January 20, 2023 Sports Betting, Casino, Legal, Online, Finance

US gambling's illegal gray market

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As highlighted by an American Gaming Association report, the gray market is siphoning hundreds of millions from regulated industries. Gaming America asks - what should be done about this?

The regulated US gaming industry is considered to be one of the most highly supervised sectors in the nation. However, the patchwork, staggered nature of gaming legalization across the States has exacerbated the impact of numerous illegal or ‘gray’ markets – where is no way to enforce standards in these spaces.Illegal and unregulated gambling operators often base their headquarters offshore from where they offer their services. This undermines the economic and tax contributions of the legal gaming industry, and also puts illegal operators in a position to flaunt regulations.

The demand for gambling in states where it remains illegal is huge. This is evidenced by the amount that Americans bet with illegal and unregulated operators – $511bn according to a recent report by the American Gaming Association (AGA). In total, unregulated markets have cost the legal gaming industry $44.2bn in gaming revenue and states $13.3bn in lost tax revenue, as per the AGA.

ILLEGAL SPORTS WAGERING – A RISKY BET

Sports wagering is one area where the effects of a lack of regulation are painfully evident. Americans have wagered an estimated $63.8bn on sports with illegal bookies at the opportunity cost of $3.8bn in gaming revenue and $700m in state taxes. With Americans projected to have cast $100bn in legal sports wagers by the end of 2022, these findings indicate that illegal sportsbook operators have seized almost 40% of the US sports betting market.

"A lower number of legal outlets creates increased demand and supply of gray market betting markets. So, although it may seem counterintuitive, states may be well-served to keep tax rates low for sportsbooks."

Legal sports betting is an industry that has accelerated immensely in the past few years, with Massachusetts, Maine and Kansas joining the list of states where it has been legalized in 2022. This means that a strong majority (30+) of US states have legalized some form of sports betting, with a lot of excitement surroundin Ohio's recent launch.

Some experts say this only makes sports betting more enticing to those who are living in states where it is illegal – demonstrated by the $63.8bn wagered at illegal bookies. And illegal operators are becoming savvier at appearing to be legitimate.

Almost half (49%) of past-year bettors used illegal operators, and an AGA report shows that nearly half of these gamblers believed they were wagering legally.Experts have expressed concern over the potential impact of the illegal gray betting market on the integrity of sports. Illegal sports betting is often associated with match-fixing and other forms of corruption. Since these activities are not monitored or regulated by the government, it is difficult to gauge the full extent of their impact.

Furthermore, illegal betting markets can put athletes at risk of exploitation. In some cases, athletes may be coerced into participating in illicit activities in exchange for money. The Alcohol and Gaming Commission of Ontario (AGCO) recently told gaming operators to halt wagering on the UFC due to non-compliance with its standards. The organization was informed of publicized alleged incidents, including insider betting and reports of suspicious betting patterns in multiple UFC events. Ontario’s no-nonsense approach to the matter demonstrates why North American regulated betting is so highly regarded. These illicit practices are more likely to occur in unregulated markets, where organizations like the AGCO don’t have authority.

"AGA found that, in the past 12 months, slot machines in Nevada have an operator win rate of 7.16% compared to the 25% average win rate on unregulated machines. This demonstrates how regulation lowers the exploitation of gamblers."

THE LARGEST UNREGULATED MARKET – ICASINO GAMING

When the overturning of PASPA in 2018 enabled states to allow legal sports betting, most expected to see a greater rate of iGaming adoption to accompany it. However, iGaming has achieved legality in only seven states compared to the 30 states that offer sports betting.

TransUnion Senior Manager of Strategic Planning, US Gaming, Declan Raines (see more on page 22), notes that in the six states (Connecticut, Delaware, Michigan, New Jersey, Pennsylvania and West Virginia) where iGaming was legal in 2021, it generated $970m in tax revenue – compared to $560m for sports betting in 30 states. The appeal of iGaming is so overwhelming that desire for these games spills outside the confines of land-based casinos, often to nearby retail and travel locations with heavy footfall.

A single airport slot operator, Airport Slot Concession, in Las Vegas reported it had broken the $1bn all-time milestone in November 2022. It did so by operating 1,400 slot machines at Harry Reid International Airport. IGaming’s popularity in the regulated market translates to its dominion over the gray market. Americans wagered $337.9bn on illegal iCasino websites, with a potential loss of $3.9bn in state tax revenue from $13.5bn in estimated revenue.

The 5,284 participants in the AGA’s survey were asked which of 22 prominent online slots and table games providers they gambled with. The results showed that 52% gambled in legal channels only, 30% gambled in illegal channels and the remaining 18% gambled in a mix of both legal and illegal channels.Americans bet over $337.9bn a year with illegal operators, costing the legal industry $13.5bn in revenue and state governments a $5bn loss in potential tax revenue.

GOING IN FOR THE SKILL

Unregulated gaming machines are also often known as ‘skill machines’ and they are located in commonplace locations across the US, such as convenience stores and bars. The prolific nature of these devices was shown in the AGA’s report, which estimated there were 580,651 unregulated machines in the US.

With 870,000 regulated machines statewide that would mean 40% of all gaming machines in the US are unlicensed. These illegal machines aren’t subject to the same standards as regulated ones, meaning they can take advantage of customers. AGA found that, in the past 12 months, slot machines in Nevada have an operator win rate of 7.16% compared to the 25% average win rate on unregulated machines. This demonstrates how regulation lowers the exploitation of gamblers.

Another downside of the gray market for skill machine gaming is the level of criminality that it ushers along with it. For instance, a lawsuit was filed against slot manufacturers and a store in Hazelton, Pennsylvania over the murder of a store clerk in November. The lawsuit argued that the illegal nature of the slot operation meant that it did not have proper security measures in place, making it an obvious target for armed robbers.

HOW TO TACKLE THE GRAY MARKET?

The most obvious answer to how to eradicate gray or black markets of any kind is to legalize the product they are profiting and pilfering from. However, since PASPA’s overturning, we have seen four years of a disparate legalization process in certain states – this should not be expected to accelerate with immediate effect in states likes California or Texas, for example. A more common-sense solution for the moment is for stakeholders with an interest in the regulated gaming industry – and the tax revenue that comes with it – to band together and crack down on the gray market.

"Sports wagering is one area where the effects of a lack of regulation are painfully evident. Americans have wagered an estimated $63.8bn on sports with illegal bookies at the opportunity cost of $3.8bn in gaming revenue and $700m in state taxes."

One way to do this on a state level is to lower tax rates for gaming operators, which may be a bitter pill for some legislators to swallow – but should make economic sense in the long run. For instance, New York’s aggressively high tax rate of 51% on sports betting means that only nine sportsbooks are able to operate there. New Jersey, meanwhile, has 17 legal sportsbooks with a tax rate of 14.25% (which is closer to the average national sports betting tax rate).

A lower number of legal outlets creates increased demand and supply of gray market betting markets. So, although it may seem counterintuitive, states may be well-served to keep tax rates low for sportsbooks. In doing so, they are more likely to drive illegal operators from the market and increase tax revenues in the long term. AGA President and CEO Bill Miller commented: “All stakeholders – policymakers, law enforcement, regulators, legal businesses – must work together to root out the illegal and unregulated gambling market. This is a fight we’re in for the long haul to protect consumers, support communities and defend the law-abiding members of our industry.”

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