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Tokin’ gesture

Insight | Analysis

If the legal cannabis market in California is anything to go by, then lowering taxes won’t necessarily mean tax revenue taking a hit, writes Scott Longley, who says states would do well to take note

There are two linked factors that will have an outsized influence on the success of sports betting in the US and both are already in evidence in New Jersey, according to the analysts.

The first and most obvious is the availability of mobile. The figures from February and March both point to a percentage of handle that comes via online at about 80% with the vast majority of this coming via mobile.

Such is the mobile weighting that it is even ahead of the percentage of sports betting conducted via mobile in other much more mature markets such as the UK. It is, as Chad Beynon, gaming analyst with Macquarie in New York, says, a “positive surprise” and higher than expected.

“What is interesting is that there is still a lack of support for mobile in states such as New York,” he adds. “We expect for legislators to take notice of the mobile strength in New Jersey and make it a higher priority.”

As it stands, New York is set to be a retail-only opportunity, a move that Patrick Coffey, gaming analyst at Barclays in London, suggests is less than optimal, and not just in terms of what New York can gain from regulating sports betting.

“There has been some confusion relating to NYC mobile sports betting but the news-flow suggests that New York governor Andrew Cuomo is focused more on retail sports betting rather than online in the short term,” he says. “In our view this will have a detrimental impact on New Jersey retail sports betting, most likely impacting Meadowlands retail betting as we would expect a fair proportion of Meadowlands’ retail customers in New Jersey would be NYC residents.

“More importantly, New York regulating sports betting is a major step on the path of US sports betting being less hope and more tangible opportunity.”

Similar sentiments come from the transatlantic team at Morgan Stanley who, in assessing the prospects for the various players either already in the US market or who are set to launch, suggest that the split between online and retail in New Jersey is a “decent benchmark.”

“It’s clear, in our view, that the US market size will be driven by online availability, and states that want tax revenue are recognizing this,” they wrote in a note published at the start of April.

The onshore draw
There is a direct correlation here between online availability, tax revenue and the degree to which US regulated entities can hope to draw customers onshore after years of playing with offshore sites.

For some insight on how this flow can be influenced by tax rates, the team at Jefferies looked at another current market opening in the US: the rise of legal cannabis.

“Tax rates are a key area of consideration for the size and value of the legal sports betting market,” say the team led by James Wheatcroft in London and David Katz in New York. “If states pitch tax rates too high, then we expect the illegal sports betting market to continue flourishing.”

The Jefferies team go on to point out that history already shows with cannabis that high taxes (pardon the pun) have unintended consequences.

The first area is tax volatility. “Broad-based low tax rates appear to provide a more stable revenue stream,” the analysts say. “Higher taxes applied to smaller tax bases prove more volatile and mean they cannot be relied on for cross funding.”

But perhaps more pertinently for the US gaming scene, the Jefferies team point out that higher taxes could lead to increased black market activity as customers “inevitably prioritise pricing.”

To back up this claim they point to a survey conducted by Eaze Solutions in July last year, which showed that 18% of California respondents made a cannabis purchase from an unlicensed business in the previous three months, and 84% of those are ‘highly likely’ to buy from that source again due to the illicit market having cheaper products and no tax.

The study concluded that a 5% decrease in California marijuana tax rate could drive as much as 23% of black-market customers to buy from licensed cannabis businesses instead.

The Jefferies team then point to evidence produced by the US National Bureau of Economic Research from its paper ‘The Taxation of Recreational Marijuana: Evidence from Washington State’ that shows that consumer demand for marijuana is price-inelastic in the short run, but becomes price-elastic within a few weeks of a price increase.

In other words, it takes time for consumers to become aware of a more competitive offer but once it is put in front of them, they switch.

The good news for proponents of lower gaming taxes is that state politicians appear to be aware of the equation that lower tax rates can lead to higher tax takes. The Jefferies team point to the examples from Oregon, Colorado and Washington where since 2016 tax rates on cannabis have fallen

Table 1: Cannabis tax rates in three US states

State 2016 tax rate 2018 tax rate
Oregon 25 17
Colorado 29 15
Washington 75 37

Source: Jefferies

In gaming, apart from Delaware where the sports betting tax is 50%, states generally have tax rates that fall below the rates for cannabis. New Jersey, for instance, is 7%–the poster child again–while Mississippi is 11% and Nevada is 12%.

Looking ahead, the Jefferies team suggest it is reasonable to expect tax rates in legalized states as coming in at around the 15% mark.

“As we have seen in other regulated gaming markets such as the UK, we would expect taxes to start off relatively low while the market grows and then to rise as the market matures and the market share is dominated by regulated operators.”