Source: The Montana Tavern Times, Feb., 2005, published monthly by Continental Communications, 125 W. Granite St., Suite 102, Butte, MT 59701. Killing the goose that lays golden eggs? That' the general consensus of Montana gaming operators who are facing a proposal to double their video gaming machine tax in the 2005 Montana Legislature.
Senate Bill 179 by Sen. Ken Toole (D-Helena) would increase the video gaming machine gross revenue tax to 30 percent from 15 percent for businesses operating more than 10 machines. The tax would remain at 15 percent for operators with 10 or fewer machines. At least two other bill-draft requests to increase the tax are ready to be introduced, pending the outcome of SB 179.
"The misconception out there is that a gaming operation makes money hand over fist," said Brad Brown, a Billings certified public accountant who has several gaming operators as clients. "That is not the case. You've got operators now who are actually holding less revenue (than five years ago)."
Toole' bill targets bigger operators, under the presumption that they make an excessive profit. But Brown and many other operators say higher revenues do not translate into higher profits.
"People think that the guy with 20 machines makes twice as much as the guy with 10 machines," said Grant Lincoln, president of Century Gaming, Montana' largest route operator. "We have as many guys struggling at 20 as we do with 10."
According to Brown, all operators are experiencing steady increases in nearly every expense item of their business, including utilities, labor costs, insurance costs, and promotional costs. And larger operators naturally are seeing the largest increases in business expenses.
So the growth in expenses to run a larger casino is in most cases eating up the growth in revenue gained with more machines, operators say. Double the tax rate on top of that financial situation, and you've got trouble, business authorities say.
"A doubling of the tax rate," Brown said, "would be devastating to the state of Montana."
"We'd probably end up closing," said Bill Brown, of BB' Casino and Lounge in Butte. "It'd hurt a lot of people in Butte."
"We're barely getting by as it is," said Bill Heisler, co-owner of the Classic 50s and other businesses in Great Falls. "It would affect every operation we have, directly."
Heisler said jobs would be lost, leaving more duties for the remainder of the staffs and the owners themselves.
Brown, the Billings CPA, gave the following real-life scenario: A 20-machine operator grossed $4.5 million in revenue last year from all departments of the operation, including restaurant, bar and casino. The operator earned a pre-tax gross margin of 8 percent, or about $360,000, on that $4.5 million. The hold (the amount of money retained by a machine and not paid out to the player) was $1.3 million--about 29 percent--with $3.2 million being paid out in win prizes. That $1.3 million hold was taxed at 15 percent, for a total VGM tax of $195,000. The business, then, experienced a net margin (income after the VGM tax but before promotions, income taxes, operating expenses and any capital improvements) of about $165,000 (gross margin of $360,000 minus the VGM tax of $195,000).
Obviously, doubling the VGM tax to $390,000 would completely wipe out the net margin and put the business $30,000 in the red.
"It' just ludicrous," Brown said. "Legislators, I would hope, will study the industry before they take such ill-conceived action."
You Can't Pass It On A tax increase is especially injurious to gaming businesses because they can't pass it on to the customer like most businesses can. For example, an increase in cigarette taxes can be passed on to consumers through higher prices on cigarettes. But the gaming industry is stuck with the same maximum bets and payouts, "prices" mandated by state law. So gaming operators basically have to eat any tax increase.
"It' an unfair tax," said Nick Alonzo, of the Montana Club in Missoula. "Any increase comes directly off my bottom line."
Ever-increasing expenses without any way of increasing revenue through "higher prices" is resulting in a phenomenon of sorts in Montana' gaming industry--call it the "Incredibly Shrinking Margin."
According to the University of Montana' Bureau of Business and Economic Research, Montana gaming operators in 2002 averaged a net margin (before capital costs, promotion costs, and income tax) of just 8.5 percent. That amount is down from 13.8 percent in 1997--a decline of about 38 percent. And operators are saying that since 2002 their margins have dwindled even further.
Lincoln said that as the gaming industry matures, "it becomes more and more competitive, resulting in smaller and smaller margins."
