Abstract
Highlighted by recent changes enacted by both Tennessee and Ohio, states are continuing to figure out how to best maximize the bang for their buck when it comes to collecting tax revenue from sports wagering operators.
Just like the saying “there is more than one way to skin a cat,” there is most assuredly more than one way to collect tax revenue for sports betting.
More than 30 states and the District of Columbia now have legalized commercial sports wagering, and the rules that come with taxing operator revenue are practically unique from state to state with very little overlap. Regardless of method and rate, there have been plenty of tax receipts generated by sports wagering—the running total is more than $3.8 billion in the post-PASPA (Professional and Amateur Sports Protection Act) era, including more than $1.3 billion in 2023.
Some states have high taxes with no deductions for promotional credit, such as New York and its 51% rate. Others have a high-tax, high-deduction model, with Pennsylvania the leading proponent with a 34% state tax rate while allowing practically unlimited deductions each month.
Some have adopted a hybrid approach in which the percentage of deductions gradually increases over a length of time, or a fixed dollar amount of promotional deductions are allowed. This is true for Connecticut in the case of the former and Louisiana in the latter.
Tennessee and Ohio, however, are the first states in the post-PASPA era to change their tax structure or and/or tax rate after legalization and launch. It is too early to say if either state will achieve its intended goal of higher tax revenues, but both states have left something to be desired when it comes to the finished product currently used.
Let's start with Tennessee, which launched sports wagering in November 2020 with a 20% tax rate on adjusted gross revenue (AGR). That was among the highest rates in the country, but what irritated operators more was the mandatory 10% hold they had to achieve. That is three percentage points (42.9 percent) above the industry standard of 7%, and operators were subject to a $25,000 fine if they failed to achieve that threshold.
Despite the challenge of trying to “win” $10 out of every $100 wagered, which included odds pricing that would be less ideal versus offerings in other states, operators often at least came close to reaching or exceeding that loftier target. In 32 months of wagering when handle and revenue were made available by both the Tennessee Education and Lottery Corporation (TELC) and its successor, the Sports Wagering Council (SWC), operators collectively posted holds of 9% or higher 75% of the time (please see Table 1), and nine of the 11 operators were able to maintain a 10% hold in 2022.
Tennessee Monthly Holds
Additionally, Tennessee sportsbooks outpaced their peers nationwide over the past three years as the hold across the U.S. has risen for a variety of reasons. Neither government agency provides figures by sport category, but it is reasonable to believe Tennessee bettors have mirrored national trends of wagering more on parlays and in-game action—two types of bets that generally favor the house more than single-event wagering.
Volunteer State sportsbooks cleared that 10% threshold in each of the first six months of 2023, and their collective 11.11% hold in the first half of this year was nearly two percentage points higher than the 9.25% attained spanning the rest of the country (please see Table 2).
Tennessee Hold vs. U.S. Hold
Tennessee collected more than $153 million in tax revenues from sports wagering in the first two-plus years of action. It was highlighted by back-to-back months last November and December when the inflow into state coffers topped $9 million for each month.
But the passage of SB 475 in May changed the method of taxation for operators effective July 1. The tradeoff to no longer maintain a 10% hold and the removal of a mandate to have official league data was a 1.85% tax on the amount of wagers accepted monthly. With the change in tax method comes the scrutiny of the potential of Tennessee leaving tax money on the table given its operators have outperformed the national average when it comes to hold.
Using a simple benchmark of $300 million as a monthly handle, a 1.85% tax rate would generate $5.55 million in tax revenue. Under the old method of taxing 20% of gross revenue, operators would require having a collective 9.25% hold to generate that same $5.55 million in tax receipts. If the collective hold is higher, the state misses out on revenue. When bettors fare well, operators are paying more than they would off their revenue.
While past results are not indicators of future outcomes, a look at the six months prior to the changeover showed that the 20% tax on adjusted gross revenue generated nearly 12.1% more tax revenue—approximately $4.4 million—than what would have been generated with the 1.85% tax on handle because of operator performance (please see Table 3). While the handle tax would have generated more revenue in January because the hold on AGR came out to 8.85%, it was 9.7% and higher in the other five months, highlighted by a 12.77%-win rate in May.
20% Revenue Tax Rate vs. 1.85% Handle Tax Rate
That month, the 20% tax rate on revenue created a spread of nearly $2 million between the two methods. Given the national hold outside Tennessee for July nearly reached 10.5%, it is a reasonable assumption that operators in the Volunteer State would have surpassed 9.25% and thus paid less in taxes than it would have under the new method.
Unfortunately, there will be little more than assumptions of which method is better as opposed to direct comparisons since the Sports Wagering Council opted not to publish collective operator revenue totals in its published monthly reports. This will also give pause to other states who may consider this method of taxation as an option.
Ohio launched sports wagering in grandiose fashion to ring in 2023 with the largest simultaneous multi-operator launch in the post-PASPA era. Operators could look past not being able to deduct promotional credits for the first four years of wagering since the tax rate was an industry-friendly 10%.
When the Buckeye State set a national record for monthly operator revenue in its debut with close to $209 million, early lamentations over lost potential revenue were to be expected. The decision to double the tax rate, though, was unilaterally pushed through Ohio's budget by Gov. Mike DeWine, more as a message for operators to both work within the state's regulatory framework and ease up on the relentless ad campaigns that come with launching in a new state.
The occurrence of advertising saturation should not have surprised DeWine or any Ohio resident given it is status quo that comes with a launch in a new marketplace. And when the marketplace contained 16 mobile sportsbooks, it is understandable that a feeling of not being able to escape offers and promotions over the airwaves would exist. The ads remain popular and—for operators—needed during a cycle in which they ramp up during the late summer ahead of the NFL season, carry into the fall and winter, and reach a crescendo with the Super Bowl.
The new rate took effect July 1, and the state received nearly $7.5 million worth of tax receipts in the first month of wagering with the 20% tax. It stands to reason Ohio will see plenty of additional tax revenue from the doubling of the rate, but if there is a saving grace for operators to DeWine's move, it is that it can be undone after a study is performed by a commission.
But even if it is rescinded or negotiated downward to a “middle ground” of 15%, the impact on smaller operators may wind up having the state pay a bigger price in the medium or longer term than the state collecting more money as those increased tax payments would have come at the expense of advertising and promotional credits that could have been put towards bettors.
It is already challenging enough to have sports wagering be a successful endeavor on either side, be it operator or state, but antagonizing the very people you want to conduct the business that generates a relatively low-maintenance stream of tax revenue is not a winning bet for anyone involved.