How sound economic analysis can lead to counter-intuitive results

Phedon Nicolaides, 14 September 2014

Introduction

On 11 September 2014, the General Court, in case T‑425/11, Greece v Commission, sided with Greece and annulled Commission Decision 2011/716.[1] Greece had appealed against that Decision in which the Commission found that certain casinos had received aid that was incompatible with the internal market.

Until 1994 there were in Greece three casinos which were located at Mont Parnes, Corfu and Rhodes. In 1995, six more casinos were allowed to be established. The price of the ticket for entry into casinos was fixed by public authorities. For the first three casinos, the entry price was EUR 6 euro. For the others it was fixed at EUR 15. Casinos were also allowed to offer free tickets to their customers for certain promotional purposes. However, irrespective of whether they actually charged an entry price or waived the price of a ticket, casinos had to pay to the Greek state 80% of the nominal value of the entry tickets they issued.

The Commission was of the opinion that the three casinos mentioned above obtained an advantage because they paid to the Greek state EUR 4.80 [= EUR 6 x 80%] per ticket while the others had to pay EUR 12 [= EUR 15 x 80%]. This resulted in a difference of EUR 7.20 per ticket.

At first sight there is an obvious advantage for the casinos that paid only EUR 4.80 per customer who entered their premises, instead of EUR 12. And, again at first sight, the Greek state lost EUR 7.20 per customer who frequented the low-price casinos. It seemed to be clear that this measure of regulation of entry prices constituted state aid. However, the General Court reached a different conclusion.

The gist of the judgment

The General Court noted first that the difference in what the casinos had to pay to the state was proportional to the ticket prices. As a result, the amounts they could keep were also different but still proportional. The three casinos could keep only EUR 1.20 [= 6 – 4.80] which was lower but in the same proportion as the amount of EUR 3 [15 – 12] which the other casinos could keep [i.e. (3/1.20) = (12/4.8)].

According to the Court, the measure in question was not equivalent to a reduction of the tax base because the amounts paid by each casino corresponded to 80% of its revenue from tickets. In typical cases of reduction of the tax base, beneficiary companies pay less than others with the same revenue. But in the case of the Greek casinos, their revenue varied depending on the price of the ticket they could charge.

To put it in simple terms, casinos paid to the Greek state 80% of what they could charge and kept 20% of what they were able to earn. The fact that those which charged EUR 6 paid only EUR 4.80 was not an advantage because they also kept a smaller amount [EUR 1.20] than the casinos which charged EUR 15, paid to the Greek state EUR 12 but could also keep a higher amount [EUR 3].

Then the General Court turned its attention to the fact that casinos could also offer free tickets. The Commission argued that the practice of offering free tickets conferred an advantage to the casinos that paid to the Greek state only EUR 4.80 instead of EUR 12 because entry was costly. When entry was free, there was zero fee revenue for casinos and what they paid to the Greek state had to come out of their other income [e.g gambling, drinks, food, etc]. The Court acknowledged that indeed there was an advantage for the casinos that paid the lower amount.

However, it went on to observe that the Commission referred to the practice of free tickets in order to reinforce its finding that the difference in entry prices was an advantage for the low-price casinos. The Court noted, however, that it had already rejected that finding and concluded that it had to annul the Commission Decision.

This was an amazing legal victory for Greece, given the fact that at first sight there was an indisputable favourable treatment of the three casinos that paid only EUR 4.80 to the coffers of the Greek state. In the next section I will provide a different perspective to this case.

An alternative assessment

A convincing explanation of the existence of advantage must take into account the effect of both the difference in entry prices and the practice of free tickets. As the Court acknowledged, free tickets that generated zero income for casinos were advantageous to those casinos that had to pay to the state EUR 4.80 per customer instead of EUR 12.

Had the Greek state not regulated entry prices, each casino would have charged a price that would maximise its revenue. But casinos would not charge a very high entry price because they would not want to turn punters away. The optimum price depended also on the prices of other services offered within casinos. The optimum price was for the bundle of services. But since we do not know those prices we will have to ignore them.

Both the Court and the Commission focused on relative prices. They should have instead considered the effect of absolute prices. To understand this, let’s conduct the following thought experiment. Assume that a casino that charges EUR 6 attracts 100 customers. Since it can keep EUR 1.20 per customer, it makes EUR 120. By contrast a casino that charges EUR 1000 attracts just a single customer and makes EUR 200 [= EUR 1000×20%]. Ignoring the possible revenue and costs once customers enter the casinos since we have no information, it is obvious that the latter casino is better off not because it pays to the government EUR 800 [= EUR 1000×80%], but because it charges a higher price. Yes, it keeps the same proportion of what it charges as the other casino, but in the end what matters to it is how much money it puts in its pocket.

