A Proposal for an Improved Pari-Mutuel Model - By Cal MacWilliam

By Cal MacWilliam

Facing increasing competition from a range of gaming alternatives, racing is being forced to provide a more competitive gaming product. Fortunately, horse racing has a significant comparative advantage over other forms of gambling. It is essentially the only form of gambling in which an individual player has a reasonable chance of winning over the long run. Playing the horses is a game in which skill, hard work, diligence, and intelligent play can lead to a real expectation of profit. We must capitalize on this natural superiority.

An Alternative Takeout Structure

Unfortunately, the way the game is presently structured largely eliminates racing’s natural gaming advantage. The system was basically set up wrong in the first place. Here is why.

Suppose in a race a total of $150,000 was bet to win, and the winning favorite had $100,000 bet on him. In a takeout-free environment $50,000 would be returned as winnings, and a $2 bet would pay $3. Now impose a 17% takeout. Of the $150,000 bet, only $124,500 will be returned to the public; the other $25,500 is retained as takeout. The payoff on a $2 bet is now $2.40. What just happened? The winnings per $2 bet have been reduced from $1.00 to $0.40—a whopping 60% reduction in winnings from a 17% takeout—and the shorter the odds, the higher the “tax” on winnings. This happens because both the winnings and the original stake are subject to the takeout. This is like taxing not only one’s capital gains in the stock market, but the entire original investment. It just isn’t appropriate.

At the extremes, a 17% gross pool takeout on a $2.20 payoff reduces winnings by 77%, while the winnings on an extreme longshot are reduced by only 17%. This extremely heavy takeout on short-odds winnings makes it difficult to win at the races over the long run.

We have shot ourselves in the foot because we set it up wrong in the first place.

The easy solution: Only apply the takeout to the winnings portion of the pool. In the example above, we would only apply the takeout to the $50,000 in winnings, not to the entire pool. We would tax this at 18.5%. Because the takeout is not applied to the entire pool, the takeout rate would need to be higher to generate equivalent revenue. This 18.5% applied to the $50,000 in winnings results in a payoff of $2.80.

Under the current system the payoff is $2.40. Under the proposed system the payoff would be $2.80. The alternative takeout system in this instance increases winnings by a whopping 100%. These bets are now profitable for many players. By switching to a gain-based takeout over a gross pool takeout, we would increase winnings on favorites by up to 200 or 300% and only reduce winnings on longshots by less than 2%, yet the total takeout/revenue remains constant. We would move to a pari-mutuel system in which winnings would be taxed equally across the odds spectrum, and the massive distortion and disincentive that currently exist would be removed.

Using Dec. 3, 2010, at Hawthorne as a random real race day example; of the 54 win, place, and show payoffs on that card, 49 would have paid higher returns under a gain takeout than under a gross pool takeout. Many would have paid more than 100% more in winnings and 22 of the win, place, and show payoffs would have paid double-digit higher winnings. Yet revenues would have remained the same.

By increasing the payoffs on short-odds bets and making the game more winnable, we would attract new and win back many lost customers; increase the churn significantly; dramatically increase the number of playable opportunities; essentially eliminate the occurrence of minus pools and the resultant need to restrict betting; attract more bridge jumpers and higher volume from these clients; and increase the average bet size as bets move to shorter-odds horses. All of which could lead to a conservatively estimated increase in handle in the short term of 40%, and a potential doubling over the medium term. Serious and professional horseplayers will immediately recognize the implications of this new system and will respond favorably with greater play and larger bets.

The system proposed here corrects the error made when the pari-mutuel system was first established. While it may appear, at first blush, to be but minor tinkering, upon greater inspection and reflection it is far from a subtle shift—it could truly be a game changer. By reinforcing racing’s comparative advantage as the best gaming experience available, this is a change that could place the industry firmly back on the road to economic sustainability.

Cal MacWilliam is a small-scale owner-breeder and recreational horseplayer. He lives in Bethesda, Md., and is a senior economist at the World Bank. His horses reside at Ghost Ridge Farms near York, Pa.

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