money that might provide a better return for track owners, such as increasing the number of races, adding to the capital improvement budget and broadcasting races nationally.

According to Mike, states that started out thinking they could run racinos like their lotteries are discovering that they can’t — in other words, they can’t run them as high-tax operations with little capital investment because “for the gaming industry … capital investment is the equivalent of oxygen.”

And while slots initially seemed liked the savior for racetracks, research and experience are showing mixed results. As it turns out, slot players are not wagering on races. A better fit, Mike says, would be table game players, who he believes are more likely to wager on horse racing, and vice-versa.

The lesson learned here is that policy decisions are not always the best business decisions. Arbitrary choices about tax rates, the types of machines that can be played, the number and location of facilities, hours and other operational issues fly in the face of good economics and create an artificial environment where market forces don’t determine success.

It’s a little bit of deja-vu, since we went through similar exercises when gaming was introduced in riverboat markets about a decade ago and in Atlantic City when casinos opened there 25 years ago. States wary of gambling imposed a host of restrictions, most of which have disappeared over the years as policy-makers realized they were not only unnecessary but also counterproductive. To give you an idea of how far these restrictions went, regulators in New Jersey not only controlled things like hours of operation, but also hotel room furnishings. They also required casinos to use smoked glass so you couldn’t actually see in from the outside. They even required those who wanted to become dealers to complete a three-inch-thick disclosure form that asked them to document, among other things, the past four generations of their family and where their ancestors had lived.

Unfortunately, because of stereotypes about our industry, we often face these kinds of obstacles whenever casino gambling is introduced. Adding to that challenge are the constant changes in government. Of course, this is not only an issue at the state level, as I have explained, but also at the federal level. And at no time is this problem more acute than at the beginning of a new session of Congress and a new administration.

Significant personnel changes have been made in the second term of the Bush administration, but it is not yet clear how — or if — those will impact us as an industry. What is more certain is that the start of the 109th Congress has already brought changes in leadership and the makeup of committees that handle gambling-related legislation. The most significant is the ascension of Sen. Harry Reid of Nevada to minority leader in the U.S. Senate. Also, Sen. Ted Stevens of Alaska is taking over the chairmanship of the Commerce Committee from Sen. John McCain, who used his role on that panel to advocate for a bill that would ban college sports wagering. Sen. McCain is now chairman of the Indian Affairs Committee.

Despite these changes, we don’t expect any dramatic shift in the legislative agenda because the bigger picture — control of the White House and Congress — remains the same. Some of the issues we are likely to face in the upcoming session include Internet gambling, sports wagering, taxation, security and immigration issues, although I’m sure there will be unexpected issues as well.

In an industry as dynamic as ours, it’s important to have an ongoing dialogue with legislators like yourselves so that you are always informed when making important policy decisions that can have a dramatic impact on both our business and the fiscal health of your state. As Churchill implied, you have to remain open to new ideas and continue incorporating them into your thinking.