Michael Pollock / Cut casino tax rate to encourage investment

Changing tax policy is the best way to attract more capital investment in Atlantic City’s casino hotels.

This summer marks the 50th anniversary of the 1964 Democratic National Convention, an event that was supposed to underscore and cement Atlantic City's position as one of the nation's leading convention destinations. Hopes were high in advance of such a monumental opportunity. State Sen. Frank S. "Hap" Farley gave a speech in October 1963 at the Jefferson Hotel where he implored the crowd: "We can't strike out … It's a chance to prove we're better than Chicago, Miami or the rest of them."

The chance to host a national political convention is an irresistible attraction to civic boosters. This year, the mayor of Columbus, Ohio promised that he could deliver the state's electoral votes to the Republican presidential nominee in 2016 if Republicans agree to hold their convention that year in his city.

With hindsight, Farley would have done better to promise New Jersey's electoral votes if the Democratic Party stayed away in 1964. Atlantic City did worse than strike out. That 1964 Democratic National Convention proved to be the single worst event in the city's history, eclipsing everything from hurricanes to Nor'easters to incidents of political corruption.

Atlantic City was already in decline in August 1964, and the level of decay was apparent to all but the most ardent civic boosters. David Brinkley of NBC News ran a special segment on the city's decline, and similar footage aired on other networks. The print media were even more vicious.

The Indianapolis Star wrote: "Early arrivals are dubious, inspecting rooms without TV or air conditioning and puzzling dark stains on the dingy wallpaper."

The Washington Star noted: "As a convention town, this is strictly Endsville. Now I know this is a resort left over from the early 1900s, but they could clean the rooms …"

The Cincinnati Enquirer arguably captured it best when it described the city as "'paying for poverty at peak prices. Our room looked like something out of a Charles Addams cartoon book."

After that convention, the bottom dropped from the Atlantic City economy, and the city's fortunes plummeted.

The culprit was "disinvestment," an economic disease that can ravage cities like an aggressive cancer. "Disinvestment" is the process in which businesses elect not to invest further capital in their ongoing operations. The decision to "disinvest" is an arguably rational decision, based on an analysis of economic factors. Essentially, business owners have determined that they cannot realize an acceptable return on any further investment, so they simply elect not to invest. Their capital can be put to better use elsewhere. The decline in investment results in a decline in the quality of the assets that remain, and that further feeds the logic that additional investment is futile, which in turn makes the downward spiral more severe.

Businesses in Atlantic City that were still making a profit were increasingly deciding against reinvesting those profits in the city. Investment by the private sector drew to a virtual standstill. The hotels and motels along Pacific Avenue and the Boardwalk took their profits, and the city's capital stock, out of town.

The disinvestment process in Atlantic City was already under way in 1964, having begun shortly after World War II. The Democratic National Convention and its attendant shower of negative publicity simply punctuated the decline, effectively making a mockery of anyone who dared consider investing in the city.

We need to remember that in 2014 because the seeds of disinvestment remain. I am not warning against negative publicity, which is merely a symptom of the disease, the fever that indicates the flu. The real disease is the same as it was in 1964: declining, non-competitive returns on investment.

Operators and investors weigh potential returns against all other options. Where will they get the greatest return? What are the comparative risk factors? Where is the future brighter, or dimmer?

For Atlantic City, such decisions become self-fulfilling prophecies. When the city's future looks bright - as it surely did a decade ago - it attracts investment, which further brightens the outlook. When the city's future looks dim - as it has for most of the past five years - new investment is harder to come by, which further dims the outlook. Decisions that were once routine, such as the regular refurbishment of rooms or restaurants, become more difficult to justify.

When the outlook is rosy, investors are more likely to conclude that Atlantic City can withstand regional competition by investing in itself, taking advantage of low tax rates, a tourism infrastructure and a concentration of gaming capital to insulate itself from local competition by reaching a broader, more-affluent demographic.

When the outlook is pessimistic, investors are more likely to conclude that regional competition will continue to gnaw at Atlantic City's market share, and therefore the returns on invested capital will continue to erode.

In both instances, the underlying facts have not changed. The demographics remain as they were, as does the likelihood of further regional expansion. Only the outlook has changed.

