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e Casino Tax Policy: Identifying the issues that will determine the optimal rate By Michael Pollock Managing Director Presented to: NATIONAL TAX ASSOCIATION 103rd ANNUAL CONFERENCE ON TAXATION November
e Casino Tax Policy: Identifying the issues that will determine the optimal rate By Michael Pollock Managing Director Presented to: NATIONAL TAX ASSOCIATION 103rd ANNUAL CONFERENCE ON TAXATION November 18-20, 2010 Hyatt Regency McCormick Place, Chicago Contents ABSTRACT... 4 TAX RATES: POLITICAL CONSIDERATIONS TEND TO DRIVE PROCESS... 5 ECONOMIC CONSIDERATIONS Atlantic City case study: regression analysis...12 Employment: critical factor...23 Case study: Atlantic City hub vs. East Coast spokes...25 Massachusetts case study...30 CONCLUSION ABOUT THIS REPORT Page 2 of 38 Table of figures Figure 1: Capital investment in Atlantic City: Figure 2: Effective tax rates by state 8 Figure 3: Regression analysis: room nights to gaming revenue, 1978 through Figure 4: California slot units and average daily drive-in visitors from southern California to Las Vegas 13 Figure 5: Visitors from California as percentage of total Las Vegas visitation 14 Figure 6: Annual Las Vegas visitation statistics 14 Figure 7: Las Vegas Strip properties opened since Figure 8: GGR for Las Vegas Strip, Reno-Sparks, and Laughlin NV to Figure 9: Hypothetical casino, basic assumptions 16 Figure 10: Hypothetical casino: no rooms, no new competition 16 Figure 11: Hypothetical casino, no rooms, new entry in market 16 Figure 12: Hypothetical casino: new entry, new hotel 17 Figure 13: Multiple scenarios of rooms, GGR per night 17 Figure 14: Multiple scenarios, tax rate vs. GGR 19 Figure 15: Multiple IRR scenarios, incremental GGR and tax rate 20 Figure 16: Multiple IRR scenarios: construction cost and tax rate 20 Figure 19: Casino jobs vs. gaming-revenue tax rate 24 Figure 20: Jobs per casino vs. gaming-revenue tax rate 25 Figure 21: Employment and employee compensation in Atlantic City casinos 26 Figure 22: Employment and Direct Payroll for New Jersey casino industry (2009) 28 Figure 23: Estimated employment levels at regional casinos (non New Jersey) 28 Figure 24: Atlantic City casino industry, in-state spending on goods and services 29 Figure 25: Local and State Government Revenue per year in Massachusetts 32 Figure 26: Changes in revenue for Massachusetts per casino 33 Page 3 of 38 Abstract This paper examines the process by which state Legislatures and others determine tax rates for casino operations. The research demonstrates that such policies, largely based on political and related considerations, fall short of determining an optimal rate. Rather, tax considerations should be based on a broader, more encompassing definition that would examine and project tax revenue from all potential sources. The following report through case studies, interviews, regression analyses and related studies shows that the highest rate is not likely to be the best rate and could be counter-productive. Page 4 of 38 Tax rates: Political considerations tend to drive process The legalization of casino gambling is arguably one of the most critical public policy decisions that state lawmakers will make during their tenure. Such legislation authorizes an entirely new industry that offers a wide range of potential impacts. While lawmakers will pay close attention to many facets of the proposed legislation from the number of casinos to their locations and licensing requirements few lawmakers pay close attention to what is arguably the most essential aspect of gaming legislation: the tax rate on gross gaming revenue. The tax rate on gaming is the most vital public policy decision that legislators will make, as it offers implications in a variety of areas, including: Level and type of capital investment Employment Tourism enhancement Demographic and geographic appeal of a casino The tax rate will help determine the type of business model that casino operators will pursue, yet it is rarely given the proper level of scrutiny. If anything, decisions related to the tax rate are often based on political considerations. In some cases, the importance of the rate as an engine that will guide long-term policy is simply misunderstood. The evidence for that can be found in the overall trend dating back 30 years, in which rates started out in the single digits and then rose consistently, reaching effective tax rates of more than 72 percent. This conclusion is bolstered by a variety of anecdotal evidence as well. For example, when Maryland voters approved a referendum to legalize casinos in 2008, we met shortly thereafter with officials from the Maryland Lottery who were beginning the process of authorizing the casinos, based on a statute that established an effective tax rate of about 70 percent. The officials were concerned that they were not sensing significant interest from potential bidders for the proposed five licenses, with the likelihood of one license receiving no Page 5 of 38 interest at all. Our comment