OBSERVATIONS

Observation: State-Sponsored Gambling: Promise of More Revenue, And More Questions for Policymakers October 2009

State-Sponsored Gambling: Promise of More Revenue and
More Questions for Policymakers

By Jeff Perlee

Jeff Perlee

As states across the country deal with budget problems both chronic and critical, it’s a safe bet that more will give serious consideration to expansion of state-approved and state-sponsored gaming. The reason is simple: Significant new dollars are available.



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Jeff Perlee is an attorney specializing in gaming issues. He is the former chief executive officer of Empire Racing and previously served as general counsel of the Illinois Lottery and director/CEO of the New York Lottery.

Gambling-related revenues are a small share of most states’ overall budgets, and as recent Rockefeller Institute research shows, they are now declining a bit after three decades of uninterrupted growth. But they are nonetheless a consistent revenue stream that in many cases is easier to expand than less popular taxes. Rockefeller Institute research shows that 10 states now collect more than
$1 billion a year in gambling-related revenue, while another seven collect more than $500 million annually. Legal gaming takes place in all but two states (Hawaii and Utah) as a result of state laws, federal approval of Native American casinos, or both.

Today, when most people think of the gaming industry, privately run casinos such as those in Nevada and Atlantic City may come to mind. But private casino operations are found in only 12 states. In these states, most gambling revenues come in the form of special taxes and, in some cases, upfront licensing or authorization fees. Public revenue from privately run casinos fluctuates significantly with the performance of the larger tourism economy, a fact that casino-heavy states like Nevada and Mississippi have come to learn painfully in downturns.

In contrast to the sprinkling of private casinos, more than 40 states feature some form of publicly operated gambling. This sector includes traditional state lotteries as well as racinos (racetrack-based centers with lottery terminals), video-lottery terminals in bars and other public settings, and longstanding pari-mutuel betting at racetracks. Industry estimates indicate that such public gaming accounts for more than 60 percent of all monies legally wagered in the United States.

Government revenues from these public gaming sources generally provide a relatively steady source of revenue which is less susceptible to the fluctuations of a boom-or-bust economy. This may be one reason why Nevada — the birthplace of private casinos in America — is now seriously considering instituting a state lottery.

Historically, public policymakers have been somewhat conservative in efforts to maximize the revenue-raising effectiveness of state-sanctioned gaming operations, because of concerns about pathological gambling and other issues. As one saying in state lottery circles goes, “They expect us to produce, but not really succeed.”

Such ambivalence is particularly in evidence when the economy is booming and public coffers are flush with tax receipts. In such times, states are content to operate their public gaming franchises on a largely
status quo basis characterized by limited investment, little or no new initiatives, and very modest innovation, especially when compared with competing operations in the private sector.

One result of such indifference in boom times has been an accumulation of as-yet untapped opportunities for growth — a lot of upside potential for revenue, in the eyes of many budget directors and elected officials.

It is this perceived opportunity that has led several states to consider fundamental restructurings of their public gaming assets, including lotteries, off-track betting (OTB) and video slot machine programs.

The impetus for the most advanced restructuring plans has been tied to various states’ interests in an immediate, upfront infusion of revenue. In the past two to three years, several states — including New York, Texas and California — have considered proposals designed to generate an immediate lump-sum payment from a private funding source. These proposals involved a securitization of future lottery cash flows by transferring the right to a portion of these cash flows to a newly created trust owned by the state and new investors. In this format the state would continue to operate the lottery while the portion of the cash flows transferred to the trust could be leveraged, thereby producing a large upfront infusion of revenue to the state. Other states — including Indiana, Iowa and Massachusetts — have studied restructurings that would involve an upfront payment with additional yearly payments from improved, outsourced management of the monopoly asset. An October 2008 legal opinion by the U.S. Department of Justice, in response to inquiries from Indiana and New Jersey, said states must “exercise actual control over all significant business decisions made by the lottery enterprise” in order to be exempt from federal laws prohibiting interstate promotion and advertising of lotteries. While the Justice Department decision prompted Indiana Governor Mitch Daniels to drop a proposal to lease the Hoosier Lottery to a private operator, the Obama administration may take a different direction. It’s unlikely we have seen the last of such potentially lucrative proposals.

