States Should Get All the Facts Before Subsidizing ‘Free Bets’

At the beginning of “Rounders,” a movie about poker, the lead character describes an important rule of gambling: “If you can’t spot the sucker in your first half hour at the table, then you are the sucker.”

As their governments began to legalize sports betting following Murphy v. National Collegiate Athletic Association in 2018, policymakers in many states sat at tables with representatives of the sports betting industry. The industry won big in those discussions, and it cost states tens of millions of tax dollars.

The issue is the tax treatment of “free bets,” those “Your first $100 bet on us!” promotions featured in incessant advertisements for sports betting apps.

State taxes on sports betting typically are levied on a sportsbook’s gross gaming revenue after it pays out winning bets. However, some states allow the sportsbook to lower its taxable revenue by the full or partial amount it offered in free bets.

These deductions usually eliminate a third of a state’s taxable gross gaming revenue, according to data collected by Legal Sports Report. However, when sportsbooks make a major promotional push—around a major event such as the Super Bowl, for example—these deductions can account for more than 100% of a state’s gross game revenue, meaning the state collects no tax from the betting operators.

And that cuts into tax collections. For example, Legal Sports Report found that deductions for promotional plays dropped Pennsylvania’s tax collections to $203 million from roughly $308 million, and Colorado’s fell to $29 million from about $52 million. Not every state reports this data, but the pattern holds in those that do.

In contrast, roughly half the states with sports betting don’t allow these deductions. That group includes New York, the state with by far the most tax revenue from sports betting.

The tax revenue that Colorado, Pennsylvania, and other states lose from deductions for promotions are modest in the context of their total tax collections. But that’s because sports betting taxes only bring in tens of millions of dollars annually in most states. Sports betting is a low-margin business, and the resulting tax collections always will be dwarfed by revenue from lotteries and major state taxes.

But small doesn’t mean inconsequential. So why are states giving this money away?

Generally, a state offers a tax incentive to keep a business from moving to another state. But sports gambling companies want to operate everywhere. DraftKings and FanDuel aren’t choosing a location for a new headquarters. They’re national operators that want their product in the hands of new customers across the country.

One textbook argument for the deduction is that it provides a more accurate measure of the tax base. However, states levy excise taxes on gambling in part to offset the social cost of gambling. That’s why many states dedicate a portion of the resulting revenue to gambling addiction programs. This tax, like other sin taxes, is about more than economics. States that legalize cannabis don’t subsidize free marijuana giveaways.

The simple reason states subsidize free bets to hook new gamblers is that policymakers didn’t fully understand what they were dealing with, and the gambling industry took advantage.

Lawmakers were presented with cigars, booze, and promises of revenue windfalls rather than legislative analysis. As one Kansas legislator later explained, the state subsidized free bets because the sports betting companies asked for it.

But after some disappointing revenue reports, lawmakers in states including Colorado and Virginia are clawing back these deductions or eliminating them outright. Others, such as Ohio, are raising tax rates as they learn more about the industry and the resulting revenue.

It’s an encouraging development. A state’s tax rules should be written to benefit constituents and tax revenue, not the national companies desperate for market access.

The odds are in the states’ favor. Policymakers should learn the rules and bet accordingly.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Richard C. Auxier is a senior policy associate in the Urban-Brookings Tax Policy Center. His work focuses on state and local tax policy, budgets, and other finance issues.

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