How PA Is Hurting Its Online Gambling Industry Before It Even Starts

The bad news is the state has saddled its prospective online casino operators with an exorbitant tax rate on their online slot revenue.

At 54 percent, the rate is more than double where operators have stated they’re comfortable. It could lead to fewer licensees and almost certainly less revenue for the operators and the state.

Here’s why.

Slots are the revenue king

Slots account for about 70 percent of all online gaming revenue in New Jersey. Table games account for about 20 percent of revenue and poker the final 10 percent.

Pennsylvania will likely be less reliant on slots for a couple reasons.

With an interstate agreement between New Jersey and Nevada in the offing, the market conditions for online poker will be much improved over the current situation in New Jersey. It’s conceivable that if Pennsylvania joins the New Jersey-Nevada-Delaware coalition, it could see online poker account for 15 percent, or possibly even 20 percent, of total online gambling revenue.

Second, if Pennsylvania’s online operators emphasize table games over slots, they might be able to bring the table game number up to 25 percent.

However, even under these ideal conditions, slots are still 55 to 60 percent of all online revenue. Based on this slightly tweaked New Jersey model, a Pennsylvania operator generating $25 million annually would be paying the following rates:

• 54 percent on $15 million
• 16 percent on $10 million

That’s an average tax rate of 39 percent on all online revenue. New Jersey operators, by contrast, pay a flat 17.5 percent.

Licensing fee is a hidden tax

The licensing fee is also much higher in Pennsylvania — $10 million (and as high as $12 million) compared to $400,000 paid by online operators in New Jersey.

If we space the cost out over five years, Pennsylvania online operators are essentially paying $2 million in taxes before they take a single wager, every year for the first five years. That’s five times as much as New Jersey operators.

Going back to our average Pennsylvania online casino operator with yearly revenue of $25 million, the licensing fee is akin to paying an eight percent tax.

Not enough meat on the bone

At the end of the day, the burdensome tax on slots, coupled with the sky-high licensing fee would lead to obligations (a combination of taxes, licensing fees and other regulatory costs) of around 50 percent for our hypothetical Pennsylvania online operator.

In New Jersey, the same obligations work out to around 20 percent. That means the tax rate and licensing fee is 30 percent more in Pennsylvania. And that difference is impossible to overcome.

As we’ve documented in the past, the top operators in the New Jersey market have EBIDTA margins in the 10-15 percent range. And the ceiling is likely near 20 percent.

No matter what Pennsylvania operators do, the 30 percent difference between Pennsylvania and New Jersey is too much to overcome. It’s virtually impossible for PA operators to turn a profit.

Will the licenses sell out?

Because it’s created an unfavorable climate for operators, instead of selling online gambling licenses like hotcakes, the state could find itself with multiple unclaimed licenses following the application period. That will happen despite the state wisely deciding not to limit operator licenses to in-state, land-based casinos.

There is the possibility Pennsylvania’s casinos will decide to buy the licenses defensively, to keep out-of-state companies from entering the market. They might also decide to grab a license now, hoping the legislature corrects the tax rate at a later time.

Still, that doesn’t change the fact that the hefty upfront fee and the tax rate of 54 percent on slots makes it virtually impossible for any operator offering all three verticals (slots, table games, and poker) to realize a profit in its first five years. Even in year six, when the burden of the licensing fee has been fully amortized, they’d be lucky to break even.

Because of this, instead of collecting an estimated $100 million (per the state’s fiscal note), and as high as $140 million in licensing fees in a very favorable climate, the state might only realize $80 million in upfront licensing fees.

Here are three possible scenarios:

Favorable market conditions

If casinos claim all the licenses through a combination of in-state and out-of-state casinos, the state would collect about $140 million from licensing fees:

• $100 million from 10 casinos paying $10 million for the triple-license.
• $24 million from other entities paying $4 million for each of the remaining six licenses (two from each category).
• $16 million from the $1 million fee for a platform provider license.

Neutral market conditions

In this scenario, most of the licenses are claimed (multiple casinos would likely pass on online poker and maybe slots due to the tax rate), and the state would bring in $100 million in upfront licensing fees:

• $60 million from eight casinos paying $10 million for the triple-license.
• $28 million from other entities paying $4 million for each of the remaining six licenses (two from each category).
• $12 million from the $1 million fee for a platform provider license.

Poor market conditions

Under this scenario, around half of the licenses are claimed, and the state would collect around $80 million from licensing fees:

• $50 million from five casinos paying $10 million for the triple-license.
• $20 million from other entities paying $4 million for each of the remaining six licenses (two from each category).
• $10 million from the $1 million fee for a platform provider license.

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Poor market conditions will lead to less revenue

Even if all the licenses are claimed, the operators will all be resigned to hemorrhaging money for the foreseeable future. Gross gaming revenues would come in much lower than expected.

Operators will have to cut costs somewhere, and that will likely lead to less marketing and fewer customer-friendly offers.

Instead of the $70-$80 million in recurring revenue it anticipates — the figure analysts predicted if the state went with a more reasonable slot tax rate — Pennsylvania might realize only half that projection.

Bottom line

In the end, the decision to increase the state’s cut of revenue with a high tax rate will likely backfire. Pennsylvania is almost certainly going to receive less tax revenue. And the state could cause some potential operators to sit on the sideline.

The one saving grace is lawmakers could decide to correct this at a later date.