Gaming Policy Models, Part 1: Preparing for the Casino
July 2010

Gaming varies widely from state to state and from country to country. As a consequence, regulatory systems can be very similar or significantly different. A unifying factor is often the underlying policy goals. The reasons for, and the policies that underlie, any one jurisdiction’s gaming regulations can be characterized by examining the intended goal for that jurisdiction’s regulatory system as a whole.

Over the past 25 years, I have been fortunate to represent casino companies and governments both in negotiating casino contracts. In most cases, the state government has primary authority to adopt and regulate casino gaming. From my experience, states with the greatest preparation and foresight are more likely to succeed.

A suitable place to start is the state’s preparation in tackling the issue of bringing gaming to its state. One analogy is the purchase of a car. When you go to buy a car, you and the car dealer have a common goal: to have a car change hands. The results, however, may be different than your original expectations. You may go in thinking you want to buy a Ford Taurus with no options but be talked into leasing a BMW instead. While a BMW is a great car, it may not be what you want or need. Why are car dealers so good at up-selling? Because they know far more about selling cars than you do about buying them.

Similarly, to be successful in any negotiation, a state government must understand the motivation of the other party. Casino companies are looking to maximize profits. The question is how the company will go about achieving that goal. First-rate companies do this through long-term planning. They will not take the money and run. Still, the casino’s and the state’s overall objectives may not be the same. For example, the casino company may not want competition, but the state may be better off with multiple competitors. After all, Las Vegas would be much different today if the state had only issued a single license in 1931.

But what is the mindset of most states? In the most basic sense, the state should determine why it wants gambling, what it hopes to attain and how it is going achieve its goals. What I am talking about is not a beauty pageant response to what gaming will bring—raising taxes and increasing employment. While legalizing casinos to solve immediate fiscal problems is in vogue, forward-thinking states are looking at fitting the casino industry into their long-term plans. Surprisingly, most start negotiations with little or no preparation. Returning to my car analogy, car dealers love unprepared customers. These customers end up buying what the dealer wants to sell.

The state should start by considering why it wants the casino. Is it to be an icon of the state to attract tourism? This is the Australian model, which has also been adopted loosely by New Orleans. If this is the state’s approach, the state should consider things like airport improvements, hotel rooms, restaurants, convention areas, entertainment, recreation and marketing. Another consideration is whether the casino will be part of a larger urban renaissance, in which case the state should work with the city to consider architecture and design, signage, project planning, and joint marketing programs. Urban developments can also raise land ownership issues that require planning for land purchase or lease. If job creation is important, the state should consider the casino’s responsibility to hire locally and use local products.

States also need to do their own economic analysis. They need to understand the demand curve for casino gambling. They should know where this demand curve is coming from—either inside or outside of their state boundaries. Obviously, attracting new tourism is better than merely redistributing the money within a community, but establishing a casino also may have beneficial impact if it keeps money in a community that would have otherwise been spent at a casino in a neighboring state. After determining the demand, the state should consider what size casino or the number of casinos best meet those demands. What are projected revenues? What size of capital expenditure is reasonable to expect of the casino company? Based on the projected demographics of the player, where should the casino(s) be located?

A state then needs to fit this information into its own situation. A major issue is how to address the costs associated with major externalities, or what people typically call the negative impacts associated with the expansion or legalization of gambling. What are some of these impacts? First, problem gambling may rise based on the increased availability of gambling. Second, street crime may increase due to larger concentrations of people and potentially changing the nature of the area from a 12-hour day to a 24-hour day. Third, the new casino area may need increased infrastructure, including utilities and roads, and public services such as fire, police and medical. Fourth, the new casino area may have increased environmental impacts such as pollution and litter. Fifth, the industry may attract organized crime if poorly regulated, if not through ownership then through parasitical problems.

Casino companies in it for the long haul will also want to address these issues, because their solutions are consistent with long-term planning. Responsible casino companies are really looking for three things: (1) a secure environment that does not jeopardize their licenses elsewhere; (2) a stable environment where the political winds will not change dramatically and impact their ability to do business; and (3) a place where they can maximize long-term returns.

When a good casino company makes a presentation, they will address many externalities—street crime, infrastructure and organized crime at a minimum. But they also will be willing to address the other issues. Therefore, states must be prepared and as well informed as the casino companies wanting to build in their state and should be prepared to discuss all externalities along with a plan to abate them.

This includes an understanding of these costs, who typically bears these costs, and how money is allocated to pay for the services related to addressing those costs. For example, if new or improved utilities are required for the casino, who is responsible for these services and how are they going to be paid? The same should be considered for police and fire protection, traffic, problem gambling, and the like.

The state is now almost ready to go to negotiations or requests for proposals. But before this happens, the state still needs to consider taxes and regulation. Tax rates are often thrown around without context. For example, can the casino industry support a 20 percent gross revenue tax? Maybe, but maybe not. Some monopoly markets may support a 20 percent tax, but the state needs to understand the relationship between tax and investment. The higher the tax, the lower the bottom-line profit. In a monopoly situation, if the casino company is calculating investment based on return, the higher the tax, the lower the casino company is willing to commit. In a competitive environment, the higher taxes will be passed on to the patrons in the form of higher prices. This could result in lower demand, which is counterproductive to lowering unemployment. Plus, the state needs to consider the patron: Higher pricing of the casino product may be unfair to the patron and actually drive his decision to play in casinos in other states or areas.

When a state begins to figure tax rates, the state must also consider regulatory costs and burdens. Each state that allows gaming has some regulation. The licensee’s cost of compliance with that regulation will vary greatly. Here, there is a delicate balance. Regulation is needed to maintain the integrity of the industry, and both the casino companies and the government share common goals, including assuring integrity of the games, that patrons perceive those games are honest (i.e., not run by criminals), and that the government gets all of its tax revenues. On the other hand, high regulatory costs could burden or destroy the competitiveness of the state’s industry. Regulatory costs are usually fixed costs, and the casinos typically pass these fixed costs on to the patrons in the form of worse odds at the gaming tables and slots. If everyone is subject to the same regulatory fixed costs, however, each casino must compete on a different basis. By way of an example, suppose the cost of doing business in New Jersey is higher than in Nevada. If both are competing for the same patron, Nevada will have the advantage because it can offer better odds and still make the same profit.

The challenge facing all jurisdictions that want to compete for the gaming dollar is to maintain a standard of regulatory control at the absolute lowest cost. This is not easy, particularly because it requires a streamlining of bureaucracy. There are no models to chose from. Anyone who suggests that one needs to choose between the Nevada model or the New Jersey model is misinformed. There are at least 100 different aspects of regulation, and each has at least two, and up to six, options. An example is whether to have a single or competitive market. Both work fine, depending upon what the individual state wants to achieve. For instance, if the goal is to promote tourism, the state may want the casino to serve as an icon. This requires substantial capital that may only be attracted by a monopoly franchise. If, like in Tunica, the goal is to create jobs, more jobs are created by a competitive environment. The point is that everything needs to be tailored to the needs of each individual state. Often, regulation is the most difficult to develop and is usually the most misunderstood.

Once state officials get these issues aligned with state policy goals, then they are in a position to negotiate buying their new car.

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