was: The first thing you should do is re-examine the proposed tax rate. After a lengthy pause, the officials responded: What is the second thing we should do? Two years earlier, we held a similar conversation with a Pennsylvania legislator and endeavored to point out that, even though there appeared to be a healthy bidding process underway, the proposed casinos in Pennsylvania would be relatively small, based on the proposed 55 percent tax rate. The legislator responded with a shrug. The message was simply not getting through. We fully appreciate the importance of political considerations in such decisions, and note that such considerations have been a critical factor in gaming legislation for more than 30 years. For example, New Jersey was the first state outside Nevada to legalize casinos, with voters approving a November 1976 referendum to authorize casinos in Atlantic City. The enabling legislation, the Casino Control Act, was approved eight months later, and the first casino opened in May The tax rate in New Jersey was set at 8 percent, which today is the second lowest in the nation (behind Nevada) 1. In researching this paper, we asked Steven P. Perskie who was a member of the state Assembly in 1976 and 1977, and is widely hailed as the architect of the Casino Control Act to provide the thought processes that guided the decision to set the rate at 8 percent. He responded with the following written comment: In researching the drafting of the bill introduced in 1976, after the referendum passed, we found that the highest (combined) tax on gross revenues was 7.5 percent (in Nevada). For principally political reasons, we therefore set the initial rate for New Jersey at 8 percent. We assumed that this would inoculate us from any argument in either direction (that the tax was too high or too low), and indeed we never had to defend that decision. We didn't, at that time, 1 New Jersey also imposes a 1.25 percent reinvestment obligation, which offers casinos a below-market return. We normally calculate the effective overall rate in New Jersey at 8.4 percent. Page 6 of 38 make any effort to calculate the revenue estimates for the state, as we had no idea (and, as experience would show, we had no idea) what we would be dealing with 2. So, New Jersey is hailed as a low-tax haven that has helped attract significant capital investment over the years. The following table shows the level of investment in the casino industry, by the casino industry, in Atlantic City since casino gaming began in Please note, this table shows actual, or nominal, amounts by year, as well as the amounts adjusted for inflation via the Producer Price Index to illustrate the approximate value, in today s dollars, of 30+ years of capital investment by the casino industry. Figure 1: Capital investment in Atlantic City: Year ended Annual Amount (Nominal Cumulative Amount Cumulative Amount Annual Amount (Real $) $) (Nominal $) (Real $) 1978 $52.6 $52.6 $106.8 $ $422.2 $474.8 $820.4 $ $386.9 $861.7 $708.8 $1, $713.7 $1,575.4 $1,249.0 $2, $131.2 $1,706.6 $227.0 $3, $199.8 $1,906.4 $343.1 $3, $602.5 $2,508.9 $1,020.0 $4, $547.6 $3,056.5 $929.8 $5, $182.6 $3,239.1 $315.6 $5, $526.1 $3,765.2 $895.4 $6, $361.6 $4,126.8 $600.6 $7, $298.4 $4,425.2 $479.9 $7, $1,074.6 $5,499.8 $1,683.9 $9, $125.7 $5,625.5 $196.7 $9, $136.4 $5,761.9 $212.5 $9, $198.1 $5,960.1 $305.3 $10, $246.4 $6,206.4 $375.9 $10, $276.2 $6,482.6 $409.6 $10, $541.3 $7,023.9 $786.5 $11, $587.6 $7,611.5 $854.3 $12, $269.0 $7,880.5 $399.8 $12, $200.2 $8,080.7 $295.3 $13, $203.1 $8,283.8 $284.9 $13, $334.0 $8,617.8 $463.6 $13, $462.3 $9,080.2 $656.1 $14, $1,464.3 $10,544.4 $1,975.3 $16, $551.0 $11,095.4 $695.9 $17, $499.5 $11,595.0 $577.5 $17, $792.7 $12,387.7 $858.5 $18, $963.3 $13,351.0 $967.2 $19, $651.3 $14,002.3 $543.2 $20, $85.8 $14,088.1 $85.8 $20, $3,950.4 $4,425.2 $6,769.1 $7, $3,655.5 $8,080.7 $5,519.9 $13, $6,007.4 $14,088.1 $7,108.0 $20,324.2 Source: New Jersey Casino Control Commission 2 from Steven Perskie, sent Aug. 6, 2010 Page 7 of 38 Perskie s comment makes clear that the 8 percent tax rate was based on political, not economic concerns. He wanted the legislation to be inoculated against criticism. This essentially means that, if New Jersey had established casinos later in the process, the rate would have been higher. The following chart shows that the rates in various states have drifted higher over the years, and we suggest similar political considerations were likely at play: Figure 2: Effective tax rates by state Effective tax rate Year gaming was established Nevada 6.80% 1931 New Jersey 8.40% 1978 Iowa 24.00% 1991 Colorado 20.00% 1991 Illinois 50.00% 1991 Iowa 23.20% 1991 Mississippi 12.00% 1992 Rhode Island 72.70% 1992 Louisiana 21.50% 1993 Missouri 21.00% 1994 West Virginia 56.70% 1994 Indiana 40.00% 1995 Delaware 56.90% 1995 Michigan 24.00% 1999 New Mexico 46.00% 1999 New York 65.00% 2004 Oklahoma 41.80% 2005 Maine 49.10% 2005 Florida 50.00% 2006 Pennsylvania 55.00% 2007 Kansas 25.00% 2009 Source: State gaming regulatory agencies, American