History shows that catalysts can come along to change that outlook. The 1978 opening of Resorts International was one, as was the opening of Borgata a quarter-century later. Smaller catalysts have also helped, such as the post-Borgata legislation - sponsored by then state Sen. William Gormley, R-Atlantic - that created tax incentives for incremental capital investment.

Fortunately, potential catalysts remain, although they are difficult to identify, and harder still to implement. In 2008, Spectrum Gaming Group (my company) performed a detailed Visitor Profile, which compiled 3,000 individual intercept surveys. That study showed numerous potential groups that would visit Atlantic City, if given sufficient incentive. The best example was visitors whose primary goal was retail shopping in a city (indeed an entire state) that imposes no sales tax on apparel. Another group was concertgoers.

Such groups cannot simply be targeted by marketing campaigns, nor can they be fully exploited by simply holding more concerts. The goal, as always, has been to generate more capital investment in the city, which creates more attractions. That has always been the most effective marketing campaign.

Atlantic City will not attract additional capital unless it can significantly improve the potential returns on that capital. A decade ago, Gormley's legislation showed that tax incentives - in which operators can keep some of the taxes generated by potential projects - can increase that return, and his legislation led to projects ranging from The Quarter to The Walk, among many others.

I suggest a combination of similar incentives coupled with an idea that is quite heretical: Lower the gaming tax rate. At 8 percent, Atlantic City's rate is already far below rates imposed throughout the region, and throughout most of the nation. The proposed tax rate in Massachusetts, which will attract large destination resorts, is more than three times the Atlantic City rate.

The rate should not be lowered across the board, but rather on incremental gaming revenue, which would follow the establishment of a base year. If, for example, a property generated X dollars in gross gaming revenue in the base year, that level would be taxed at 8 percent the following year. Incremental revenues beyond that rate – X plus 1 – would be taxed at incrementally lower rates, say 7.5 percent, declining to 7 percent and further.

The key, however, would be a requirement that operators must reach certain incremental thresholds in further capital investment that either expands their offering, refreshes it or both. The formula must be sufficiently robust so that the incremental decline in tax rate is sufficient to justify the proposed investment.

This can benefit Atlantic City in several ways, both obvious and not-so-obvious.

In the obvious category: Regardless of their ability to attract affordable capital, all Atlantic City operators - existing and would-be - recognize the need for a continual, unimpeded flow of capital, but all of them must demonstrate that new capital can generate more than it will cost. In other words, if the cost of capital is, say, 15 percent, a new project would have to generate more than that. Otherwise, such an investment makes no economic sense. If a lower tax rate can help clear that hurdle, such a move can provide access to capital that would otherwise be unavailable.

In the not-so-obvious category: The East Coast of the United States is quickly evolving into a saturated gaming market. Regions large and small from suburban Washington to upstate New York and beyond are within easy reach of a casino, mostly high-tax racinos or similar properties that depend on their local market for almost all of their business. An ownership tie-in with Atlantic City - known as the hub-and-spoke business model - makes sense if an operator can incent its customers in the high-tax jurisdiction to spend some quality time at its property in the low-tax market (in this case, Atlantic City). Both properties benefit. That is the essence of the Caesars model, and increasingly it is being developed by other operators as well, notably Mohegan. A system in which incremental revenue at the Atlantic City hub is taxed at an even lower rate enhances the incentive to leverage the hub-and-spoke model.

Would such enhancements be enough to warrant that additional capital investment in Atlantic City? In the absence of a detailed study, we can only speculate. But we do know that the alternative - the status quo - is not attracting that capital.

I do suggest, however, that such a formula is achievable.

I have staked my career on the notion that gaming is best positioned to advance public policy - in Atlantic City or anywhere else - if it can attract significant capital investment, which remains the basis for achieving numerous policy goals, from tourism promotion to employment growth. Further, I fundamentally believe that tax policy remains the principal means by which government can achieve the goal of attracting capital investment, if it is willing to invest in some creativity and political courage.

Fifty years ago, Atlantic City hosted a major convention, and promptly went into a tailspin. That may seem like a long time ago. In economic terms, it was yesterday.

Michael Pollock is former editorial page editor of The Press and former spokesman for the New Jersey Casino Control Commission. He authored the award-winning book, "Hostage to Fortune: Atlantic City and Casino Gambling," published in 1987 by the Center for Analysis of Public Issues in Princeton. Today, he is managing director of Spectrum Gaming Group, a global research and analysis firm based in Linwood.

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