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Local Revenues from in

Introduction

In recent months, the Office of Budget and Management (OBM) has been repeatedly called upon as an agency to comment on the performance of casino revenues relative to the forecasts in the executive budget for FY 2014. Some local governments and school districts have expressed concern that casino revenues are not performing as well as forecast and have asked for advice about budgeting casino revenues going forward. This research memo is part of OBM’s response to such requests. The memo is advisory, insofar as OBM has no official role in forecasting the distributions of casino tax revenues to the locals. Casino tax revenue distributions are actually established in the Constitution, and no casino tax revenue goes to the state general fund, which means that OBM’s concern with casino tax revenues is restricted to the state portion. That state share of casino tax revenues is only 10 percent of the total, and is dedicated to regulatory and purposes, as is explained in later sections.

Nevertheless, in this memo OBM presents a brief analysis of the trends in Ohio casino tax revenue, a comparison of performance in FY 2013-2014 with prior forecasts, and some cautions about forecasting revenues in FY 2015 and subsequent years. The basic message of the memo is that the Ohio casino tax is a new revenue source that is still subject to considerable uncertainty, competition for gambling dollars is increasing, both within and without the state, and there is evidence across the nation that overall gambling may be approaching saturation levels. In light of all this evidence, local governments and school districts should budget casino revenues very conservatively and not be surprised when performance does not match forecasts, from whatever source.

OBM Memo Page 1 History

From 1974 until 2009, the only legal gambling in Ohio, aside from such as , and betting on , was run through the Ohio . The lottery was authorized by a constitutional amendment in 1973, and the first tickets were sold in 1974. In 2009 the situation changed when Ohio voters approved a constitutional amendment (Issue 3) to allow four full , with both slot machines and table , in specified locations.

The constitutional amendment also set the casino tax rate at 33 percent of gross revenue

(although the tax base is called gross, it is actually after prize payouts) and defined how the tax revenue would be distributed. A full 90 percent of casino tax revenue is distributed to local governments and school districts, with the other 10 percent being shared among state agencies for casino commission regulatory costs and tax administration (3%), for programs to prevent and treat problem gambling (2%), for enforcement training (2%), and for horse racing purses and other racing purposes (3%). As mentioned earlier, the distribution of casino tax revenues is actually set forth in the Ohio Constitution,

Article 15, Section 6, Division (C) (3) and cannot be modified without a constitutional amendment. The first Ohio casino, Horseshoe Casino Cleveland, opened in May 2012. The first distribution of casino tax revenue in Ohio was in July 2012. The last of the four Ohio casinos, Horseshoe Casino Cincinnati, opened in March 2013. Horseshoe Casino Cincinnati revenues were first distributed in July 2013.

Ohio (VLT) gambling is an entirely different type of enterprise than Ohio casino gambling. Legislation authorizing VLT operations in Ohio was passed in HB 1 of the 128th General

Assembly, in 2009.1 The started regulating VLTs at Ohio horse racetracks in FY 2012. Scioto

1 As a part of Am. Sub. H.B. 1, the state’s biennial operating budget for FY 2010-2011, the General Assembly amended R.C. 3770.03 and enacted R.C. 3770.21 to authorize the installation and operation of VLTs at seven horse racing tracks across the state under the control and regulation of the Ohio Lottery Commission.

OBM Memo Page 2 Downs in Columbus opened in June 2012 with 1,787 VLTs.2 VLT revenues are not taxed, as casino revenues are. Instead, because the lottery is a state enterprise and the VLT operator is essentially a franchisee of the lottery, the state shares in the VLT gross proceeds. Gross proceeds from VLTs are split between the horse racetrack operators (66.5%), and the Ohio Lottery (33.5%). Net profits from the VLT program, similarly to net profits from traditional lottery ticket sales, are transferred to the state Lottery Profits Education Fund (LPEF) and used to help pay for the state share of primary and secondary education. There is no distribution of VLT profits to local governments.

The rest of this memo discusses the forecasts of operating revenue from casinos and racetrack

VLTs and the legal allocation of those revenues to state funds or local governments. The memo does not address license fees, which are also a significant source of revenue but are received on a different schedule and have different distributions than operating revenues.

