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Online Gambling Tax Analysis Appears Promising But Remains Flawed...By Jay Graziani

The current economic slowdown predictably has governments looking for new sources of tax income, and the internet gambling industry seems to be next in the spotlight. Not only does online wagering represent a novel and untapped tax base, but growth in online gambling is apparently recession-proof. To wit, the chief executive of the European Remote Gambling Association said recently that he would "expect to see growth for the industry of around 10 percent this year." In the face of a global recession that has decimated most industries, that's big news.

The push towards legalization has continued on the federal level, with U.S. Representative Barney Frank's (D-MA) "Internet Gambling Regulation and Enforcement Act of 2007" (H.R. 2046) and U.S. Rep. Jim McDermott's (D-WA) companion bill "Internet Gambling Regulation and Tax Enforcement Act of 2008" (H.R. 5523) remaining as the two most significant pieces of online gambling legislation to be introduced on the federal level. Unfortunately, neither bill successfully became law, and both will need to be reintroduced for consideration by Congress, presumably later this year. Together, these bills would establish a regulatory framework for internet gambling within the U.S. and provide a licensing and taxing structure to capture federal revenue.

In September of last year, PriceWaterhouseCoopers (PWC) completed an updated tax estimate of the federal revenue effect of legalizing, regulating, and, most importantly, taxing internet gambling ( A similar analysis was completed in November 2007, but the more recent estimates are about 22% higher due to an increase in the projected growth of online gambling.

The PWC estimates encompass a variety of scenarios which could occur under the Frank and McDermott bills. Two "necessary evil" provisions had to be included in the Frank bill for it to have any chance of receiving the necessary legislative support. First, any state would have the right to opt-out of internet gambling within its borders. Secondly, professional and amateur sports leagues would be able to opt-out, prohibiting online gambling licensees from accepting wagers on any of their games.

Assuming sports leagues opt-out (and most certainly will), PWC estimates federal revenue derived from internet gambling of $0.5 to $2 billion in the first year, and $11-40 billion over the first decade of regulation, depending on how many states actually opt-out. Those are no small beans. Notably, this analysis does not necessarily claim that more gambling activity will take place under legalization. Instead, McDermott implies that the government will just essentially be collecting its "fair share" of tax revenue for activities that are now conducted outside the reach of U.S. tax collectors, underground and offshore. It's no secret that the U.S. Treasury has been quite bitter about the millions in gambling dollars flowing offshore, and regulation is merely an attempt to keep that money within U.S. borders so Uncle Sam can grab his slice of the online wagering pie.

While the PWC analysis has been trumpeted as a convincing boost in the fight for legalization of online gambling, there are at least 3 major flaws in the analysis. First, the figures regarding sports wagering are almost certainly overestimated considering current federal gambling laws. Second, restrictive tax burdens placed upon wagering operations may decrease the attractiveness of online gambling, hindering growth of the industry. Last, a significant portion of gambling activity may remain offshore or underground even in the face of legalization.

The impact of sports leagues opting-in is significant according to the PWC analysis. They estimate $100-500 million more in tax revenue in the first year, and nearly $12 billion in additional revenue over the first decade of legalization, boosting the 10-year total to over $50 billion if all professional leagues were to opt-in. This is 15% to 30% higher tax revenue than scenarios where no sports leagues opt-in. Nonetheless, the major sports leagues, including the NFL and NCAA, have been vocal in their opposition to sports wagering in the U.S, and getting them to opt-in to this program is a long-shot if not an outright impossibility. Those citing the higher, opt-in figures are certainly overestimating the potential tax revenue.

But even with the blessing of the major sports leagues the PWC analysis is overly optimistic. It's not clear if the PWC analysis assumes the repeal of the Professional and Amateur Sports Protection Act of 1992 (PASPA), a federal law which prohibits betting on sports in all but a few states that were grandfathered in under that Act. The Frank bill specifically stated that it would not override existing federal gambling legislation, including the Wire Act and PASPA. Despite the State of New Jersey's recent attempt to overturn PASPA, success is far from guaranteed and sports gambling may remain inaccessible to the majority of the nation for many years to come.

Next, imposing a tax wedge upon a now-unregulated industry may stifle growth or even cause contraction. Licensees will have to strive to turn a profit with the additional imposed tax burden, not to mention any taxes which will certainly be enacted by individual states, as well as licensing fees and costs associated with compliance with federal regulations. These burdens will of course flow downhill to rest squarely upon the players' shoulders.

With McDermott's 2% "deposit tax" and Frank's licensing fees, online gambling providers will have to "up the juice" on their players, offering worse payouts than offshore operators. Las Vegas already rakes their players over the coals on most bets, and a nationalized online gambling structure could be expected to worsen the problem. By the time Uncle Sam grabs his share of the pie, players will be left with unattractive payouts, and deposit bonuses, the backbone of internet gambling marketing over the past decade, will be financially untenable. Forget betting at -105; legalization may very well make -120 the industry standard. Under taxation, growth in the online gambling industry may slow dramatically.

Finally, the PWC analysis seems to assume all current (and projected future) online gambling activity will immediately be funneled into legitimate sources that will be transparent to the IRS, and therefore taxable. This will almost certainly not be the case. The PWC tax estimates derive over 50% of revenue from individual income tax receipts. To think that all gamblers will suddenly start reporting all of their income to the IRS is shockingly naïve.

The increased taxation imposed on licensed operators will make them much less attractive than "illegal" (underground and offshore) providers. And there will be other significant advantages for players to remain underground - higher limits, better odds and betting lines, anonymity, wagering on credit, and avoidance of "compulsive gambling" regulations that may limit transactions, to name just a few.

"Illegal" operators, meaning local bookies and offshore unlicensed sportsbooks, should enjoy a large competitive advantage under the currently proposed framework. While it's easy to say these operators will be excluded from the market, the utter failure of UIGEA in stopping the flow of funds offshore suggests that unlicensed operators will not be shut down easily. Experienced and savvy gamblers will continue to push their action through underground bookies and offshore sites as long as the incentive remains for them to do so.

While the PWC tax analysis may seem to be exciting at first glance, it will generate much less revenue in reality than on paper. Couple that with the significant disadvantages regulation would bear down on individual players, and we once again find that government intervention will do little more than hurt all parties involved. While the Frank and McDermott bills seem to be a step forward, the online gambling industry needs to hold out for much better legislation.

Jay Graziani

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