The economics of casino taxation

Abstract

In this article, a model of the costs of a casino is developed that focuses on the implications for economic welfare of different taxation schemes for casinos. The situation being considered is in a country where casinos cater exclusively to foreign tourists. The goal of the country is to determine the maximum amount of taxes that can be extracted from the activities of this sector under different systems of taxation. When the price of gambling is set by regulation above its competitive level, the economic losses created by excessive investment in the sector can be reduced by taxation. A turnover tax on the amount gambled can maximize both tax revenue and the economic welfare of the country. Due to administrative constraints, a number of countries rely on the taxation of the casinos’ fixed assets or a combination of a turnover tax and a tax on fixed costs. The model is applied to the situation in North Cyprus. The annual economic efficiency loss from its poorly designed tax policies on casino gambling is estimated to be about 0.5% of GDP.

Acknowledgements

The comments and suggestions of Eric Li greatly improved the analysis. In addition Hasan Ulas Altiok provided very helpful assistance in securing the some of the data used in this article.

Notes

¹ In North Cyprus the house take is set at 10% based on a previous regulation made by Turkey prior to their abolishing casinos. In Belize, the casino operators association has set the house take as 15%. In contrast, in the USA the house take is in the order of 3.5% of the amount gambled at website: www.bestpayoutcasinos.net/

² The Globe and Mail (2005) Ontario puts brakes on slot machines, Toronto, Ontario, Canada, 21 January 2005, p. A5; Khaleej Times (2004) Casinos’ number to double after bill, reprinted from Daily Mail, UK, Abu Dhabi, 24 October 2004, p. 24.

³ In North Cyprus, it is against the law for a local resident to enter a casino to gamble. Until recently this was also the law in the Dominican Republic.

⁴ The condition of free entry of casinos into the sector is critical for the subsequent findings in the article. As many tourist destinations allow free entry or actively recruit firms to set up casinos in their regions, we feel that it is important that the economic losses inflicted as a consequence of such policies be clearly understood.

⁵ This is similar to the situation discussed by Mankiw and Whinston (1986).

⁶ In this article we make the simplifying assumption that there is only one size of casino in terms of the fixed costs incurred by casinos in this market. If there are economies of scale in casinos, then if the size of the casino were increased due to greater investment and greater fixed costs, the conclusion of this article would be further strenghtened. There would be a larger welfare gain if there were fewer casinos but each having a larger volume of business and operating more efficiently.

⁷ It is estimated that the investment costs for the equipment in a typical casino with four roulette tables, five gaming tables and 85 slot machines is approximately US$ 520 000. Casino decorations, kitchen, equipment and vehicles bring the total investment costs (excluding the buildings) for such a casino to average US$ 832 000. If an annual user cost of capital of 15% of the value of these assets is assumed, the annual cost of these assets would be US$ 124 800. The rental cost of the building is estimated to be approximately US$ 52 000 per year. The annual cost of the utilities amounts to approximately US$ 31 200 per year, and the fixed labour cost associated with the operation of such a casino is approximately US$ 364 000 per year. The user cost of 15% is based on a real opportunity cost of funds of 10% plus an annual rate economic depreciation of the fixed assets of 5% of their market.

⁸ Casino operators report that as they increase their promotions offering ‘free’ airfares to potential tourists from Turkey to gamble in the casinos of North Cyprus, the proportion of people who accept their offer but spend large amounts of time on the beach increases.

⁹ For casino gambling on riverboats in the US the value of the price elasticity of demand for casino gambling, was found by Thalheimer and Mukhtar (2003) to be approximately −1.0.

¹⁰ In the real world a partial number of casinos such as 6.2 will not exist. However, for the purpose of this illustrative example we have allowed for a fractional number of casinos to exist in order to make the computations easier for the reader to follow.

¹¹ A casino retention rate of 3.6% of the amount gambled is close to what is obtained for casinos in such places like Las Vegas where the rates are set in a more competitive environment (website:www.bestpayoutcasinos.net/).

¹² This tax policy question might arise when either a state or province levies a tax of T* on the fixed costs of casinos (perhaps through its licensing authority), while central government has the authority to levy taxes on the turnover of the casinos.