Gaming in 2004: Sink or Swim in the Tax Tidal Wave

I appreciate the opportunity to speak with you today on a topic that has consumed our industry for much of the past year and, I expect, will continue that way into 2004. And it’s certainly a pleasure to be here with my old friend Grover, especially because I knew he would be able to offer a fresh perspective on this critical issue for our industry.

A year-and-a-half ago, an op-ed was published in the Washington Times about the legislate-litigate strategy against the snack, fast-food and soft-drink industries, dubbed “Big Fat” by opponents. But it could just as easily have been about the gaming industry. “As budget shortfalls continue to climb,” the op-ed reads, “it is not unreasonable to suspect that tax increases on Big Fat products will win the support of general fund-minded lawmakers, albeit in ‘obesity prevention’ disguise.” It goes on to say this: “Anti-obesity activists, tax-and-spend politicians, and trial lawyers are convinced that Big Fat is the next target for vilification, regulation, tax increases and litigation.” Sound familiar? It should. Not only to those of us in the gaming industry, but also to Grover, who wrote that op-ed.

The past two years have brought a sea change—or more like a tidal wave of change—for our industry, paralleling the experience of so-called “Big Fat.” Spurred by political expediency—and no doubt egged on by gambling opponents—we have seen some policy-makers dial up the rhetoric against our industry. We have seen unheard-of tax rates of 70 percent and higher, along with increasing calls for state-run casinos. And now that trial lawyers have drained tobacco dry, and suits have been filed against “Big Fat,” some are attempting to jump on the gaming industry bandwagon as well.

I’m afraid the climate in 2004 is not much different than last year. Many states across the country are again facing difficult choices. Even though the once-flagging U.S. economy is showing major signs of growth—the stock market is rebounding, businesses are expanding and unemployment levels are falling—governors and state legislators are still facing serious budget deficits that need to be addressed.

But there’s one significant difference: Today we have the benefit of seeing the real impact of last year’s gaming tax increases.

In Illinois, where as you know the state’s top gross gaming tax rate increased last year to an unheard of 70 percent, the governor is now discovering what industry analysts have been predicting since the increase was first proposed: that his plan was fundamentally flawed.

The government can’t saddle an industry with an unfair tax burden and expect “business as usual.” Faced with declining cash flow, casino operators in the state had little choice but to scale back plans for capital investment, reduce operating hours and cut jobs. Across the river at casinos in neighboring St. Louis, where lower admissions fees attracted Illinois gamers, revenues increased 11 percent, while revenues in Illinois were 10 percent lower. The impact has been felt not only by casino operators and their employees but also by the industry’s hundreds of vendors and suppliers in the state.

The unexpected shortfall in gaming tax revenue has left the governor looking for additional sources of tax revenue in 2004. It should come as a surprise to no one that just last week he indicated that he would be receptive to proposals to expand gambling. Additional gambling opportunities—increasing the number of riverboat licenses, adding slots to the tracks or legalizing video poker in bars—could create competitive challenges. Lifting the cap on gaming positions, on the other hand, could bring greater business opportunities. But making predictions on what is going to happen in Illinois is like winning the Pick 6.

The other tax increases came from the unlikeliest of sources: Nevada and New Jersey. The gaming tax rates in these states were the lowest in the nation: 6.25 percent and 8 percent, respectively. With lower tax rates, the industry had invested more heavily in Nevada and New Jersey.

But in a year when a majority of states were facing budget deficits—approaching $70 billion collectively in fiscal year 2004, according to the National Conference of State Legislatures—the economic crises in Nevada and New Jersey were not unique. In an effort to balance the state budget, the Nevada legislature increased the tax on gross gaming revenue 0.5 percent, bringing the rate to 6.75 percent. An increase like this—of just one-half a percentage point—can have a dramatic effect on growth, especially here in Nevada, where gaming is central to the state’s economy. On top of the 0.5 percent increase in the gross gaming tax was a new 10 percent tax on casino entertainment. One industry analyst called Nevada’s tax increase a “huge deal” because “gambling is the lifeblood of [Nevada’s] economy.” Deutsche Bank analyst Marc Falcone called the move a “horrible lesson in upside-down economics.”

