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Ax the Room Tax

by Steven Miller

ecause Nevada makes so much of its living off a handful of historically good ideas, you'd think it would be the last state to want to hobble its largest industry's most creative businessmen. But in fact that's exactly what the Silver State does—imposing on its hotel and resort sector a kind of lock-step socialism that suppresses innovation, treats many firms unfairly and increasingly poses a danger to Nevada's primary source of jobs and economic stimulation.

The source of all this mischief—and more—is the room tax. That it could even conceivably be seen today as a possible threat to Nevada's continued gaming preeminence is more than ironic. From the very beginning, the rationale for a tax on room rentals was the "substantial benefits" that the tax—spent collectively—was supposed to bring to Nevada's tourist-related businesses (and derivatively, to state businesses in general) [See "The First Room Tax,"]. Yet the economic future that is hurtling down on Nevada is one quite hostile to the core concept incarnated in Nevada's room tax system.

As one major Las Vegas resort executive recently described it, the original idea in 1955 was to "throw money into a hat" so that "small casinos located along a dusty desert strip with rather modest motels attached" could build a convention hall, promote Las Vegas as a destination, and grow.

That was part of it, to be sure, but there was more. If that had been the extent of the plan, no problem would exist today. Research shows, however, that the "idea" in 1955 went significantly further. It included:

1) Getting that year's Legislature to give larger counties the authority to establish "fair and recreational boards1" endowed with the power to issue and sell both general obligation and revenue bonds.

2) Getting the Clark County Commission to establish such a board.

3) Holding a special county bond election at which a majority of the small number of voters voting could approve obligating the taxpayers of the county to repay convention hall construction bonds.

4) Getting local government to impose on all hotels, motels and and gaming establishments new taxes, the revenue from which would redeem the bonds.

Politically, the strategy was a success. The Nevada Legislature passed the "fair and recreation board" legislation March 17, 1955; the Clark County board established a county fair and recreation board Nov. 18, 1955; the bond issue passed March 20, 1956; and on Jan. 21, 1957, almost a year later, the county commission passed Ordinance 76, imposing the taxes as of April 1, 1957.

Flying a Public Flag

What was the motivation for this whole elaborate scenario? It was the prospect of being able to use Clark County's ad valorem tax base—in name, if not in final fact. By the 1950s Nevada's gaming and resort industry had long experienced high barriers in the nation's capital markets. So flying the flag of a "public purpose" was a way for the industry to at last enter the bond markets—and the tax-exempt ones at that. Though a few knowledgeable local taxpayers might grouse about the burdens the industry was placing on the public's credit, the new taxes on the resort and gaming industry were there to keep such discontent manageable.

It was in many ways a clever—if morally casual—solution to a knotty problem. But whatever advantage it may have had in the Fifties is lost today, when capital markets are eager to loan to sound resort-industry firms. Nowadays, essentially only the downside remains.

The Rube-Goldberg-like scheme assembled 40-plus years ago collectivized a central part of Nevada's resort-industry—its marketing effort. Confronted with a largely hostile world, the small casinos along the dusty Clark County strip thought it the better part of wisdom to band together behind a fašade of governmental authority. Given their frame of reference at the time, the industry leaders must have thought any socialist inefficiencies inherent in the collectivized marketing program were a small enough price to pay. They also no doubt expected them to be quite manageable, given the relatively small scale of the over-all county operation.

Today of course this room-tax/collective-marketing scheme has long since spread throughout Nevada—to not only other counties but the state government as well. At the same time, the percentage of room rentals confiscated is also much higher than 40-plus years ago. Then, the highest tax on hotel room rentals was 5 percent. Today in Clark County the total rate (including the 1 percent imposed under SB 170 in 1983) is now 10 percent. In Washoe County the rate is approaching absurdity. Though the Reno-Sparks area already for years has been suffering in the competition for visitors, the total room tax rate there last year was raised to 13 percent. According to the Reno-Sparks Convention and Visitors Authority, the average room tax nationally is only 12.36 percent. Yet the RSCVA and many of its Nevada Resort Association members led the effort last year to impose the higher room tax rates.2

Muddling Two Worlds

It's an episode that highlights many of the problems inherent in the room tax system. Generally speaking, the muddling together of governmental authority and private business interests nearly always seriously damages both spheres. Governmental authority gets used for private advantage—demolishing its claim to impartiality and integrity—while businesses are hobbled in efforts to respond to market opportunities.

