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J. Patrick Coolican

Economists: Casinos would shrug off tax hike

15 October 2007

and Liz Benston

LAS VEGAS, Nevada -- When the state teachers union announced it wants voters to approve a 3 percentage point increase in the gaming tax, MGM Mirage Chief Executive Terry Lanni offered a stark warning: "It would drive investment out of Nevada."

Lanni and other gaming executives said even a 3-cent-on-the-dollar increase in the gaming tax could radically alter casino finances and persuade the companies to build smaller, or not build at all.

It was smart politics, wagging a finger at a public heavily reliant on the gaming and tourism industries and grown rosy-cheeked with the recent flush times.

But it was also an overwrought scenario, according to economists who study gaming and tourism.

Although these economists question whether the gaming tax increase is smart tax or education policy, they doubt the increase would significantly affect the companies' bottom line, and thus, investment decisions.

Here's why:

With its smart marketing campaign, Las Vegas has become a unique consumer good, a place that evokes among visitors a mysterious feeling of freedom and glamour. And it's a feeling they can experience only here.

So they arrive in larger numbers every year. Even as the price of a stay in Las Vegas has skyrocketed, visitor volume has increased by one-third in 10 years.

Economists call this phenomenon "inelasticity of demand." As with a life-saving drug sold only at a single pharmacy, price appears to have little effect on the demand for the Vegas experience, especially for the fairly well-off, who are the Strip's most-sought customers.

This explains, for instance, the preposterous price of a bottle of vodka at a Las Vegas nightclub.

In other words, if the tax is increased, the casino resorts should have little problem passing on the cost to the consumer, who has shown a continued willingness to put up with higher prices. With their profit pool untouched, the companies will have the same pot of money to invest in future projects.

James Mak is a University of Hawaii tourism economist who's written a college textbook on the subject. He studied room occupancy and money spent by tourists in Hawaii after the state levied its first 5 cent room tax in the mid-1980s. The tax had no effect on either, he found.

He said he would expect the same in Las Vegas: "You have a fairly irreplaceable product. So in that sense, I can't see a measurable impact on the bottom line."

Keith Schwer, director of UNLV's Center for Business and Economic Research , who studies the industry, said the tax might hurt more gaming-dependent downtown operators, but otherwise agreed with Mak's sentiment.

Moreover, while adding 3 percentage points to the gaming tax would amount to a 44 percent increase - from 6.75 percent to 9.75 percent - Nevada operators would still be left with one of the lowest gaming taxes in the nation while facing no corporate income tax, unlike in competing states such as New Jersey.

Other states collect higher gaming taxes but, in exchange, limit the number of gaming licenses - and competition.

Finally, gaming revenue accounts for only about 40 percent of Strip resorts' overall profits, as business from rooms, restaurants, bars and showrooms grows in importance. In other words, a gaming tax increase would have much less effect on the big industry players than it would have a decade ago, when nearly 60 percent of revenue was taxable gambling money.

Wall Street was less sanguine about the tax increase.

For casino operators, a 3 percentage point increase in gaming taxes would roughly yield an 11 percent decline in operating profit, according to Deutsche Bank, one of the gaming industry's top lenders.

"The current development pipeline, which would create more than 124,000 jobs and countless billions in economic benefits, could be cut significantly as future projects won't pencil given that returns on investment are already quite thin," said Bill Lerner, a stock analyst with Deutsche Bank. "Further, existing casinos ... would likely have to cut jobs, resulting in diminished service levels, which longer-term could turn visitors away."

Dennis Farrell, a bond analyst with Wachovia Securities, said resort operators would be cautious about further boosting room rates because room prices will already be high to pay for the new developments. Cutting labor costs by automating casino floors with new technology would make more sense, he said.

Jane Pedreira, a bond analyst with Lehman Bros., said the tax hike would hurt marginal operators, "but the big guys will survive and perhaps find ways to innovate and save money."

Some analysts warned the tax increase could have a psychological effect with economic consequences.

A gaming tax increase of more than 1 percentage point could rile public and private gaming investors accustomed to Nevada's relatively stable tax rate, Farrell said. Investment banks and funds sink their money into casinos because they expect a certain profit margin. Investors who are expecting a 25 percent return will be unhappy if their return is now 20 percent - even if it's better than that of most other kinds of businesses, such as retail and restaurant chains that operate with razor-thin margins, he said.

That could affect lending and stock prices, and, indirectly, future spending, he said.

Bill Eadington, director of UNR's Institute for the Study of Gambling and Commercial Gaming, said the larger companies on the Strip could probably absorb the tax increase, although a rise in the gaming tax would clearly be a consideration when companies consider expanding here.

But whether you believe the economists or the brokerage analysts, on the subject of Nevada's tax system, there's far more agreement: The state can't continue to stanch the bleeding every few years by going back to gaming.

Although the portion of the general fund from gaming taxes has decreased from 39 percent to 28 percent during the past decade, the state's budget is as reliant as ever on tourism because of how it generates sales tax revenue. According to one estimate by Las Vegas consulting firm Applied Analysis, the gaming companies are responsible for 48 percent of the state's general fund.

"The idea that any one industry is an ATM machine, that's not good government," Schwer said.

And even if gaming executives are crying wolf, they and their investors are right to demand some predictability in the state's tax system. If they fear the voters will return to them every few years for another 3 percentage point pop for schools or roads or hospitals, they may begin to fear Nevada as a volatile place to do business.

"It's the principle of the tax, rather than the cost, that would be most troubling," said Bill Carroll, an economics professor at Cornell University.

Michael Mazerov, a senior fellow and state tax policy analyst at the Washington, D.C.-based Center on Budget and Policy Priorities, laughed when asked whether Nevada has a sound tax system.

"I'm laughing because a state with no personal or corporate income tax by definition doesn't have a tax system that makes sense," he said. He pointed to Utah and Arizona as high-growth Western states with corporate income taxes.

Income taxes are stable and better at keeping up with the demands for services, and if graduated, are much fairer, than sales or other taxes, Mazerov said.

Bill Fox, a tax economist at the University of Tennessee who studies state tax policy, said economists think taxes should be levied across a wide base for stability and predictability.

He noted that the problem for Nevada is that no matter how it structures its tax system, it will still largely fall on gaming companies because they make up such a large share of the economic activity.

The real issue, he said, is that the state's economy is one-dimensional.

One way to diversify an economy, he said: Improve Nevada's education system.

Sun reporter David McGrath Schwartz contributed to this story.