For example, Brown the CPA said, competition in Billings is leading many operators to focus on building good, experienced staffs by offering employees more generous benefit packages.
And, as every Montanan knows, electricity and gas costs have skyrocketed in the last few years. Insurance premiums, too, especially for employee health insurance, are jumping every year.
"I've been battling shrinking net margins for years," Alonzo said. "Everything has gone up, except your net gaming revenue."
Escalating business expenses, and the resulting erosion of net margins, have forced operators to really streamline their operations in the past few years.
"I run a tight ship now," Alonzo said. "There' not much fat. For (the state) to take another 15 percent more of my (gross) revenue just isn't fair."
Promotional costs--which include such things as complimentary drinks, free-play coupons and general advertising expenses--have jumped considerably in recent years, as competition for a fairly static customer base intensified. One gaming business authority estimated that fully 5 to 8 percent of the money going into machines is complimentary play paid for by the house.
"We give away more to attract more customers," said Mike Williams, of the Jokers Wild in Missoula.
One of the biggest hits on the net income of operators is the decline in their holds. The hold (the amount of money retained by a machine after pay-out to the player) has fallen from about 40 percent just five years ago to about 30 percent or less today, operators say. One reason? Competing operators are buying games manufactured with higher payout algorithms, which attracts players because of the higher win rate.
Though maximum payouts haven't changed (set in law at $800), the number of ways to hit a maximum payout has significantly increased, operators say. For example, new keno games have several different kinds of multipliers to help players reach the top payout.
"There are multiple ways of hitting the jackpots now," said Tom MacLaughlin, who operates Paradise Falls in Missoula. "Years ago an $800 (maximum) payout was rare, but now it' rare that we don't get one almost every a day."
Further, the state took 10 years to finally determine a method for electronically reporting gaming machine data and taxes. All the while, machine development and purchasing experienced a significant slowdown while resolution was on hold. When internet reporting finally was adopted, pent up new game designs and software were approved and released at a prodigious rate, unleashing a torrent of machine and equipment purchases and replacement--worth about $10 million last year alone.
These huge capital investments have induced operators to ratchet up promotional incentives to increase play in order to generate the income to pay for the investments.
Unintended consequences John Tooke, owner of the Golden Spur in Miles City and also a CPA, said the tax increase could have some unintended consequences.
For one, Tooke said, the tax proposal could cause some operators to dump enough machines to get to the 10-machine threshold to avoid the tax increase. That situation could have a negative impact on the very tax collections the hike hike is supposed to increase, Tooke said.
And the dumping of machines would have a seriously negative impact on Montana' three (and soon to be four or five) homegrown machine manufacturers, he noted.
If a load of operators decide to dump machines to avoid the tax, Tooke said, fewer machines would also mean "a big hit on (machine permit) fees," resulting in still less revenue for the state (2004 fees totaled $4.1 million). And, he added, what' to stop the state from changing the 30 percent tax threshold to five machines next session?
Brown, the Billings CPA, also believes the tax proposal won't raise money for the state. "It will do the opposite," he said, because many operators will either close down entirely or cut their operation and staff. Either way, the state loses tax revenue it's currently receiving.
And, he added, the tax hike could "seriously impact the banking community" because many operators would be "strapped to make their bank payment." And the liquor licenses so many banks have as collateral would be devalued in many cases because a surplus of licenses and a low demand drive down prices and cut the operators' asset values.
Those who would try to stick it out would have to cut back even more, making some tough business decisions in the process.
Williams, of Jokers Wild in Missoula, said he'd drastically reduce capital investments, from new gaming machines to kitchen equipment. He'd probably have to sell some real estate, too. Another expense to cut, he said, would be the $8,000 or more he gives annually to the community in donations.
It Ain't Broke … The fact that legislators are even considering a new tax proposal is frustrating for many in the gaming business.
"We've got a stable business market with a stable tax structure," Tooke said. "Why change it."
He noted that the current tax generated $50.1 million in 2004, and $3.1 million more than the year before.
"I think everybody' happy (with the current tax system)," Heisler said. "Don't fix what ain't broke."