Casino Tax Revenues – Forecast and Performance

Several estimates of casino tax revenue were created before any casino began operating and generating revenue. The Ohio Department of Taxation was required by law to generate an estimate of the revenue impact of the constitutional amendment (Issue 3) to allow four casinos in November 2009.3

That estimate projected that in the absence of competition from racetrack VLT gambling, gross revenue from the four casinos would be $1.95 billion (tax revenue of $643 million) and that if all seven racetracks had VLT gambling then gross revenue from the four casinos would be $1.42 billion (tax revenue of $470 million).

2 VLTs, while they are similar to slot machines and are sometimes referred to as slot machines, are technically not the same as slot machines. For one thing, slot machines are controlled by computer chips physically located in the machines, while VLTs are controlled by a centralized computer network run by the Lottery Commission. 3 Section 3519.04 of the Revised Code requires the Tax Commissioner to estimate the annual tax revenue from a constitutional amendment that proposes to levy taxes and to send it to Secretary of State to be posted on the Secretary’s Web site.

OBM Memo Page 3 A draft report from Spectrum Gaming in May 2011 prepared under contract for the Ohio

Department of Administrative Services had slightly lower projections for calendar year (CY) 2013. The

Spectrum analysis estimated that gross casino revenue would be $1.80 billion ($595 million tax revenue) if there were no VLT racetrack gambling and would be either $1.10 billion or $1.20 billion ($364 million or $396 million in tax revenue, respectively) if there were competition from VLT racetrack gambling, depending on the locations of the tracks.

In fact, we now know that Ohio gross casino revenue was $821 million in CY 2013, with only two racetrack VLT operations in effect for most of the year (two more opened in December, which is discussed in further detail later in the memo). The $821 million total was reached with the Cincinnati casino being in operation for only 10 months of the year, but even if it had been in operation for all twelve months it is likely that gross revenues would have been only $858 million.4

The early estimates of casino tax revenue, such as those done by the casinos themselves, the

Department of Taxation, and Spectrum Gaming, were based on the application of “gravity” type models, where the attractiveness of a gambling location and thus the likelihood of playing have a strong inverse relationship to the distance of the population from the casino (similar to the physical gravitational force). While the theory behind these models may be sound, using them to estimate gambling revenues at any particular location depends crucially on historical data from existing casinos on the of play and the amount gambled by the adult population within certain drive-time bands from the casino. The actual experience of Ohio casinos suggests that the parameters used in the early application of these models overstated the potential revenues of Ohio casinos. Exactly why this is so is still not completely clear, but the hypotheses include (but are not limited to):

(i) Greater competition than anticipated from pre-existing gambling venues in other states;

4 The Cincinnati casino averaged $18.4 million in gross revenue per month for the 10 months that it was in operation.

OBM Memo Page 4 (ii) Greater and more widespread competition than originally anticipated from illegal

gambling within the state (such as the recently banned “Internet cafes”);

(iii) Greater in-state racino (VLT) competition than predicted;

(iv) Restrained enthusiasm for in-state casinos;

(v) Features of the Ohio casinos that reduce play relative to other gambling venues, such as

difficulty in parking at or access to the casino.

The administration forecast of casino tax collections and distributions for FY 2014-2015, which was part of the executive budget “Blue Book” issued in February 2013, had the advantage of being informed by roughly seven months of actual revenue performance of the Cleveland and Toledo casinos and three months of data from the Columbus casino.5 The administration FY 2014-2015 forecast of casino gross revenues, tax revenue collections, and distributions is summarized in Table 1, below. Note that the executive budget document did not actually publish the tax collection forecast, but instead published the forecast of distributions to the three local funds: the county fund, the county student fund, and the host city fund. In future budget submissions, OBM intends to more clearly state the total forecasted tax collections for the biennium, as well as the distributions.

The executive budget forecasts of casino tax revenue are made on a state fiscal year basis, as are all elements of the executive budget. Local officials need to be cognizant of the difference between the state fiscal year and the local fiscal year, since the local fiscal years often coincide with the calendar year, unlike the July-June state fiscal year.

5 OBM and Taxation produced casino tax estimates for the executive budget in fulfillment of the requirement that OBM produce revenue estimates for each state fund.

