The development of gambling regulation

How regulation moved from prohibition to licensing, what technical certification establishes, and why the tax base changes the prices offered.

From prohibition to licensing

Regulation of games of chance began as prohibition and moved, unevenly and over a long period, to licensing. The reasoning behind the shift was consistent wherever it happened: prohibition did not remove the activity, it removed the ability to see it, and an unlicensed market generated the exact harms prohibition was meant to prevent while producing no revenue and offering no means of oversight. Licensing replaced a rule about whether the activity could occur with a set of rules about how it must be conducted.

Probity: who may hold a licence

The earliest concern of a licensing regime is who is operating. Suitability testing typically examines the identity and history of owners and controllers, the source of the capital funding the operation, the corporate structure through which control is exercised, and the separation of customer funds from operating funds. The last of these is a solvency measure rather than a gaming measure: it exists so that balances held on behalf of customers survive the failure of the operator.

Technical standards: what the game must do

The second concern is the game. Technical regulation is narrower than it is often assumed to be, and its scope is worth stating precisely, because a great deal of confusion follows from misreading it. Certified testing of a game generally establishes:

• that the selection mechanism produces outcomes distributed as its specification states, verified statistically over very large samples;
• that successive outcomes are independent, so no result carries information about the next;
• that the internal state of the mechanism cannot be inferred from observed outputs or reproduced externally;
• that the return computed from the specification matches the return the deployed game actually produces;
• that the deployed software is the version that was tested, usually enforced by signature checks.

What certification does not do is constrain the prize schedule. A fully certified game may retain any proportion its schedule specifies. Certification establishes that a game behaves as it says it does, not that what it says is favourable, and those are entirely different claims.

Disclosure

A third strand requires information to be published: the rules of each game, the return figure derived from its specification, and in some jurisdictions the distribution of prizes across tiers. Disclosure regimes vary in how much they require and in whether the figure must appear on the game itself or only in supporting material. Their common weakness is the one this site's editorial convention exists to address: a return figure published without its base is close to uninformative, since the same game yields quite different percentages depending on whether the base is a unit staked, an hour of play or an amount brought.

Advertising and product rules

A fourth strand governs presentation rather than mechanism: restrictions on where and when advertising may appear, on the claims it may make, on the depiction of gambling as a means of income, and on features of a game's design that regulators have judged to misrepresent its arithmetic. The clearest example of the last is a rule requiring that a result returning less than the amount staked not be presented with the signals used for a win, since a return of half a stake is a loss of half a stake however it is announced.

How the tax base changes behaviour

The final strand is fiscal, and it shapes the industry more than it appears to. A tax on turnover falls on every amount staked; a tax on gross gaming revenue falls only on the amounts retained. The two bases produce very different burdens on the same business, and they push operators in opposite directions.

A market with 100 units staked and a 5 % margin:

  gross gaming revenue          =  5.00 units

  a 2 % tax on turnover         =  2.00 units
                                =  40 % of gross gaming revenue

  a 20 % tax on gross revenue   =  1.00 unit
                                =  20 % of gross gaming revenue

Under the turnover base, the tax is fixed whatever the
margin, so an operator can only cover it by widening the
margin - that is, by worsening the prices offered.
Under the gross revenue base, the tax falls when the
margin narrows, so competition on price is not penalised.

This is why the choice of base is a consumer question and not only a revenue question. A turnover tax puts a floor under the margin an operator must charge, and that floor is paid by the people staking. The shift toward gross-revenue bases in a number of jurisdictions during the late twentieth century was argued largely on that ground, and it also had the effect of making licensed operations able to compete on price with unlicensed ones, which is the same logic that produced licensing in the first place.

The remaining structural problem

Regulation can establish that a mechanism is honest, that an operator is solvent, that returns are as stated and that presentation is not misleading. It cannot make a commercial game's expected value non-negative, because the negative expectation is not a defect in the arrangement - it is the arrangement. Every regulatory regime therefore operates on a product whose arithmetic is fixed against the person staking, and every measure described above concerns the conditions under which that arithmetic is applied rather than the arithmetic itself.