This reasoning leads us to the conclusion that the different entry prices fixed by the Greek government in fact conferred an advantage to the high-price casinos, not the low-price casinos precisely because the high-price casinos were able to make more money per customer who entered their premises. The Court was right that the relative amounts paid to the government were the same. But that was not the relevant point. The relevant point was the absolute amount of the net revenue for each casino after the payment to the government was made.

The reader may object that the example above is contrived, which of course it is. But if we wish to carry out a more realistic assessment of the situation, we need to consider whether the different entry prices had any impact on demand or the willingness of punters to enter casinos. The issue now is not whether the typical customer would not object to paying EUR 15 instead of EUR 6, but whether the price of EUR 15 would turn away anyone who would want to gamble. It is unlikely that customers had a choice of either EUR 6 or EUR 15. This is because casinos were spatially far apart [Corfu, Athens region, Thessalonica, Rhodes, etc]. But even when they were in the same region, it is also unlikely that the difference of EUR 9 [= EUR 15 – EUR 6] would be sufficient to induce anyone to travel several kilometres to go to the cheaper casino. Hence, the difference in prices was not important or relevant for most customers. The only question is whether the price of EUR 15 was so high that it put off customers. Neither the Commission, nor the Court asked that question. If the price of EUR was too high for some customers, then perhaps the benefit that high-price casinos derived from keeping EUR 3 was offset by the fact that they had fewer customers. We cannot know for sure. But if that were true, it would have meant that the revenue-maximising price was below EUR 15. However, casual observation would suggest that this is unlikely to be the case. Gambling is addictive or highly entertaining. It is unlikely that punters would have been put off by a price of EUR 15.

Therefore, the conclusion is that, if the price of EUR 15 did not have a noticeable effect on demand, the high-price casinos derived an advantage from the differential price fixing because they were able to make a larger amount of money per customer.

Let’s now consider the role of free entry tickets. Free tickets were used for promotional purposes. The first thing we need to take into account is that promotional activities in themselves are costly. But they are undertaken because they generate income that is expected to cover their costs. For example, a new customer with a free ticket tells his or her friends and the casino gets extra customers or the same customer comes again. Second, the offer of free tickets was voluntary, not mandatory. Since, casinos were not forced to offer free tickets, they must have done it only when they expected to gain from it. This is irrespective of the amount they had to pay to the government or the amount they were allowed to keep. The only question is whether the fixing of prices at different levels enabled some casinos to increase their advantage further by being able to offer free tickets. Again, it appears that it was the high-price casinos that could have benefited more.

Since free tickets were promotional instruments, casinos would have to attract four extra customers for each free ticket in order to break even. That is, the low-price casinos would lose EUR 4.80 per free ticket but make EUR 1.20×4 = EUR 4.80 with extra four customers. Similarly, high-price casinos would lose EUR 12 per free ticket but make EUR 3×4 = EUR 12 with four extra customers. Casinos would offer free tickets only if they would attract more than four extra customers or generate more than four extra visits from the customer with the free ticket.

Assume indeed that they are able to attract six extra customers for every free ticket. Low-price casinos lose EUR 4.80 but make EUR 7.2 [= EUR 1.20×6], a net gain of EUR 2.4. High-price casinos lose EUR 12 but make EUR 18 [= EUR 3×6], a net gain of EUR 6. Once more, it is the high-price casinos that generate more revenue from promotional activities. And they are able to do that because the fixed higher price allows them to keep a larger amount of revenue even when they pay to the government a larger amount than the casinos for which the entry price is fixed at a lower level.

In conclusion, this is a case where proper economic analysis should have been carried out. Undoubtedly, the competitive relations between the different casinos were much more complex than what is described here. But because economic analysis can lead to counter-intuitive results it should not have been ignored.

[1] The text of the judgment of the General Court ca be accessed at:

http://curia.europa.eu/juris/liste.jsf?pro=&nat=or&oqp=&dates=&lg=&language=en&jur=C%2CT%2CF&cit=none%252CC%252CCJ%252CR%252C2008E%252C%252C%252C%252C%252C%252C%252C%252C%252C%252Ctrue%252Cfalse%252Cfalse&num=T-425%252F11&td=%3BALL&pcs=Oor&avg=&page=1&mat=or&jge=&for=&cid=70256

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