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Unpleasant truths

Insight | Analysis

Pennsylvania’s hefty tax on slots may weigh heavily on operators’ bottom lines, writes Daniel O’Boyle, but stakeholders in the Keystone State remain confident that they can develop profitable igaming businesses there.

From Governor Tom Wolf signing legislation into law in October 2017, operators had to wait almost two years before regulated online gambling launched in Pennsylvania. Among the initial wave of licensees to go live were Penn National Gaming’s Hollywood Casino, Greenwood Gaming and Entertainment’s Parx Casino and Rush Street Interactive’s SugarHouse Casino.

While there was great excitement around the launch of online casino in New Jersey back in 2013, reaction to the Pennsylvania launch has been muted at best. It may be the largest online casino market to open to date, with the state having 12.1 million inhabitants, but the price of entry appears remarkably high.

Operators must fork out $10m for licenses covering online slots, table games and poker. On top of that, the state imposed an effective tax rate of 54% on slots.

Pennsylvania is not the only state to offer a high rate of tax for online slots. In fact, the figure remains slightly below Delaware’s effective 58% tax rate on both land-based and online machines. Yet compared to New Jersey, the tax rate may appear suffocatingly high when the Garden State’s 17.5% rate is less than a third of what Pennsylvania operators must pay.

While the rate may look extortionate to outsiders, it is not an especially new or surprising figure to those in the commonwealth. In 2004, the state passed the Pennsylvania Race Horse Development and Gaming Act, which legalized land-based slots in Pennsylvania for the first time, but with an identical 54% tax rate. 

“The tax rates are the same,” Parx Casino senior vice president of interactive gaming and sports Matthew Cullen explains. “Whether it’s land-based or online, if you’re operating slots you’re paying 54% of your revenue in tax. We’ve been dealing with giving away 54% of our revenue to taxes for over a decade now, so that’s really just the world that we live in. And being the number one casino in the state and one of the largest on the east coast, we’ve still been able to thrive and I expect that it’ll be the same for online as well.” 

Matthew Cullen, Parx Casino

Cullen concedes that with the majority of revenue being handed over to the state, it’s going to have an impact on profitability, but he argues that to date, it hasn’t proved a drag on Parx’s performance. 

“It’s something we’ve had a chance to adjust to for a while,” he says. “The tax rate has not inhibited us in the 12 years that we’ve been open. We’d love to have a lower rate but it’s not.” 

But for an operator not well-versed in Pennsylvania’s land-based casino market, the tax rate could easily be a dissuading factor for a company targeting an igaming partnership in the Keystone State.

In August, Thomas Winter, senior vice president and general manager of online gaming at New Jersey- based Golden Nugget Casino, told iGB North America that the double whammy of the tax rate and license fees would wipe out profits.

Thomas Winter, Golden Nugget

“We are very excited by the prospect of operating in Pennsylvania because it’s close to New Jersey and the only large online casino market available at the moment,” Winter commented. “That being said, the regulatory costs are extremely high, from the upfront license fee to taxes, which means that profitability will take up to five years to materialize and will likely remain in the single-digit range.”

Cullen says that for Parx, the experience with land-based slots in the state should at least make the early stages easier.

“I wasn’t here when we launched land-based slots, but I would imagine there was an adjustment period with some difficulty where we tried to work out exactly how best to build the business against this tax rate,” he says. “There are of course differences, but having been through it should help us know what we face as we launch online.”

Cullen adds that while he didn’t believe that the rate of tax was driving any players to play unlicensed games or to play elsewhere, it still may cause difficulties to smaller casinos in the state. These venues, he says, may not bring in enough revenue to be able to weather the tax rate in the same way as Parx.

“I do believe dealing with the tax rate would be harder for many of the other casinos in the state for the simple fact they don’t make as much revenue as we do,” Cullen says. “But I don’t believe there is a significant amount of competition between states for online players.

“Players aren’t really driving to New Jersey to play a different operator’s games, no matter how close they are to the state line. And I don’t think that it’s driving people to play unlicensed slots at all, that’s not something I think there’s ever been much reason to worry about.”

When online slots were legalized, there were discussions to offer a lower tax rate, but amid fears that this would have a negative effect on land-based business as players may choose to play online instead of going to a physical casino, the figure remained at 54%. 

“There was actually a lot of debate to change the tax rate and have it slightly different between online and land-based,” Cullen points out. “We actually supported not having a difference, we supported letting the two be on a level playing field. We didn’t want players, or businesses for that matter, to try to push online at the expense of land-based gaming. 

“We wanted to keep land-based competitive even as mobile gaming comes in. A lower tax rate for online slots obviously would have driven much more players, some of which might have been potential land- based customers, to play online. 

“Even though the acquisition costs per player for mobile gaming are definitely more expensive, and the player acquisition process is much more competitive, which was a big part of the argument for why some people wanted them to be different, we thought it was best to keep the tax rate the same for both scenarios.” 

That difference between land-based acquisition costs and mobile acquisition costs can be substantial, however. While a land-based casino tends to spend around 2% of gross gaming revenue on advertising, as the existence of the physical casino location acts as a form of advertising in itself, online operators must spend to attract new players. As a result, igaming operators tend to spend about 25% of gross gaming revenue on online player acquisition in order to build their player databases, according to one industry expert. 

Cullen acknowledges that a lower tax rate would help in player acquisition but believes that developing a strong base of players is still possible with the higher tax rate. 

“Our marketing budget is just as large as other big casinos in jurisdictions where taxes are lower. The tax rate hasn’t made us unable to advertise,” he says. “However, I have to believe that for online slots, because our margin is lower on these games because of the tax rate, that we would have more to spend on marketing if the tax rate were much lower.”

In July, the first month in which igaming was legal in Pennsylvania, interactive slots made $517,712 in gross revenue—and $238,147 after tax. While the amount paid was significant, Cullen says it must be remembered that highly taxed online slots still offer a better opportunity than no online slots. 

“You also have to remember that there was no gaming—with the exception of horse racing—in Pennsylvania before [the Pennsylvania Race Horse Development and Gaming Act],” he explains. 

“So I would think that having slot machines with a high tax rate would have been very preferable to having no slot machines and no revenue at all from slots. 

“Now we have online slots and we have a high tax on the revenue we bring in from online slots,
but that’s preferable to bringing in no revenue from online slots. Unfortunately, just the world that we’re in, sometimes you have to operate against a high tax.”