Gaming Association Notably, this trend is not universal. Kansas, as well as Massachusetts (with a proposed tax rate of 25 percent) and Ohio (with a proposed rate of 33 percent) are coming in much lower than other states that have joined the gaming fraternity in recent years. Note also that the recent decision by certain slots-only states to add table games notably West Virginia, Delaware and Pennsylvania was accompanied by significant reductions Page 8 of 38 in the tax rate on tables, a move that recognizes that labor-intensive table games operate under different profit margins and would not work under tax rates exceeding 40 percent. Still, despite such examples, decisions regarding the tax rate are still made without a complete understanding of the policy implications, and are still guided by political considerations. One further example occurred recently in Indiana, when Spectrum performed a study for the Casino Association of Indiana as to the impending effects of increased competition from neighboring states, particularly Ohio where voters approved a referendum in 2009 authorizing full-service casinos in Columbus, Cleveland, Cincinnati and Toledo. Our report recommended, among other things, that Indiana legislators consider revising their existing tax system for riverboat casinos to encourage capital investment. The present system, adopted in 2002, incorporates a graduated tax rate in which the first $25 million in annual GGR is taxed at 15 percent, and the rate rises to the point where GGR over $600 million (a point never reached in the state) would be taxed at 40 percent, a bracket that was added in We suggested that such a system guides policy decisions by operators in everything from marketing strategies to capital investment, and such decisions are not always in the best interest of the state. As an alternative, we suggested that the state consider a system that allows reductions in tax rates in certain instances as an incentive for capital investment by requiring that operators who seek to participate in any incentives must develop plans as to how they intend to invest in their properties, or otherwise advance public policy in Indiana. Regulators could be empowered to approve such plans. Indiana lawmakers should consider and measure the impact of any potential incentives based on some broad parameters that could include: Will incentives cannibalize, protect or grow existing tax revenues? 3 Indiana Business Review, Spring 2009, The Two-Sided Coin: Casino Gaming and Casino Tax Revenue in Indiana, by Jim Landers, PhD Page 9 of 38 Will incentives lead to additional capital investment in Indiana? Would such incentives increase employment, promote tourism or advance other policy goals? Wherever possible and practical, the burden should be on participating casino operators to demonstrate that incentives would create employment in their region, make them more attractive and ultimately help to ensure their success in an increasingly competitive environment 4. The suggestion was never discussed by Indiana lawmakers, and we were quietly advised that such a suggestion was simply politically untenable even though Indiana would almost inevitably face a significant competitive threat, leading to a decline in revenue, under the present system. This report will endeavor to make clear that decisions with respect to tax rates should be based on complete economic considerations. Economic Considerations The goal in establishing an optimal gaming tax rate for any state would be to optimize revenue from all sources. In other words, a casino that employs more people would generate more tax revenue than one that would not. This would be true regardless of whether the state has a personal income tax. For example, casino employees tend to live within relative close proximity of the casino, thus their overall personal spending would tend to be concentrated in those areas, which creates its own ripple effect by inducing further spending. We also note that an optimal tax rate would be one that maximizes capital investment in a property, rather than one that chokes off capital investment. Capital investment, in our experience, is the lynchpin to generating revenue for both the operator and the public sector. 4 Analyzing Potential Challenges, Opportunities Facing Indiana s Casino Industry, October 19, 2009, p. 8 Page 10 of 38 Capital investment essentially determines the level, type and quality of amenities that can be added. Over time, in market after market, we have seen that a casino property that adds amenities particularly hotel rooms - can help achieve certain results: It helps grow the market, and not simply cannibalize business from competitors. It helps other area businesses by increasing the frequency of visitation, as well as the average length of stay. In turn, this helps generate further investment in such businesses, either through expansions and improvements or by attracting entirely new business development. It prods both competitors and other businesses to invest more capital in their