In New Jersey, the state approved new taxes on casino revenue in 2003. On top of the 8 percent gaming tax—plus other taxes and fees—Atlantic City casinos now pay a 7.25 percent tax on net income and a 4.25 percent tax on the complimentary rooms and meals for high rollers and other special guests, or “comps.” The impact of this increase was felt even before it took effect. When the New Jersey governor first proposed the tax increase, investors flinched, and casino stock prices fell 6 percent. That’s more than $500 million in capitalized market value. One analyst has predicted that some major Atlantic City casino companies will continue to lose significant market value now that the taxes are in place.

Since the neighboring states of both Maryland and Pennsylvania are seriously considering legalizing racinos, it is imperative that Atlantic City casinos—now more than ever—expand and improve their operations in order to keep customers and attract new ones. Further tax increases will only hinder Atlantic City’s ability to remain competitive, jeopardizing what has been a steady source of revenue for the state—a reality the governor now appears to have recognized. He announced last week that he is no longer pushing for increasing gaming taxes or adding slots to the state’s racetracks—another possible threat to Atlantic City casinos.

The experiences in Illinois, Nevada and New Jersey should serve as cautionary tales for states looking to solve their economic problems with gaming tax revenue. And yet, some states with existing operations still are open to tax increases, while those considering gambling expansion are proposing tax rates or business models that are not economically viable.

In Maryland, after legislative attempts in 2003 failed to bring slots to racetracks, the governor last week proposed the construction of two state-owned slots facilities in addition to four at state racetracks.

This idea of a state-run facility is, on many levels, a bad idea. Every jurisdiction with legalized casino gaming has in place an extensive regulatory regime to ensure fairness of the games, prevent criminal activities and determine the scope of the industry. These regulatory controls are important to ensure public confidence in the integrity of this industry because they create an important system of checks and balances. This system ceases to exist when government and owner become one and the same. Without those checks and balances, you create inherent conflicts of interest in many areas. While the government’s primary responsibility is to protect the public interest through creation and enforcement of the law, the primary ownership goal for any casino model is maximizing profits for shareholders. Governmental ownership would threaten the effective casino regulatory model that ensures public confidence in the integrity of gaming through strict regulation of the casino owners or managers.

Governmental ownership also is totally at odds with the efforts of most legislatures to remove politics and political decision making from the highly regulated business of casino gaming. The few ethical and legal problems that have arisen in the casino industry’s history underscore the merits of an independent gaming board, free from influence of state politics, and the demerits of governmental ownership that would inevitably inject politics into the business of gaming.

There are other more practical business obstacles as well. It would be difficult for the government to effectively compete with commercial casinos in the highly competitive field of casino marketing. How would the public react to millions of public funds being used to draw people to casinos? Governmental ownership also would lead to significant fiscal and political conflicts related to many of the commonly used marketing tools. For example, what would be the public reaction to spending public funds to induce people to gamble through the use of free goods and services (“comps”) paid for by taxpayers?

Beyond these issues, governmental ownership of a casino is a bad idea for the same reasons governmental ownership of any private enterprise is a bad idea. The business of government is and should be government and the creation and enforcement of the law, not running a casino business. Otherwise, why stop with casinos? Why shouldn’t governments own sports teams? Amusement parks?  Airlines? Automobile manufacturers? History has rejected the entire notion of state-owned enterprise.

Despite these powerful arguments against state ownership, Maryland is not alone in pursuing this business model. The governor of Illinois first raised the prospect of a state-owned casino last year, and this year the governor of Kansas has followed suit with a more formal proposal. The mindset in these states is to maximize profits without regard for business or ethical considerations.

This failure to recognize the potential long-term impact of policy decisions has been manifested in other ways as well. As they face acute budget crises, lawmakers are not taking the Illinois lesson to heart: While higher tax rates might seem like the way to bring in more revenue, lower tax rates actually bring greater long-term economic benefits.

That is because the tax rate determines the very nature of the industry. High tax rates suppress capital investment and other expenditures, limiting jobs as well as revenue, thus reducing the potential tax revenue for the state. In short, the tax policy will determine whether the state has “destination type resorts,” which the National Gambling Impact Study Commission praised for their economic benefits, or “convenience-type gaming,” which the commission criticized for not providing a comparable number of good-quality jobs or economic development.

