Tax Refund

***A version of this blog post first appeared as an opinion piece at Bloomberg Tax. You can read that version here.***

At the beginning of “Rounders,” a movie about poker, the lead character describes an important rule of gambling: “If you can’t spot the sucker in your first half hour at the table, then you are the sucker.”

As their governments began legalizing sports betting—which was mostly prohibited outside of Nevada until a Supreme Court case in 2018—policymakers in 18 states sat at tables with representatives of the sports betting industry. Let’s just say the industry found the game to its advantage, and it cost states tens of millions of tax dollars.

The issue is the tax treatment of “free” bets, those “Your first $100 bet on us!” promotions featured in incessant advertisements for sports betting apps.

State taxes on sports betting are typically levied on a sportsbook’s gross gaming revenue after it pays out winning bets. However, some states allow the sportsbook to lower its taxable revenue by the full or partial amount it offered in free bets.

According to data helpfully collected by Legal Sports Report, these deductions typically account for, and thus eliminate, a third of a state’s taxable gross gaming revenue. However, in months when sportsbooks make a major promotional push—like when a state first launches sports betting or around a major event like the Super Bowl—these deductions can account for more than 100 percent of a states’ gross game revenue, meaning the state collects no tax from the betting operators.

For example, over the past 18 months, promotional bets accounted for just over a third of gross gaming revenue in Pennsylvania and Colorado. As a result, Pennsylvania’s tax collections dropped from roughly $308 million to $203 million and Colorado’s fell from about $52 million to $29 million. Not every state reports this data, but the pattern holds in those that do.

In contrast, roughly half the states with sports betting do not allow these deductions. That group includes New York, the state with by far the most tax revenue from sports betting.

The tax revenue that Colorado, Pennsylvania, and other states lose from deductions for promotions are modest in the context of their total tax collections. But that’s just because sports betting taxes only bring in tens of millions of dollars annually in most states. Sports betting is a low-margin business, and the resulting tax collections always will be dwarfed by revenue from lotteries and major state taxes (no matter what your local politician promises).

But small does not mean nothing. So why are states giving this money away?   

Typically, a state offers a tax incentive to keep a business from moving to another state. But sports gambling companies want to operate everywhere. DraftKings and FanDuel are not choosing a location for a new headquarters; they are national operators who want their product in the hands of new customers across the country.

Now, there is textbook argument for the deduction: It provides a more accurate measure of the tax base. However, keep in mind that states levy excise taxes on gambling in part to offset the social cost of gambling. That’s why many states dedicate a portion of the resulting revenue to gambling addiction programs. This tax, like other sin taxes, is about more than economics. States that legalize cannabis don’t subsidize free marijuana giveaways.

As wonderfully detailed in the New York Times, the simple reason why states subsidize free bets to hook new gamblers is policymakers did not fully understand what they were dealing with, and the gambling industry took advantage. Lawmakers were presented with cigars, booze, and promises of revenue windfalls rather than legislative analysis. As one Kansas legislator later explained, the state subsidized free bets because the sports betting companies asked for it.

But after some disappointing revenue reports, lawmakers in states including Colorado and Virginia are clawing back these deductions or eliminating them outright. Others, like Ohio, are raising tax rates as they learn more about the industry and the resulting revenue.

I personally enjoy betting on sports, and of course there are limits to the taxes that states can levy on these companies. But a state’s tax rules should be written to benefit constituents and tax revenue, not the national companies desperate for market access.

The odds are in the states’ favor. Policymakers should learn the rules and bet accordingly.

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