Six principles for successful Internet gambling regulation

Today the Reason Foundation publishes my policy brief on keys to successful state regulation of Internet gambling.

Thanks to a Department of Justice’s December 2011 memo on the parameters of the Wire Act, states can now license real-money intrastate online casino games. Earlier this year, Nevada became the first state to permit online wagering, and in August granted the first online operating license to South Point Poker LLC, which was to have launched trials last month. Since the Reason report went to press, South Point disclosed that its software is still undergoing independent testing but hopes to have its site up by the end of the year.

Elsewhere, Delaware has enacted legislation to authorize online gambling under the auspcies of the state lottery commission and Illinois has begun selling lottery tickets online.

It goes without saying that U.S. citizens should be free to gamble online, just as they legally can in casinos throughout the country. The degree of regulation is subject to debate, but unfortunately remains a necessary element in policy. Yet lessons about taxation and regulation can be learned from experiences in Europe, as well as from regulation of brick-and-mortar casinos in the U.S. With a better understanding of usage trends, consumer game choices and operator cost models, legislators who want to offer constituents the freedom to play online can craft an environment that supports a robust online gaming climate, as opposed to one that drives legitimate operators away.

Regulation should derive from an enlightened approach that respects the responsibility and intelligence of its citizens. Internet gambling can be a safe, secure pastime. Overall, the government’s only goal should be to protect users from theft or fraud. Gambling should not approached as an activity that needs to be controlled or discouraged under the rationale that it is a “sin” (to moralists) or “destructive behavior” (to social utilitarians), and then, hypocritically, politically tolerated so it can be excessively taxed on those rationales.

Although it is likely states will differ in the particulars of how they structure the license and tax arrangements, a successful climate for legalized Internet gambling is likely to derive from the following fundamental principles. Lawmakers should heed the following guidelines:

Create a competitive environment

Consumers are best served when there is ample competition. The greater the competition, the more incentive competing companies have to offer better value-both to win new customers, and to keep existing ones loyal.

The state government itself should not compete for players

As a corollary to the competition guideline, states should not attempt to operate online casinos themselves. They should also be wary of giving incumbent lottery management companies a built-in advantage, such as an automatic license set-aside. Experiences in Europe, where some countries initially granted exclusive Internet poker and other gaming licenses to lottery operators, have shown that such ventures are rarely competitive, are inefficiently run, and do not draw players.

Recognizes intrastate online gambling has different cost structure than brick-and-mortar casinos

States that do not account for the difference in cost models between brick-and-mortar casinos and Internet counterparts are setting themselves up for failure. An Internet gaming site can be established with a capital investment that is a fraction of that required to build a land-based casino. But revenues scale down as well; one reason an online poker room can support penny-ante games. States must grasp the lower revenue and tax expectations and set up tax and licensing structures so they are compatible.

Tax operators not players

On the other hand, states should avoid creative new tax structures purely on the justification that some hold the opinion that gambling is a vice or sin. Players should not be taxed through levies on their accounts or through “hand charges” that are paid directly to the state, as some European countries have attempted (again without success; players migrated to Internet casinos in countries without such taxes). Meanwhile, winning players under law are obliged to report winnings (and are often held accountable though W-2Gs). Anything else is double taxation.

Do not attempt to “protect players from themselves.”

State legislatures tend to have a love/hate relationship with gambling. They covet the tax revenues, yet they believe that they are being “responsible” by creating artificial notions, such as limiting casinos to “riverboats” or out-of-way locations, in the belief that this will somehow either mask or temper the popular appeal of gambling. The ineffectiveness of these measures is seen in how these conventions gradually fall by the wayside. Likewise, regulations that infantilize players, such as a since-revised Missouri rule that limited player chip purchases to $200 per hour, have proved ineffective and easy to defeat.

Don’t discount the market as an effective regulator

The Internet itself offers numerous resources in the form of information sites, message boards and discussion groups where players can exchange information about the quality and reliability of particular sites, the general skill level of players, and any concerns about sites that might be cheating or too tolerant of collusion or poker bots. Independent game analysts have proved adept at identifying problem software and posted their findings.

The return of Internet gambling is only a matter of time; the consumer demand is there and the fiscal situation in many states makes the taxation opportunities attractive. While a number of states will resist, for most, the issue should lead to serious debate. The paper, in addition to making the principled case for legalized Internet gambling, addresses and recommends policy approach with an aim toward creating win-win-win regulatory environments for consumers, game site operators and state governments.

The full report can be downloaded here.