OBM Memo Page 5 Table 1: Tax Period Estimated Collections and Distributions: FY 2014-2015

Casino gross revenues Tax collections Tax distributions Quarter ending Sep-30-2013 $241,808,580 $79,796,832 77,202,617 Quarter ending Dec-31-2013 $220,759,376 $72,850,594 79,796,832 Quarter ending Mar-31-2014 $242,316,123 $79,964,320 72,850,594 Quarter ending Jun-30-2014 $252,845,939 $83,439,160 79,964,320

Total FY 2014 quarters $957,730,018 $316,050,906 $309,814,363

Quarter ending Sep-30-2014 $259,718,449 $85,707,088 $83,439,160 Quarter ending Dec-31-2014 $234,805,904 $77,485,948 $85,707,088 Quarter ending Mar-31-2015 $256,657,881 $84,697,101 $77,485,948 Quarter ending Jun-30-2015 $265,317,498 $87,554,774 $84,697,101

Total FY 2015 quarters $1,016,499,732 $335,444,912 $331,329,297

Actual casino tax collections for the quarter ended September 30, 2013 were $70.2 million, or

12.0% below the $79.8 million forecast (these collections were distributed in October 2013). Actual casino tax collections for the quarter ended December 31, 2013 were $68.7 million, or 5.7% below the

$72.9 million forecast (these collections were distributed in January 2014).

Table 2 shows the estimated distributions to the three local distribution funds (90% of the total) and the four state funds (10% of the total), by fiscal year, for FY 2013-2015.

The local distribution funds in Table 2 receive casino tax revenues in the following proportions:

(i) Gross Casino Revenue County Fund: this fund receives 51% of casino tax revenues.

Quarterly distributions from the county fund to individual counties are based upon each

county’s proportionate share of state population. Furthermore, the most populated city

located in a county with population over 80,000 (according to the 2000 Census) receives

fifty percent (50%) of the amount otherwise allocated to the county. The cities

receiving fifty percent (50%) of the county distribution are: Akron, Canton, Cincinnati,

OBM Memo Page 6 Cleveland, Columbus, Dayton, Toledo and Youngstown. In FY 2013, of the $89.0 million

distributed from the county fund, $68.3 million went to counties and $20.7 million went

to the eight eligible cities.

(ii) Gross Casino Revenue County Student Fund: this fund receives 34% of casino tax

revenues. Semi-annual distributions are made to school districts on the basis of school

district share of county enrollment.

(iii) Gross Casino Revenue Host City Fund: This fund receives 5% of casino tax revenues.

Cincinnati, Cleveland, Columbus, and Toledo receive quarterly distributions of five

percent (5%) of the gross casino tax revenue collected at the casino within that

respective city during the previous quarter.

Table 2: Executive Budget Forecasts of Casino Tax Revenue Distributions Fund Fund Name FY 2013 FY 2014 FY 2015 5JG0 County Fund (5JG0) $89,996,921 $158,005,325 $168,977,942 5JH0 Student Fund (5JH0) $59,997,947 $105,336,883 $112,651,961 5JJ0 Host City Fund (5JJ0) $8,823,228 $15,490,718 $16,566,465 5HS0 Casino Control Commission Fund (5HS0) $5,293,937 $9,294,431 $9,939,879 5JK0 Ohio State Racing Commission Fund (5JK0) $5,293,937 $9,294,431 $9,939,879 5JN0 Law Enforcement Training Fund (5JN0) $3,529,291 $6,196,287 $6,626,586 5JL0 Problem Gambling & Addictions Fund (5JL0) $3,529,291 $6,196,287 $6,626,586

Estimated Total Distributions $176,464,551 $309,814,362 $331,329,298

Percent Change from Prior Year 75.6% 6.9%

Table 3 shows actual distributions for FY 2013, which were quite close to the estimates, as one

would hope they would be given that the forecast was made when half the fiscal year was known. The

right hand portion of the table also shows distributions made in the first half of FY 2014. Because the

casino tax is still relatively new and there are not well established patterns of play the normal seasonal

OBM Memo Page 7 variation in revenues is not yet known. Therefore, the partial year FY 2014 results should be

extrapolated with caution.6

Table 3: Forecasts vs. Distributions, FY 2013-2014 (partial) FY 2014 Forecast, three Fund Fund Name FY 2013 Forecast FY 2013 Actual Difference quarters FY 2014 Actual Difference 5JG0 County Fund (5JG0) $89,996,921 $89,021,910 ($975,011) $117,223,521 $106,886,430 ($10,337,091) 5JH0 Student Fund (5JH0) $59,997,947 $59,347,940 ($650,007) $78,149,014 $71,257,620 ($6,891,394) 5JJ0 Host City Fund (5JJ0) $8,823,228 $8,727,638 ($95,590) $11,492,502 $10,479,062 ($1,013,440)

