February 28, 2004

BY KOLEMAN STRUMPF

With the steady rise of commercial activity on the Internet, Congress has been moving toward a formal prohibition of online gambling. While such policies might spring from a moral viewpoint, they are unlikely to succeed in limiting online betting. Because Internet gaming operations are often located outside the United States, there is little Washington can do to restrict them.

Moreover, a prohibition policy has perverse effects and encourages the behavior it seeks to curtail. This is illustrated by a close examination of one of the most popular forms of gambling: sports betting. There is a large demand for sports betting, and a large illegal sector has arisen to provide it despite a longstanding policy of prohibition. A similar ban on all Internet-based sports betting also is likely to fail. A legalized regime is a better way to mitigate the potential dangers of Internet betting.

To begin, let's take a closer look at betting on major sports, which is illegal in all states except Nevada, regardless of whether it involves the Internet. While these bans are primarily enforced by states, the federal government does get involved if wagers cross state lines or there is an alleged involvement of organized crime. So how successful has this regime of prohibition been at eliminating sports betting? By almost any measure it is a failure. A recent report from the National Gambling Impact Study Commission estimates that individuals wager $80 billion to $380 billion dollars with illegal bookmakers. This is nearly 100 times the amount bet on professional sports with legal bookmakers in Nevada.

The sheer size of the illegal sports betting markets tells only part of the story. I recently completed an analysis of illegal bookmakers in New York City using records seized in a series of arrests by the Kings County (Brooklyn) District Attorney office. I found that illegal bookmakers utilize policies that exacerbate the potential harm of gambling. First, they offer short-term credit and allow bettors to wager for a week or longer without fronting any money.

Second, illegal bookmakers take advantage of people's mistakes. They know that many bettors are fans of certain teams. In the case of the bookmakers I have records for, about a quarter of the bettors appear to be Yankees fans who wager consistently on their team. The bookmakers understand this tendency and ''price discriminate'' against such bettors: They charge them a higher price for their Yankees bets. While price discrimination does have an important role to play in free markets, it is likely that consistent use of it would be precluded if sports betting was legalized and aboveboard.

Right now, Internet gambling is catering to U.S. citizens from bases in countries as diverse as Antigua, Costa Rica and Australia.

Presuming the current attempts at prohibiting Internet sports betting persist, what might we expect to see? First, there will be a growing alliance between Internet bookmakers and the more traditional illegal bookmaker. The on-street bookmakers have experience in providing and servicing financial credit, which would be difficult for the Internet books to provide given the difficulty of enforcing a debt contract from afar.

Second, prohibition will drive the Internet operators farther from the United States. An important feature of the Internet is that it makes physical distance largely irrelevant, and from a bettor's perspective it is just as convenient to wager online with an Antigua bookmaker as with one down the street. As bookmakers move farther from U.S. soil to escape its influence, it will become harder to legalize Internet gaming in the future as the bookmakers get ensconced in their offshore locations.

A far more sensible policy would be to legalize Internet bookmakers. This would allow policies that could limit the potential excesses of gambling and minimize the role of the criminal element. As side benefits, a legalized regime would likely displace the widespread illegal operations. It is perhaps understandable that such an option is rarely considered. Gambling is a subject that many feel passionately about. But the argument for legalization and regulation should have appeal for opponents and supporters of gambling alike.

Koleman Strumpf, associate professor of economics at the University of North Carolina-Chapel Hill, is a visiting fellow at the Cato Institute, www.cato.org.

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