IS ‘FREE PLAY’ FREE OF RISK?

James Lewis and Kristine Marsilio, Associates specializing in gaming law at Duane Morris LLP, consider reducing and eliminating promotional play to increase tax revenues.

As the US sports betting market develops, states are actively considering methods to increase potential tax revenue from legalized wagering on games. One method includes restricting operators from deducting promotional play from their gross gaming revenues (GGR) – an incentive also known as either 'free play' or 'free bets,' which sports betting operators use to expand their user base. While such deductions can leave hundreds of millions of dollars on the table, states should consider whether targeting that revenue will produce the desired effect, before they rush to curtail or eliminate an incentive that attracts new consumers to an industry with relatively low profit margins.

Since 2018, sports betting has expanded rapidly. As of February 2023, sports betting is live or regulated in 36 states, plus the District of Columbia. It is anticipated that an additional four to six states will enact legislation to authorize sports betting before the end of 2023. Longer term, legal sports betting is estimated to spread to 42-46 states before 2025. The proliferation is driven, in part, by both consumer demand and an interest across American statehouses in new revenue streams. Often, figures employed in sports betting statistics are remarkable and difficult for legislatures to ignore.

But the eye-popping figures associated with sports betting "handle" – the amount of money wagered by a bettor – can be misleading. Sports betting statistics often include handle as a measure of an enterprise, market or particular event. National handle figures are generally estimates, but some identify handle figures to be as high as billions of dollars per month. But handle neither equates to taxable revenue nor the profit that sports wagering operators generate. On a simple sports wager, whether it concerns the spread, over/under or a prop bet, approximately 50% of the wagers are victorious. Paying out those winners significantly reduces the total handle, sometimes even decreasing the total by more than half. GGR is the amount of the operator’s winnings less any value deductible by statute.

So where does promotional play fit? It usually follows a predictable script. If a new player creates an account, the operator provides some free wagers, play and other chances to win real money without the player incurring financial risk. As some states legalized sports betting, they allowed operators to deduct promotional play losses from their GGR calculations without limit, which resulted in significant reductions to otherwise taxable revenue.

The rationale for allowing deductions is simple. When a state legalizes sports betting, people need to play for the state to collect taxes. Until recently, sports betting was largely illegal with minimal exceptions. Thus, promotional play is an incentive to attract new users, who often continue wagering after promotional play ends. For operators, promotional play encourages people to test their platform risk-free, which is essential to their ability to capitalize on market share. In today’s competitive atmosphere, operators battle tooth and nail for market share against many formidable opponents, and every opportunity to differentiate themselves counts.

However, now that sports betting is ubiquitous, there is an increasing focus on whether promotional play should continue. Some regulators have expressed concerns that the current level of promotions runs afoul of responsible gaming provisions and anti-predatory marketing practices. For example, last year, Virginia prohibited online sports betting operators from deducting either bonuses or promotions from online sports betting revenue after 12 months of activity. This year, Colorado has initiated a multi-year sunset on the percentage of lawful promotional play deductions. Arizona permits scaled deductions for a finite period. Louisiana imposes a $5m cap annually. Other states do not permit any deductions for promotional play, including Illinois, Indiana, Massachusetts, Tennessee and West Virginia.

Those decisions come as legal sports betting operators are already contending with both steep competition for customers and high operational costs. Sports wagering is a heavily regulated industry, and authorized operators often pay significant amounts in taxes and other licensing fees, compared to those in unregulated markets.

As states continue to re-evaluate their sports wagering regulations, and while the sports betting market in their respective states matures, other states will inevitably reconsider how they treat promotional play deductions. Therefore, it is imperative for both elected officials and the public to understand the meaning of wagering terminology before rushing to judgment. When properly regulated, free play, an incentive enjoyed by the public and operators, is a way to preserve a healthy industry, ensuring continued state revenue.