This view is supported by economic analysts and others who follow this industry. In its 2000 annual report, the Missouri Gaming Commission cautioned that tax increases could blunt future tax revenues for the state and discourage investment. A 1998 report by the Council of State Governments urged state officials to consider lower tax rates to encourage investment. Wall Street analysts also have written extensively on this subject, saying that higher taxes deflate return on investment, making our companies’ shareholders less likely to support either new or improved operations.

However, some states debating gambling expansion proposals have not taken this economic reality into account, proposing effective tax rates from 54 percent to 87.5 percent.

Amidst the tax tidal wave, there has been a bright spot. The chairman of a legislative panel on gaming in Mississippi said last month that he doesn’t foresee tax increases on casinos during the next four years. Like Nevada and New Jersey, Mississippi adopted the business model of a lower tax rate and free-market conditions, which has translated into significant economic benefits for the state.

As states deliberate over gambling policies, we are left to consider what the immediate future holds for our industry. Will the lessons of 2003 influence expansion and related policy decisions in 2004? Will some in government continue to use the legislate-litigate strategy on gaming as part of an effort to curb what they perceive as unacceptable behavior? The answers, I believe, are yes and yes. To an extent, though, the outcome can be tempered by our active involvement in the process.

While the AGA doesn’t take a position in any debates over gambling expansion, we have become increasingly involved as an information resource to counter the voodoo economics and fabricated social-cost arguments coming from anti-gaming forces. Last year I appeared as a witness at public hearings in Maryland, Massachusetts, Rhode Island and Pennsylvania to set the record straight on gaming-related issues. Just last week, I was invited to speak in the U.K. before the British Parliament’s Scrutiny Committee on Gambling and at a forum in London for local public officials. Our message is this: The notion that enormous taxes on our industry are justified to balance the budget or to pay for enormous, fabricated social costs is flat-out wrong. While we can’t be the sole solution to economic problems, if we are part of a carefully crafted plan we can bring significant benefits to our host communities.

The challenges we face as an industry in making these arguments are difficult but not insurmountable. A recent statement by a gambling opponent gave a good illustration of the forces at work in every gambling policy debate. Last month he told the Las Vegas Review-Journal that as part of his strategy to curb gambling expansion he would be working to “contain [gambling] and constrain [gambling]”—in other words, advocate for policies, including higher taxes and more regulations, to make our industry less profitable. Just as some lawmakers used “obesity prevention” as a disguise for their support of tax increases on Big Fat products, they will use problem gambling as a justification for gaming tax increases and other onerous, unwarranted policies. Others will support policies that are bad for the state in order to sabotage plans for gambling expansion. For example, recent statements by gambling opponents show that their support for state-owned casinos is intended as a poison pill—the theory being that the pressure to legalize slots will end if private interests that stand to profit from gambling licenses are cut out of the picture. Unfortunately, there will always be an element of political expediency and moral opposition that will interfere with the right business decisions. In 2004, we must continue to articulate our concerns about ill-conceived policy because beneath these debates over gambling expansion are fundamental truths about our business that continue to be lost on too many lawmakers.

I told a group of state legislators last month that they are for all intents and purposes our partners in a business enterprise. When they legalized casino gaming and licensed our companies, there was an implicit contract: We would be allowed to do business in their states in exchange for creating jobs, stimulating capital investment, and, above all, generating tax revenue for various state governmental services and purposes. This may be a hard concept for some to swallow, but they need to recognize that punitive policies against an industry that they themselves have sanctioned will impact their own bottom line.

I think Winston Churchill was on target when he said, “There are two ways of securing cooperation in human action. You get cooperation by controls or you can get it by comprehension.” The obvious solution here is fostering a greater understanding of our business and how it works. If the existing partnership between the states and our industry is to continue to thrive, we need to emphasize the long-term implications of ill-conceived policy decisions. Only then will our industry be able to fulfill its economic promise while states continue to fulfill their obligation, commitment and duty to their citizens.