Total of the Three Local Distribution Funds $158,818,096 $157,097,488 ($1,720,608) $206,865,038 $188,623,112 ($18,241,925)

Total Statewide Distributions $176,464,551 $174,552,764 ($1,911,787) $229,850,042 $209,581,236 ($20,268,806) Percent variance -1.1% -8.8%

Competition from Racetrack VLT Gambling

Unlike Ohio casino gambling, racetrack VLT gambling in Ohio is not taxed. Racetrack VLT

gambling is licensed and regulated by the Ohio Lottery Commission (OLC), and the state receives a share

of operating profits. The state receives 33.5% of VLT gross revenues (as with casino revenues, while this

is called gross, it is after prize payouts), which are transferred to the state LPEF, as are other lottery

profits. Unlike the casino tax allocations, local governments do not receive any of the VLT profits.

Racetrack gambling facilities, unlike casinos, do not have table games like , ,

, etc. They only offer VLTs, which from the viewpoint of gamblers are functionally equivalent to

slot machines. For the two that have been open for months and competing directly with casinos

in close geographic proximity, the win per machine per day has been higher than for the casino

operating in the same market. The difference is especially pronounced for the Thistledown Racino

compared to the Cleveland Horseshoe Casino. Thistledown Racino has had greater overall VLT revenue

than the Cleveland Casino’s revenue for the first half of FY 2014, despite having far fewer

machines. These results are shown in Table 4, below.

6 Actual distributions are available at http://www.tax.ohio.gov/tax_analysis/tax_data_series/GrossCasinoRevenue.aspx

OBM Memo Page 8 Table 4: Comparison of Casino Slot vs. Racino VLT Performance, FY 2014 Venue Month Machines Gross Revenue Win/Machine/Day Columbus Hollywood Casino Jul-13 2,525 $11,618,767 $148.44 Aug-13 2,525 $11,350,003 $145.00 Sep-13 2,522 $10,786,135 $142.56 Oct-13 2,517 $11,640,183 $149.18 Nov-13 2,517 $11,764,169 $155.80 Dec-13 2,516 $10,849,125 $139.10

Pct difference from Columbus casino Scioto Downs Racino Jul-13 2,106 $11,164,026 $171.00 15.2% Aug-13 2,106 $11,103,808 $170.08 17.3% Sep-13 2,107 $10,512,493 $166.31 16.7% Oct-13 2,107 $11,241,957 $172.11 15.4% Nov-13 2,104 $11,279,380 $178.70 14.7% Dec-13 2,101 $10,974,120 $168.49 21.1%

Cleveland Horseshoe Casino Jul-13 1,849 $11,700,853 $204.14 Aug-13 1,849 $11,882,708 $207.31 Sep-13 1,827 $11,104,392 $202.60 Oct-13 1,827 $10,965,337 $193.61 Nov-13 1,827 $11,552,931 $210.78 Dec-13 1,781 $11,194,485 $202.76 Pct difference from Cleveland casino Thistledown Racino Jul-13 1,123 $11,398,923 $327.43 60.4% Aug-13 1,127 $11,802,047 $337.81 63.0% Sep-13 1,141 $11,811,460 $345.06 70.3% Oct-13 1,150 $12,874,230 $361.13 86.5% Nov-13 1,152 $13,290,552 $384.56 82.4% Dec-13 1,151 $10,710,794 $300.18 48.0%

As more racetrack VLT facilities open, competition for gambling dollars between racetrack VLTs

and the four casinos will intensify. As of this writing, the only two racetrack VLT operations with

substantial history are the Scioto Downs Racino, which competes for slot machine gambling with the

Columbus casino, and the Thistledown Racino, which competes for slot machine gambling with the

Cleveland casino. in Lebanon (roughly 30 miles northeast of Cincinnati), opened on

December 12, 2013, and Hard Rock Rocksino in Northfield Park (about 20 miles southeast of Cleveland)

opened on December 18, 2013. Three more racinos are scheduled to open in 2014 in the Dayton (first

quarter), Cincinnati (second quarter), and Youngstown (third quarter) areas. Increased competition from

OBM Memo Page 9 racinos is one of several reasons that local governments should use caution in budgeting estimated casino tax distributions in 2014 and beyond.

Whether this pattern of racino VLTs outperforming casino slot machines will also persist in other markets is unclear. A sample of two is not really sufficient to draw broad inferences. However, this is yet more reason for local governments to be cautious in budgeting estimated casino revenues.

