Legalizing Internet Gaming, Part II: State Governments vs. Private Parties

Article originally appeared in Gaming Management on 03/07/11

In our previous article, we described the legal landscape in the U.S. regarding Internet gaming. We explored such federal laws as the Wire Act and the Unlawful Internet Gambling Enforcement Act and described how certain states, such as New Jersey, have sought to legalize intrastate Internet gaming. In this article, we will consider who should operate the online gaming operation if a state decides to legalize intrastate Internet gaming—state government or private parties—and examine the benefits and pitfalls associated with each.

State-run gambling operations are common in the U.S. Many state governments operate their own state lotteries. Moreover, several foreign jurisdictions have launched, or are in the process of launching state-run online gaming operations. For instance, this past July, the British Columbia government launched North America’s first officially sanctioned online casino. This allows British Columbia residents to log on to and play games in five categories, such as casino, bingo and sports lottery. Additionally, the Ontario government is expected to launch a provincially run gaming site that could offer everything from lottery ticket sales to interactive, casino-style games and poker online.

State-run gaming operations have several advantages. They allow the state to receive 100 percent of the net profits derived from online gaming, as opposed to a percentage derived through tax. This additional revenue can be substantial. For instance, officials for the Ontario government estimate that a legalized online gaming operation could add $100 million annually to its provincial coffers. Thus, a state government would have additional funds to invest at its discretion, be it in core public services, such as education, transport and safety, or in specialized programs that address negative externalities caused by gambling.

A state-run online gaming operation may also help garner public confidence in the integrity of the operation. Equally important, a state government can be said to have a vested interest in ensuring that its constituents do not succumb to such vices as gambling addiction, because an increase in problem gambling would lead to a proliferation of crime and the breakdown of the moral fabric of the state. This is a particularly important factor because, according to Michael Graydon, president and CEO of the British Columbia Lottery Corp., research has indicated that online gambling is about 5 percent more addictive than regular gambling.

Having a state-run operator may also reduce the need and cost of regulatory investigation and enforcement, because the government will assign the persons responsible for operating the gaming industry and maintain oversight of its operations. In contrast, a jurisdiction with privatized gaming will have to invest considerable time, resources and money into ensuring that applicants are suitable for licensure, and will have to continually monitor its licensees to ensure they are operating fairly and honestly. Moreover, the efficiency of the regulatory compliance may increase, because the state-run operator will be more cooperative and better coordinated with its sister government agencies that regulate the industry.

With that said, state governments often limit their involvement in the gaming industry to the operation of lotteries for several reasons that are applicable to online gaming.

To begin, public operation of gambling is most easily accomplished when it requires low investment and operator risk, has high margins, can be set up quickly and has few social, law enforcement and control problems. These factors favor state-run lotteries but do not necessarily favor the operation of online gaming. For instance, the costs involved in setting up and maintaining a safe and secure online gaming network that can only accept bets from certain persons who are located within the state may exceed the costs associated with setting up a lottery. Moreover, unlike lotteries that offer high margins, online gaming operations (that offer house banked games) have far greater earnings volatility, which can subject the state to large monetary losses.

If a state-run gaming operation loses money, the state’s funds will ultimately be at jeopardy. A risk will exist, therefore, that the state may have to divert tax revenues from other programs to subsidize these losses. This would effectively negate the generation of state revenue, which is the primary reason for legalizing online gaming. A prime example of a government-run gambling operation that became financially unviable is the New York State’s Off-Track Betting Corp. (OTB). The OTB was forced to shut down after four years of losses totaling $38 million. Despite taking more than $1 billion in bets every year, the OTB was unable to cover its operating costs for years and accrued liabilities of $220 million. Over 1,000 employees lost their jobs and were left without health or pension benefits.

Moreover, state governments, as institutions, are not designed from an entrepreneurial perspective. Specifically, proponents of private ownership assert that a government does not have the expertise to enter the gaming industry (be it land-based or online). As a consequence, a state operator would have to hire, and depend upon, personnel who derive from privatized gaming industries. State operators also may have difficulty recruiting and retaining qualified personnel due to the differences between public and private salaries.

State government operations also face many inherent hurdles. Most notably, government-run operations do not necessarily exude innovation. Having a monopoly of the regulated market only increases the likelihood that the government operations may drift toward the routine. Accordingly, if patrons find the singular government operation to be an unacceptable option, they have no alternatives but to again turn to unregulated sites.

Finally, despite the aforementioned increase in trust in the gaming sites, some believe that the public’s trust in government would be impaired if the government ran gaming operations for profit. Specifically, while government may allow gambling, is it proper activity for the government to promote? If the goal of government is to allow but not encourage gambling, can it both effectively operate a casino and regulate itself? Proponents of private ownership, therefore, argue that state governments cannot promote gambling to increase revenues and also effectively ensure that gaming operations are being run responsibly through programs and regulation designed to address the negative externalities caused by gambling. For instance, people who had previously hesitated about gambling online might be enticed to try out the government-run sites, because they see it as a government-sanctioned activity. This would be especially acute if negative publicity showed that a government-run online operation was the inevitable ruin of a dysfunctional gambler.

To conclude, a state must consider a variety of factors specific to its proposed online gaming industry before deciding whether to operate the industry itself, or to allow privatized operators to do so. These factors include the size of the online gaming industry, the capabilities of the respective state and concern over regulation of the industry. If a suitable system is chosen, the industry will be in a good position to succeed and generate revenue for the state (be it via taxation of a private industry or receipt of all of the revenue as a public industry). If, however, the state does not carefully consider its needs and capabilities in determining the most appropriate system, it may experience not only a loss in revenue, but the integrity and fairness of the online gaming operation will most likely become compromised.

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Karl F. Rutledge
Karl F. Rutledge
Partner, Chair - Commercial Gaming Group

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