Washoe County's room tax situation is a good example of the latter. Absent the legal compulsion that hotels and motels are under to collect the 13 percent room tax, they could charge significantly less for rooms than anywhere in the country.

One of the major reasons for the pre-eminence of Las Vegas in the national competition for conventions, marketing experts agree, has been its relatively low room tax. The story is the same elsewhere. Though New York's tax remains higher than any in Nevada, its recent lowering helped produced a big upsurge in visitor business for the Big Apple.

According to Sparks Nugget proprieter John Ascuaga last year, a mere 1 percent differential gave the Nugget a significant edge when recruiting conventions. What then would be the impact on Washoe County firms of a differential that—in a competitive market—that could range as high as 13 percent?

Driving Business to the Wall

Few businessmen would ever think soft demand for their product or service means they should raise prices. But such thinking comes easy in government circles. Demand for postage stamps falls? Raise the price! Ridership falls off on the New York subway? Raise the fare! People aren't coming to Washoe County? Make it more expensive!

But it's not just the foolishness of politicians that gets such inanities enacted into law. Though they negatively impact consumers and business generally, these policies can still serve the interests of particular firms—as Nevada's room tax system shows.

When a government tax rate gets too high, it begins to operate like a protective tariff, discouraging trade. Signficantly, however, its effects are not felt evenly across the full breadth of the market. Those competitors who are operating with a narrower profit margin are first to suffer from the new pressure on earnings, and so, first to be driven to the wall or out of business altogether.

"The higher the tax, the more we lose," is the way Dilip Patel, owner of Reno's Gatekeeper Inn and Easy 8 Motel phrased it. He was speaking during the 1999 push for a higher Washoe County room tax.

These uneven effects mean that certain players in a given market can actually find it to their advantage to raise industry costs across the board. Such an anti-competitive practice would be subject to prosecution under anti-trust law—unless, of course, the attempt is made from within the precincts of government itself. Private-public "partnerships" can be ideal for such a ploy. Nevada's "convention" or "visitor authorities"—the original fair and recreations boards, now generally renamed—are a classic example.

For several reasons, the larger old-line gaming firms that make up the Nevada Resort Association have long dominated the Silver State's visitor authorities. One reason is that the larger gaming companies usually have more clout with elected officials (whose campaigns they regularly help fund)—officials who usually fill the other seats on the convention authority boards. Another reason is that larger firms can usually more easily allow executives to devote time to board business.

The result is that in many ways Nevada's convention and visitor authorities tend to be creatures of a particular segment of the tourism industry. It's a sector with interests often distinct from the rest of the industry, but which nevertheless dominates decisions on the raising or lowering of room taxes. This one sector also tends to control all the industry tax proceeds that end up in convention authority coffers.

Were Nevada's authorities private, voluntary associations, the problematic aspects of this situation would not be a public policy concern—any business people in the association who felt they were being misrepresented or abused could withdraw their contributions and go form new arrangements with colleagues who share their goals. As it is, however, Nevada's convention authorities are governmental bodies, support of which is compulsory. Thus, these inequities in truth constitute cases of governmental misconduct and abuse.

Rigid Nevada

One of the most serious problems with the Silver State's room tax is the distinct—if unacknowleged—rigidity it imposes on businesses and businessmen currently active in Nevada's resort industry.

Marketing is a key area where this is evident. Each year hundreds of millions of dollars of capital that could be used for targeted marketing are blocked from going into unique, highly specialized and niche-sensitive uses. This happens because by law 10 to 13 percent of state hotel and motel room revenues must go to municipal governments for the room tax—the bulk of it to be channeled into one-size-fits-all government advertising programs. To the extent that a firm in the resort industry has—or wants to develop—a unique product or service targeted to a specialized clientele, to that extent the collectivized and generic promotions run by the convention authorities are beside the point. Thus Nevada's room tax system sucks up marketing capital and mandates that it not be used flexibly, as innovative resort industry entrepreneurs might want.

Most serious in the long run for the Silver State are the barriers the room tax has erected to diversification of Nevada's economy. State, county and city room-tax laws operate to keep Nevada locked into a gaming-resort economy. It does this by blocking use of hundreds of millions of dollars of room rental revenue for any purpose other than resort-industry promotion—under the aegis, of course, of the local convention authority.

