A reasonable and fair tax on skill games will increase funding for the state

By Dr. Peter Zaleski, economics professor at Villanova University and lead consultant at the Philadelphia-area analytics firm Meadows Metrics. Dr. Zaleski is a consultant to Pace-O-Matic.

The Pennsylvania skill game industry has long supported legislation to regulate the market and set a tax rate on their gross revenues. The industry is backing two bills, SB 706 and HB 2075, that would set a reasonable 16% tax on skill game revenue. 

Yet, casino operators in Pennsylvania argue that a tax rate different from what they pay violates constitutional guarantees designed to ensure that taxation is fair. The casinos recently filed a lawsuit asking the court to either force the state to apply the same tax rate (54%) to skill games that is applied to slot machines or to abolish taxes on slot machines altogether. 

There are two main reasons why skill games and casino slot machines should be taxed at different rates. First, skill games are not slot machines as the Pennsylvania Commonwealth Court reaffirmed. Playing a slot machine involves pushing a button and waiting for the outcome. Casinos know exactly how much revenue they can make because the percentage payout is programmed into the machines. For years, casinos have not been sensitive to the tax rate because the profitability of these machines is high even when taxed at 54%. Playing a skill game, on the other hand, involves following instructions and making decisions that influence the outcome. Experienced skill players can win consistently; that is not true for slot machine players. These are two fundamentally different types of games. So, the argument for taxing them at the same rate is unfounded.

Second, the two industries operate under different business models. Casinos’ primary purpose is to provide a place where people can gamble on games of chance. Seventeen casinos operate in Pennsylvania with an average of 1,500 slot machines per location. They are in the business of providing slot machines to their visitors.  

The types of businesses that offer skill games include fraternal organizations (American Legions and VFWs), volunteer fire companies, restaurants, bars and convenience stores. These locations are not in the primary business of providing gaming opportunities. Rather, skill games supplement their income – income on which they already pay taxes.

These locations offer skill games because the games are more profitable than other uses of that floor space. If skill games weren’t profitable, store owners would install something else, shelves of snacks perhaps; restaurants and bars would install a jukebox perhaps; and fraternal organizations would install a pool table perhaps. In other words, skill games are at these locations because they represent the best use of that space. Because of this sensitivity to the profitability of skill games, policymakers must consider how location owners would respond to paying a considerably higher tax on these devices.

Our research estimates that a tax rate of 16% on skill games would maximize tax revenue collected by Pennsylvania. An increase in the tax rate lowers the profitability of the machines. At any higher tax rate, smaller retailers and fraternal organizations would not profit enough from skill games to be worthwhile. As a result, they would likely reduce the number of games. These are businesses that survive thanks to skill game revenue. At a tax rate of 54%, we estimate that skill games would be so unprofitable that they would only be present at larger retailers. The impact of a higher tax would inevitably fall on smaller locations that rely on skill game income the most. Further, some locations may even opt to replace legal, taxable skill games with illegal machines – exacerbating an already growing problem with illegal gambling devices. 

Casinos are large, highly profitable organizations. Skill game locations are small businesses. A state tax rate policy should reflect this difference.