Gambling Revenues Overall, Interstate Competition, and Substitution (Cannibalization)

Competition for gambling dollars in the U.S. is fierce, and since 2008 has taken place in an environment where discretionary consumer spending has been restrained by relatively high rates of unemployment – and thus reduced consumer confidence – and consumers acting to reduce household debt in response to the financial crisis and recession of 2008-2009. While some states or markets are still experiencing growth in gambling revenue, they tend to be newer entrants into the gambling market

(like Ohio; see Table 2), and in many cases the growth for these new entrants is at the expense of existing venue revenue. Examples of this “cannibalization” of existing markets, which is a term one sees used by industry experts, has occurred in a number of places. We present a few as examples.

The Center for Gaming Research at the University of Las Vegas (UNLV) published a study in March 2013 that stated that Atlantic City casino gross revenue fell by 41% from 2006 to 2012. Atlantic

City casino revenue has continued to fall in 2013. Competition from casinos in , , and New York is widely cited as a reason for the declines in Atlantic City.

In Saint Louis, the nation’s fifth largest casino market, gambling revenue has dropped by 5% to

7% from 2012 to 2013, and total St. Louis area gambling is expected to drop from $1.1 billion in 2012 to about $1 billion in 2013. Analysts at Rubin Brown, an accounting and consulting firm that follows the gambling markets, state that consumers are spending less on gambling in mature markets after the

OBM Memo Page 10 recession. “St. Louis is among mature gaming markets finding that some customers have decided they’d rather do things other than roll or plug slot machines, the analysts said. “People, after the recent recession, are spending their money elsewhere,” said Rubin Brown analyst Daniel Holmes.7

The Rubin Brown analysts note that nationally, U.S. casinos had 2013 revenue of $31.5 billion through October, up 4 percent from a year earlier. But the rebound is very uneven: among the 23 states with casinos, gambling revenue is down in 13 states. Eight of the 10 states that have had gambling revenue increases in 2013 have expanded gambling in the last 18 months, they said. This is the pattern of new entrants taking gambling business from neighboring states. One of the Rubin Brown analysts,

Brandon Loeschner, explicitly stated that “…cannibalization is happening in the regional markets.” 8

Similarly, officials at Penn National gaming, which owns the Columbus and Toledo casinos in

Ohio, acknowledged midway through 2013 that gambling revenue has grown more slowly than it expected at those two casinos and that fierce regional competition is an issue.9

Finally, some analysts think that the win per machine per day at some Ohio casinos, such as

Columbus Hollywood, could be a sign of saturation. Fitch Ratings analyst Alex Bumazhny stated last

January that win per machine per day of less than $200 may be a sign of a saturated market: “"For me, two hundred is a threshold, …Below two hundred is more a characteristic of a saturated market." 10

7 “St. Louis, Other Regional Casino Markets See Declining Revenue,” St. Louis Post Dispatch, by Tim Bryant, December 07, 2013. 8 Ibid. 9 “Clearly the market has not met our expectations,” said Timothy Wilmott, Penn’s president and chief operating officer. “We expected to be the market leader in slot win, and right now, we’re at a 50-50 level with Scioto (Downs).” Quoted in “Penn National Disappointed in Columbus Casino’s Revenue,” Columbus Dispatch, by Steve Wartenberg, July 24, 2013.

10 “Ohio Slot Machines, VLTs Will More Than Double in Number,” Cleveland Plain Dealer, by Thomas Ott, January 24, 2013.

OBM Memo Page 11 Conclusion

Gambling in Ohio is a developing industry, with traditional lottery games having been joined by slot machines and table games at four casinos and VLT gambling at four racinos, with three more racinos set to open in 2014. Competition within the state and across state borders is intense, and growing.

While the executive budget estimates of casino tax collections and distributions have tried to take these competitive factors into account, the estimates are subject to a large degree of error. Historical patterns of play are informative but cannot be relied on too heavily because current market saturation exceeds what has been observed in past years in U.S. gambling markets. Increased enforcement of prohibitions against illegal gambling may alleviate some of the competitive pressure on legal gambling facilities, but the degree to which this will support legal gambling revenues is unknown. In reality, established patterns of play that can be relied upon to make more accurate forecasts will probably not emerge until

2016, when all casino and racino facilities in Ohio have been operating for at least two years. Local governments should be appropriately cautious in budgeting forecasted casino tax revenues in the interim.

OBM Memo Page 12