A Blog About Online Gaming and Entertainment Regulations
Legal Sports Betting Still Faces Competition From Illegal Market; Low State Taxes Could Turn The Tide
The following blog was first published by Forbes.com earlier this month, available here.
Even amidst the COVID-19 pandemic, states are moving quickly to legalize sports wagering. Indeed, just last month, Washington Governor Jay Inslee signed sports betting into law in that state, in addition to the Virginia state legislature passing a bill.
It is not surprising that even amidst the pandemic, states are still considering joining the approximately 20 states to have already legalized sports wagering since the Supreme Court ruled to allow states to do so in 2018. That is because, with a recession potentially looming, states may be looking for creative ways to replace lost tax revenue.
However, in considering legalizing sports wagering, states must consider a threat facing the legal sports wagering industry: competition from illegal local bookies and offshore operators. Indeed, few industries face competition from the illegal market in the way the emergent legal sports wagering market does. As a result, states seeking to generate tax revenue from sports wagering are, counterintuitively, well-served to consider keeping tax rates low for sports wagering operators. By doing this, states are more likely to drive illegal operators out of the market and increase tax revenues in the long run.
Until recently, the U.S. sports wagering market has been dominated by illegal bookmakers. The legal sports wagering industry has inherently low profit margins (because operators only win slightly more than 50 percent of wagers), and licensed, legal sports wagering operators continue to be squeezed by competition from underground operators. Indeed, because legal operators are subject to state taxes while illegal operators (because they operate outside the reach of state law) evade U.S. taxes altogether, illegal bookmakers possess a competitive advantage. This advantage is likely to enable illegal bookmakers to survive if states tax legal sports wagering at high rates.
Illegal operators can already offer more attractive odds and lines than legal operators—who must build the need to pay taxes into their revenues and, therefore, adjust their odds and lines accordingly—enabling illegal operators to have a better chance to retain high-volume customers. With high tax rates, the lines and odds that legal operators can afford to offer to consumers inherently decrease in attractiveness as compared to their illegal counterparts, further exacerbating illegal operators’ competitive advantage. Indeed, some industry observers believe only about 70 percent of bettors currently in illegal markets would immediately migrate to legal operators, in spite of the clear consumer protection benefits over illegal operators.
“The biggest advantage of the underground bookmaking market has in my opinion is credit,” David Purdum, a writer for ESPN who covers the gaming industry, said. “I think the amount that is bet on credit in the underground market is often underestimated. It’s going to be difficult for regulated U.S. books to overcome, especially if they’re burdened with exorbitant tax rates.”
The threat of the illegal market underscores the importance of keeping tax rates low enough to allow legal operators to win over market share from illegal bookmakers. Law enforcement can, of course, also help crack down on illegal operators, but states have the ability to foster market conditions that enable legal operators to naturally attract consumers.
With little for consumers to wager on today beyond esports, virtual sports, horse racing, and “fringe” sports such as darts or table tennis, it stands to reason that sports wagering stands to come back strong once public health conditions allow it to return.
“There’s little certainty right now, but a case can be made that sports betting, because of its popularity online, could explode post-pandemic,” Purdum said.
As for potential revenue that legal operators could hope to win over from illegal operators, the size of the illegal market has been estimated to be between $50 billion and $200 billion in aggregate bets placed, according to estimates made by such groups as the American Gaming Association, Eilers & Krejcik Gaming, and H2 Gambling Capital.
But these figures only tell a partial story, as the size of the illegal market is not a perfect projection of the potential size of a legal wagering market. Although not all bettors will immediately shift from illegal operators to legal ones, research also indicates that many individuals who do not currently wager on sports would start betting if it became legal. And, similarly, survey results show that gamblers who presently bet through illegal channels would be likely to wager even more with legal operators if sports wagering were to become legal in their state.
Results from a 2018 National Research Group poll illustrate the legal market’s potential:
- Forty-six percent of people who already wager on sports would likely wager more if gambling was legalized.
- Twenty-seven percent of people who watch sports would like to wager on sports if it were to be legalized.
- Thus, if the 46 percent of consumers who already wagered on sports increased the amount they wagered by even 25 percent—assuming those 46 percent represent the “average” bettor—that would represent an estimated increase of between $5.75 billion (from the low estimate of $50 billion) to $23 billion (at the high end) over illegal market estimates.
- Similarly, if the 27 percent of sports fans who currently do not wager but would do so if sports wagering became legal started wagering the “average” amount, that would represent an increase of between $7.8 billion (at the low end) and $31 billion (at the high end) over illegal market estimates.
- Those potential increases, which account for potential gamblers who are currently “on the sidelines” and existing gamblers who would wager more if sports wagering was legalized, suggest the actual increase over illegal market estimates could be between $13.5 and $54 billion.
Given that some industry observers suggest that the size of the illegal market may only represent 20 to 30 percent of the ultimate potential of a nationwide legal sports wagering market, even the projections above may be an underestimate.
Of course, to enable legal operators to maximize revenue and help stamp out illegal bookies, states must keep tax rates reasonable. Even then, it will take time for the illegal market to fade, and that will depend on both legal and economic pressures. But given that the COVID-19 pandemic has essentially caused the sports world to call an indefinite “timeout,” if state regulators craft legislation with an eye toward enabling licensed operators to compete with their illegal counterparts, the eventual resumption of sporting events could lead to an influx of consumers to licensed operators.
(Disclosure: My law firm represents the iDevelopment & Economic Association, a trade association that includes legal sports wagering operators and suppliers.)