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Government and Gambling: Taxation of Addiction or Addiction to Taxes?

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Gambling, alongside tobacco and alcohol, is often regarded as a vice. The main reason behind this view is that gamblers often overlook the full extent of the costs involved in their decisions. Indeed, there is a certain probability that gamblers will develop an addiction, resulting in personal debt or even devastating financial ruin for their entire family. It is then relatively straightforward for the governments to justify higher taxation of this activity. But also, in many cases, governments promote it (through national lotteries) because it is a good source of income. However, the question remains: Is higher taxation an appropriate instrument to remove the external costs of gambling?

The first challenge lies in identifying and quantifying potential external costs associated with gambling, such as an impact on gamblers’ children, increase in crime and associated public and private spending. Studies conducted by addictologists and occasionally economists attempting to estimate these costs often suffer from inconsistent calculation methodologies and a generally negative attitude towards gambling. Although gambling is a fairly standard economic activity, some authors hold an a priori belief that it is inherently detrimental (here and here). Consequently, they refuse to acknowledge its benefits, such as entertainment, or deliberately downplay these benefits when assessing its social impacts. Notably, the much-cited Australian study by the Productivity Commission authors exemplifies this tendency (here and here). This bias is partly attributable to availability heuristics, as addictologists are likely to recall the cases of addicted individuals and, as a result, may overestimate the harmfulness of gambling.

As a result, studies examining the external cost of gambling yield highly variable, inconsistent, and sometimes biased results. For example, in the US, estimates of the external costs per addicted gambler span a wide range from 2,700 EUR to 12,100 EUR, 13,800 EUR-30,700 EUR, and even as high as 48,600 EUR per year. Above all, however, these results neglect the fact that gamblers consider some of the costs when making their decisions.

Many studies portray gamblers as inherently irrational. According to the authors of the Productivity Commission, pathological gamblers are unable to “consider the true costs” of their actions. The study also questions the voluntary nature of their decision-making. However, the decision to participate or abstain from gambling is made with consideration of associated costs and benefits. This holds true even if engaging in gambling leads to addiction since individuals do not plan to become addicted (just as a driver does not get into a car with the intention of crashing). The mere presence of risk does not render a decision irrational, as virtually all human activities involve some degree of risk.

The methodology for calculating the social cost of gambling that is consistent with the standard cost-benefit analysis was brought forward by Douglas Walker (here and here). He defines a social cost as an item that arises when a given activity causes one member of society to lose money without anyone else gaining. To accurately identify the components that contribute to the cost of gambling, Walker introduces four fundamental principles:

  • Exclude transfers, such as the amount of money gambled or the value of a player’s debt, from the calculation. This money has not been lost to society or vanished. It has merely changed hands from the player to the casino or a more successful player.
  • Do not include costs that affect the players themselves. This typically involves factors like loss of productivity or employment. The gambler-employee enters into a voluntary relationship with the employer, who takes the risk and possibly compensates for the lower productivity by payroll deductions or other means.
  • Do not include pecuniary externalities. A pecuniary externality arises, e.g., when the restaurant needs to lower prices because the casino has lured away customers. This effect does not qualify as a social cost. It is a consequence of standard market process.
  • Account for comorbidities, i.e., common underlying causes of the problem. For instance, it can be challenging to establish causality between gambling and depression reliably. Is gambling a cause or a consequence of depressive states? Hence, it is not appropriate to automatically count all psychological problems and addictions as social costs.

Applying this methodology, the external costs of gambling in Czechia were estimated to 700 EUR per person per year. These include, in particular, violence, police interventions, and costs associated with bankruptcies. Having identified the nature of the external costs associated with gambling, the next step is to assess whether it is efficient to internalize these costs through taxation.

Tax is a commonly employed policy tool that is applied to markets where external costs, such as pollution or congestion, arise. If the government imposes a suitable tax, the price will increase, and the quantity will decrease to the socially desirable level.

However, the situation with gambling differs from cases such as emissions caused by driving an internal combustion engine car. While every driver pollutes, in the case of gambling, only pathological gamblers are responsible for the social harm. In the EU, 0.3-6.4% of the adult population (varying by country and the estimation technique) is addicted to gambling, whereas in the US, the figure is around 1%. Thus, it is a minority of gamblers who are responsible for the majority of externalities.

Put differently, the tax reduces consumption, but does not affect pathological players. The only benefit, perhaps, is that a higher price of gambling discourages some players from developing addiction in the future.

Another issue is that tax on gambling does not raise the cost of gambling directly. Typically, the tax is imposed on the firms’ revenues. However, the external cost is generated by the consumers. Although the economic theory informs us that the effects of taxation are independent of which side of the market is taxed, gambling is specific because most games do not have explicit prices as other goods and services. Consumers will only feel the impact of the tax if it is reflected in return to players from gambling and if this change is perceived by consumers.

While the tax on gambling is often justified by concerns about the negative effects of addiction, we find that such a tax has only limited effectiveness in addressing these concerns. The addiction to gambling is better addressed through policies that are targeted to the addicts and groups that are at risk of becoming addicts. Rather than enhancing social welfare by internalizing the external costs of gambling, the tax on gambling negatively affects producers and consumers. In this light, such a tax seems motivated by the ease with which the tax can be imposed and legitimized in the eyes of the public rather than by the concerns for the negative consequences of addiction.

Photo by Kaysha

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