Say Steve Wynn or some other innovative resort-industry leader suddenly wakes one morning with a remarkable idea—an investment opportunity that would greatly benefit Nevada but just happens to be outside the field of gaming.

If he and his other investors—and not state and county law—controlled investment of the 10 to 13 percent of his resorts' room revenue that now goes for taxes, those millions could be used for critically important venture capital. As it is, although visionary resort industry businesspeople might like to invest room revenue in new ways, by law a huge portion must always be plowed back into gaming-tourism.

Such state-imposed inflexibility in revenue allocation—no matter how many other states, nations and off-shore websites are running off with chunks of the gaming business—is a recipe for Nevada's eventual economic disaster.

Online Betting Can't Be Stopped

All studies of the Internet gambling market agree that it's growing explosively—and will continue to, notwithstanding lame-from-birth Luddite ideas like the proposed "Internet Gambling Prohibition Act."

This means that the gambling experience will be thoroughly commoditized—like everything else the Web touches. Though the experience of visiting clogged Las Vegas or Lake Tahoe will continue to appeal to many people, huge numbers of others will find that the thrill they seek is as close as their den PC—and much more convenient than physically traveling to Nevada.

In such a world, the transformative pressures on Las Vegas—not to mention the rest of the state—are going to be intense. Product differentiation will be everything, and only the most innovative and exciting establishments can hope to compete. Yet, while Nevada's dominant casino resorts have become habituated to innovating on the level of bricks and mortar, their competitors around the planet are already developing profound expertise innovating in the realm of clicks and mortar—the emerging broad-band reality where capital investment is light-years more effective.

In the next few years, as the developing tidal wave of interactive on-line entertainment accelerates, these firms will have an incredible edge. As virtually the entire planet channels massive resources into developing cyber-entertainment experience, these gaming firms will be able to simply gather the fattest fruit of Internet genius for a relative pittance and make it part of gaming experiences that will be without peer in the brick and mortar world.

In business-consultant talk, these firms will be agile—able to optimally exploit unanticipated customer opportunities. Increasingly today, such corporate agility is recognized as a make or break factor in business success. In the new growth or digital economy—where newbie firms like America Online have the market capitalization to gobble up longstanding major media giants like Time Warner—time is the new key competitive weapon.

In such a world, the competitive focus of business increasingly shifts quite naturally from mere cost to the capacity to fundamentally innovate—to determine "what companies ought to be doing, not just [how] to do a better job of what they are already doing."3

Advocates of agility—sometimes called "mass customization"—make a powerful argument that the new century will belong to the agile. And the huge market capitalization of leading Internet-generation firms like Cisco Systems, AOL and Yahoo suggests they are correct. Because these new firms have mastered the information-centred business paradigm they are the companies most able to re-invent themselves and adapt rapidly to changing global patterns of customer demand.

In such an emerging world, Nevada's top-down, socialistic, visitor authorities are hopeless economic anachronisms—artifacts much more appropriate to Soviet-style Eastern European politburos than today's emerging economy.

Today, market segmentation and the rapid creation of entirely new markets are how cutting-edge firms gain strategic advantage. In Nevada, however, convention authorities, protected by law, have a powerful vested interest in keeping the existing pie essentially as it has always been. It's a system that makes it quite improbable that Silver State companies—as such—will ever be creating those new markets and emerging with the world-class strategic advantage. Rather than agile, these firms are fragile.

Government as Subsidiary

The muddling of business and government in Nevada's convention and visitor authorities has cost the state in many areas—too many to cover in one article. A major one, however: For decades state and local governments have, by statute, been made collection agencies for the casino-resort industry. But any situation that encourages government officials to think of themselves as agents of an industry—or at least the dominant members of that industry—must necessarily end up perverting government while generating recurrent public relations problem for that industry.

There is really no sound reason for Nevada to continue the tax-based convention authority system. Ending it, on the other hand, would not only promote cleaner government, but diversification and growth of Nevada's economy. Finally, it would be fairer to all concerned—reducing conflict not only between different segments of the tourism industry and between different political jurisdictions but also between the casino industry and the Nevada public.  NJ

Steven Miller is the managing editor of Nevada Journal.


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