Arcane Federal Tax on Sports Betting Is Too Much to Handle

April 8, 2021

Have you ever wagered on sports or participated in daily fantasy sports? If you answer yes, you may have paid an obscure and little-known federal excise tax on sports betting. This month, Rep. Dina Titus (D-NV) and Rep. Guy Reschenthaler (R-PA) have reintroduced legislation, H.R. 2350, to repeal this tax.

When the tax was introduced in 1951, it was intended, at least in part, to discourage gambling and aid states and the federal government in their anti-gambling efforts by imposing a prohibitively high 10 percent excise tax on sports betting and a $50 stamp tax. Today, however, it has the opposite effect: while now imposed at a far lower rate, it increases the cost for legal operators compared to their illegal counterparts, which are theoretically taxed but presumably rarely remit.

Estimates in 1951 projected annual federal revenue of $400 million, but actual collections, not all that surprisingly, fell way short, and only six months after the law went into effect, the estimate was adjusted to $9 million. In 2019, according to an inquiry by Rep. Titus, revenue was $33 million, which is not dedicated to any gaming-specific expenditures like enforcement or addressing problem gaming.

On legal wagers, the tax is levied at a rate of 0.25 percent, and on illegal wagers, the rate is 2 percent. Both taxes are levied on the handle, which is jargon for the total amount wagered. In addition to the handle tax, a flat fee of $50 is charged per legal employee accepting wagers, and $500 is charged per illegal agent accepting wagers. Bets offered by state lotteries and on horse races are exempt, and although technically required, illicit operators rarely pay the tax. 

As with any excise tax, the legitimacy of levying such a tax derives from whether it internalizes identifiable societal costs, called negative externalities. The handle tax misses this mark, because revenue is allocated for general spending—not negative externalities associated with sports wagers. Instead, it increases the cost of offering legal sports betting in the 23 states and the District of Columbia, which have legalized wagering.

Despite almost half the states legalizing sports betting since the Supreme Court overturned the federal ban in Murphy v. National Collegiate Athletic Association, illicit gambling is no small issue. According to the American Gaming Association, Americans spend close to $150 billion on illegal bets each year. Legalization should seek to convert the majority of this spending to the legal, regulated, and, indeed, taxed market. To that end, arcane and poorly designed federal excise taxes are a hinderance.

In addition to harming the competitiveness of legal sports betting operators and daily fantasy sports, the tax also has a unique and non-neutral tax base. At the state level, sports betting taxes are almost always levied as a percentage of the value of the adjusted revenue (handle minus winnings), but as mentioned above, the federal tax is levied on the handle—a remnant of its prohibitive original purpose.

This design, which resembles a gross receipts tax, results in effective rates (as a percentage of adjusted revenue) that can be much higher than the low statutory rate of 0.25 percent indicates. Commonly, sports betting operators have revenue, known as hold, of 5 percent of the handle, which means that for every $100 you wager, the operator takes $5, of which they must pay taxes and expenses. The federal tax on that bet is $0.25, which results in an effective tax rate of 5 percent of revenue.

The tax design is non-neutral, as it favors the state lottery-run sports betting model and parimutuel betting (common for horse racing) by exempting them from the tax. This has the problematic effect of narrowing the base and means that the tax code is picking winners and losers.

Lawmakers would be well-advised to consider changes to the federal excise tax on sports betting if the industry is to be successful competing against the large illicit market for wagers.

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The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

A gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding.

An excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and make up a relatively small and volatile portion of state and local tax collections.