The Online Gambling Gusher and How to Tax It

The race is on. Not just at the horse tracks but in state capitols. Hungry for new tax-revenue sources, legislatures across the nation are rushing to cash in on the rapid growth of gambling, especially online sports wagering. This race for the cash is a close cousin to the legal-lottery movement of decades ago. Only this time, the problems of gambling addiction are far more chronic, and the adverse social consequences and costs have not been fully documented and addressed.Sports gambling has now been authorized in 30 states, with 40 percent of Americans now allowed to play locally or at home. It’s already a megabillion-dollar industry, and growing rapidly. Seven states also have authorized online casino gambling, and more are expected to follow. In New Jersey, one of the first to authorize online sports gaming, the revenue haul is beginning to show results. Garden Staters wagered almost $11 billion online in 2021 —about $1,200 for every man, woman and child living there. The state garners 14 percent of the winnings, and that’s low compared to New York, where the tax on sports gamblers’ winnings is an eye-popping 51 percent. Add to that the cut taken by the gaming platforms and other middlemen, and it’s obvious that this is a negative-sum activity for those placing the wagers.

There is also a substantial social cost when gambling is made this accessible. Besides the diversion of money from essential consumption and socially beneficial production, the downside is that at least 5 percent of sports gamblers become addicted and lose more than they can afford. In the United Kingdom, research shows that 60 percent of the problem gambling is done by 5 percent of the gamers. Sports gamblers are twice as likely to develop an addiction as those who wager only through traditional venues like casinos and lotteries, according to one study.

Accounting for these social costs is a subset of public finance theory that deserves more attention than it’s received to date. Economists talk about “social goods” — things like clean air and literacy that benefit society generally — but we don’t have adequate academic research on “social bads,” including the negative effects of revenue-producing activities like legalized gambling and recreational drugs. Without being prudish, it’s a topic that warrants deeper thought and far more research and analysis than academics and practitioners have given to “sin taxes” and “demerit goods” like alcohol, cigarettes and junk food.What about the financial gamblers?Beyond the sports gambling craze, there is another gaming industry that now warrants much deeper thought and practical actions by the public finance community: the “gamification” of stock and options speculation — those proliferating trading apps that critics claim often underplay risks and encourage emotional, impulsive behavior by rookie investors. Without naming names and pointing fingers directly at the most popular trading platforms that rain virtual confetti when traders make their bets on speculative stocks and options, the COVID-era surge in novice speculation deserves more attention as a potential revenue source: a profits tax, focused particularly on speculative trades. And let’s not forget the cryptocurrency craze.

Keynes vs. the Speculators

The political left has been salivating over financial transaction taxes for several years now. Bernie Sanders railed on Wall Street during the 2020 presidential primaries with his foundational argument that traders and One Percenters should bear the brunt of the federal revenue burden. But even putting aside the political aspirations of liberal tax-and-spenders, there is a solid reason for taxing speculative transactions. This goes all the way back to the iconic founder of modern macroeconomics, John Maynard Keynes, writing in 1936. He believed that a tax on the buying and selling of stocks would discourage speculation. His goal was to avert speculative bubbles that imperil the real economy, as in the crash of 1929.Today, a strong case can be made that leveraged short-term traders in stocks, options and futures, along with the crypto bugs, all of whose primary objective is clearly speculative, should pay a transaction tax to call out their activity for what it is: a white-collar form of legalized gambling.

The fly in that ointment for state policymakers is that a financial transactions tax should be the province of the federal government and not the states. The Constitution’s commerce clause alone probably protects the stock, options and futures exchanges from state-level taxation of the trades they facilitate. Only at the national level can large revenues be extracted from the orders of institutional investors and the big whales on Wall Street who are trading commercially and not as speculators per se.

However, that distinction could still leave taxation of the profits from individuals’ speculation to the states. Although a few states like Texas, Florida and (perhaps) Washington would arguably face constitutional restrictions on income taxation, most could legally enact an individual surtax on short-term speculative trading profits, at rates comparable to the hefty taxes now imposed on sports betters — notably higher than their individual income tax rates. A compelling case can be made for a low-double-digit surtax on profits from not only most major forms of gambling but also from financial speculations including options, futures, crypto, short sales, leveraged margin accounts and short-term stock trades.

The financial speculations alone should provide a maximum nationwide taxable profits base of about $80 to $100 billion annually. Any such speculators’ surtax should be over and above the states’ existing income taxes on such profits. Net losses would not be deductible elsewhere, which thereby imposes a clear financial disincentive to speculate and gamble. Lord Keynes would smile down upon us and ask, “What took you so long?”

A Uniform, Multistate Structure

Of course, such ideas may not fly in states like Illinois, which is home to the big options and futures exchanges and their “locals,” the day traders who exert disproportionate influence in the legislature. That said, some kind of uniform multistate umbrella tax regime for short-term profits from all kinds of speculative activities is worth serious consideration.

The more that the state tax administrators and their counterpart treasurers and fiscal officers can work together on a project like this, the more likely it will succeed. Profits of, say, less than $500 per household tax return and $100 per individual-account tax statement could be excluded as negligible, to minimize nuisance paperwork. This would also reduce regressivity.

A uniform definitional structure and an annual profits statement format is imperative here, so that brokers and gambling platforms don’t face dozens of disparate state tax regimes and idiosyncratic state-level reporting requirements. Otherwise, their first lobbying salvo against such taxes will be a rightful “burdensome administrative complexity” argument. Fortunately, the state legislatures are well familiar with uniform legislation in the regulated securities industries, so standardization is not a novel concept.

I don’t purport to have all the ultimate answers to this intriguing but complex topic, including how such revenue should be deployed. But the revenue rethinkers and their academic colleagues should make this a high-priority project. Despite all the inevitable pushback, there is a principled opportunity for a significant new revenue source here that should not be wasted on academic conjecture, hair-splitting and intergovernmental turf fights. Follow the money.

Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.