projects to ensure their attractiveness and viability. It can help the local economy in other ways, by helping to attract new market segments. It creates new sources of revenue, including room fees which are then used to market the area, thus generating more overnight visitation. It helps make a market more attractive to visitors, and thus makes a market less vulnerable to competition from other markets. It generates additional revenue for the public sector in areas ranging from property taxes to sales taxes. The phenomenon of effectively using hotel rooms and other non-gaming attractions has the ability to increase operating margins and improve a market s competitive position, which has been proven in various regions, and among different types of properties. One of the more vivid examples of this can be found in Atlantic City, which exhibited growth in annual gaming revenue every year from its inception in 1978 through 2006, although it has declined significantly in the three subsequent years and will decline further in Page 11 of 38 Atlantic City case study: regression analysis Atlantic City is an interesting case study in that it has also shown a significant increase in hotel rooms during that time, going from barely 500 casino hotel rooms in1978 to more than 17,000 as of the end of We performed a regression analysis that examined the relationship between occupied room nights and gross gaming revenue from 1978 through 2009: Figure 3: Regression analysis: room nights to gaming revenue, 1978 through 2009 $6,000 $5,000 gaming revenue (in millions) $4,000 $3,000 $2,000 $1,000 $- - 1,000 2,000 3,000 4,000 5,000 6,000 Occupied room nights (in thousands) Source: New Jersey Division of Taxation, Casino Control Commission Note the close correlation as evidenced by the R 2 value of If we eliminate the last three years (and their revenue declines), the R 2 increases to , an almost perfect correlation. This regression analysis would seem to indicate that each occupied room night in a casino hotel generates about $920 in GGR. That number has to be interpreted carefully. It does not mean that the occupants of each room spend that much on the casino floor. Based on our experience, we interpret that to mean that capital investments in hotel rooms help justify further capital investment in other amenities, from restaurants to retail to Page 12 of 38 entertainment venues. Collectively, that capital investment helps attract more visitors beyond those who stay overnight in casino hotels who then spend more over time. We also offer the example of the Las Vegas casino industry, which has managed to leverage its enormous base of capital to thrive, despite the legalization and dramatic expansion of gaming across the border in its largest feeder market California. The following chart shows that, despite a 250 percent increase in the number California slot machines over the last decade, the drive-in business from southern California to Las Vegas has remained steady. Figure 4: California slot units and average daily drive-in visitors from southern California to Las Vegas No. California slots 80,000 70,000 60,000 50,000 40,000 30,000 35,608 32,696 37,868 38,074 38,799 39,649 40,383 39,808 40,883 45,000 54,479 60,440 62,954 65,725 37,686 39,199 67,672 68,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 No. cars 20,000 10,000 19,137 25,196 10,000 5, * No. slots at California casinos No. cars visiting Las Vegas from Southern California Sources: Las Vegas Convention and Visitors Authority, from average daily automobile traffic on Interstate I-15 at Nevada-California border; Casino City s Indian Gaming Industry Report, Spectrum estimates. * LVCVA changed methodology for counting cars The growth in automobile traffic from southern California to Las Vegas has leveled off but remains high. As the following chart shows, the percentage of visitors who drive in from southern California has held steady, albeit at a lower level than it was prior to the expansion of California casinos. Page 13 of 38 Figure 5: Visitors from California as percentage of total Las Vegas visitation 50% 40% 30% 20% 10% 42% 46% 47% 46% 45% 42% 41% 41% 40% 44% 41% 41% 40% 39% 34% 34% 35% 32% 33% 34% 33% 34% 29% 34% 31% 33% 32% 31% 33% 35% 0% Source: Las Vegas Convention and Visitors Authority data, Spectrum Gaming Group estimates Note, however, that as the following table demonstrates overall visitation to Las Vegas has increased, thus demonstrating that Las Vegas is simply less dependent on California: Figure 6: Annual Las Vegas visitation statistics Avg. visits in past 5 years Avg. visits in past year No. visitors (millions) No. first-time visitors (millions) Source: Las Vegas Convention and Visitors Authority Clearly, capital investment has allowed the Las Vegas casino industry to diversify its customer base and grow, despite the significant expansion of competition within the heart of its largest feeder market. The list of major Las Vegas Strip properties that opened in the last decade
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