Whether the preference is for an upfront payment or an increase in the yearly income stream, nearly every state that operates a lottery or OTB can be expected to review the effectiveness of their day-to-day business operations — in some cases looking to outsource management, in others to improve profits from publicly operated gambling activities. This type of business review is routine in private gambling enterprises but has hardly ever been applied to the $60-billion-a-year public gaming sector.

As state decision makers consider options, they face a host of common issues. First and foremost, surprisingly, is the increased role and importance of the federal government.

In-state regulation and operation of gaming has long been an activity reserved to the states. However, as lotteries became dependent on using federally regulated airwaves for marketing — and as the Internet and new gaming technologies make state borders less relevant to the actual transaction — the federal government’s reach and role in state gaming operations has increased.

That role was highlighted earlier this year when House Financial Services Chairman Barney Frank, D-Mass., introduced a bill to legalize Internet gaming transactions beyond the current exemptions granted to the horse racing industry and state-authorized lotteries. It’s been estimated that U.S. consumers wager up to $15 billion illegally online each year — an amount which could well entice states to broaden their own public gaming operations to better regulate this trade and harness these funds toward a public purpose. It remains to be seen which entity of government — the states or the federal government — will take the lead role in this new field.

Beyond the thorny issues of federalism, perhaps the largest challenge facing states interested in capitalizing more on their public gaming assets is the need for greater institutional knowledge and understanding of this field. The smaller, and quite different, private gaming industry enjoys the benefit of scores of high-level managerial consultancies as well as several permanent academic centers and programs focused exclusively on the management and structure of casino operations. In contrast, as states seriously consider fundamental restructurings that will impact tens of billions of dollars in public revenue, they often do so without the benefit of high-level management review or public policy analysis.

This lack of institutional knowledge has been evident in some of the false starts in public gaming restructuring efforts. These include California’s recent lottery “modernization” initiative, an effort that was modern in name only since it involved a series of unimaginative statutory adjustments, at best bringing the California Lottery in line with industry standards circa 1990. That effort, tied to a series of other, unpopular, tax and revenue increases, was defeated by voters in a statewide referendum this past May. In New York and Illinois as well, discussion of monetizing public lottery assets fell apart after supporters floated wildly unrealistic revenue figures and key supporters — Governors Eliot Spitzer and Rod Blagojevich — left office in disgrace.

Yet states’ revenue needs, and the resulting interest in capitalizing on gambling assets, have proven more resilient than the fortunes of any single political figure. In Illinois, Governor Pat Quinn signed legislation that outsources management of the lottery, authorizes Internet lottery sales and makes video gaming terminals legal, all as part of a funding plan for public works projects. Indiana Governor Mitch Daniels and Massachusetts Governor Deval Patrick are among other leaders who have proposed expanding gambling operations in their states.

As states’ tax revenues remain weak and federal stimulus funds dry up, similar measures can be expected to be introduced in other states. Soon legislators across the nation will be grappling with a host of new and important questions which could re-open old and sensitive controversies. Should lotteries and other public gaming assets be updated and modernized? If so, how, by whom and for whose primary benefit? If the federal government allows gambling on the Internet, what is the proper role of the states? More broadly, should states’ primary role be that of regulator or operator?

It remains to be seen whether states will take an analytical or haphazard approach towards these questions. The experience of the last several decades is mixed. As most states embraced off-track betting operations and publicly operated lotteries in recent decades, they did so with a dizzying array of varied enabling and operational frameworks which remain little studied and less understood, despite the billions of dollars they produce. Now as policymakers search for revenue, there’s little doubt that these assets can be made to produce billions of dollars more each year. The big questions: How, and at what cost?

About the Rockefeller Institute of Government

The Nelson A. Rockefeller Institute of Government, the public policy research arm of the State University of New York, conducts fiscal and programmatic research on American state and local governments. It works closely with federal, state, and local government agencies nationally and in New York, and draws on the State University’s rich intellectual resources and on networks of public policy academic experts throughout the country.