Gambling and Tax I


It is often said that income tax law subsidises gambling. Because there is no income tax on winnings from earnings, there is a “tax expenditure” which subsidises gambling. Philosophically the concept of tax expenditure is difficult – after all, what does it mean to say that an activity should otherwise be taxed? – but the point is pretty clear: not taxing certain activities which are comparable to other taxable activities has the same effect as a direct subsidy to the untaxed activities.

It has been found by the courts on numerous occasions that winnings from gambling “with the motive of making casual gains or merely for sport or amusement” is not taxable [Duggan v Commissioner of Inland Revenue [1973] 1 NZLR 682]. In that sense, the income tax system would seem to subsidise those who casually gamble. However, in a more important sense, a progressive income tax tends to punish those who take much larger and much more serious gambles.

Assume that there are 10 typists, all of whom earn $45,000 per annum. Any one who becomes a typist will earn that much. There are also ten actresses. Nine of those actresses earn $10,000 per annum, and one earns $360,000. Any one who becomes an actress faces the nine-tenths chance that she will earn $10,000, and a one-tenth chance that she will earn $360,000. To the careful observer, it is clear that the expected value of entering into either job – typing or acting – is equal, at $45,000. And yet, the progressive taxation system results in tax treatment that is quite different. The typists will on average pay $9,290 in tax. The actresses will on average pay $14,345.

So, the tax system may subsidise risk taking in one dimension, but in another massively penalises it. By changing the payoffs in this way, the income tax encourages a form of inefficient risk aversion. In Part II, I will consider whether profits from iPredict are taxable.


7 Responses to “Gambling and Tax I”

  1. Jesse Says:

    Steve, I have often wondered about this issue. A couple of questions:

    1. If I won, say, a million dollars in Lotto would my prize be tax free based on the principle set out in Duggan v CIR?

    2. Do you know the original purpose of the rule that causal gambling is exempt from income tax? Presumably the law attempts to distinguish between the casual gambler and the professional gambler. But if, outside my day job, I casually write books for payment, that income is nonetheless still taxable. So I can only guess that the policy reason is to protect the viability of the gaming market (I would imagine that a significant amount of legal gambling activity would dry up if all winnings attracted 38% tax).

  2. stephenwhittington Says:

    1) Lotto winnings are tax free.

    2) There are many exceptions where economic income is exempted from income taxation, including money raised from testimonial matches, exceptional plate collections in a church, etc.

    There’s no real rule to it, and so it is difficult to rationalise (this is the corollary to my post on ectopia earlier). I am attracted to the idea that there is some ill intent, but I do not think that is likely.

  3. Jonathan Says:

    Steve, going off on a tangent and out of curiosity, why are donations to charities and income earned by charities exempt from taxation? Is the idea simply to encourage charitable giving?

  4. stephenwhittington Says:

    There’s no real logic to it. They have not always been so. The fourth Labour Government ended the deduction – I am unsure about the income of charities, but I can double check.

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