Cass Sunstein and I have begun thinking about how prediction markets might be regulated. (Here is a pitch for his new book "Infotopia: How Many Minds Produce Knowledge" (Oxford Press 2006) which can help you get enthusiastic about prediction markets and other uses of aggregated knowledge and wisdom. Additionally, or if you like the occasional podcast, try my "The Wisdom of Groups and the Use of Experts" from November 2005 and available here.) On the way there is the interesting question of whether we can distinguish between gambling (and its illegality in most places) and prediction markets, or at least some useful prediction markets. I don't think so, but then I don't think we can really distinguish gambling from many securities markets, but that is not the point of this post. Instead, I'd like to focus on the pervasiveness of "illegal" gambling.
Our government has been going after sports betting on the Internet, but by and large governments seem to accept rather large scale illegal gambling. Why is that? There is the formal world of Nevada gambling, numerous casinos, and so forth, but then also the huge world of workplace betting, poker games online and in family rooms, golf course wagers, and more. We make a great deal of recreational drug use in the shadow of the sort of drug dealing that attracts significant police activity, but we do not do the same for gambling. Perhaps this reflects a libertarian perspective; drugs are thought more addictive, and there may be more of a danger of third party effects. But then why regulate casinos and large scale gambling?
My intuition is that the (actual as opposed to on-the-books) regulation of gambling is best understood as a tax mechanism. It is difficult to monitor and tax poker games in private homes or wagers on the golf course, much as it is difficult to collect income taxes on casual babysitting and lawnmowing services. But when these activities take place in large, fixed settings it is easier for the state to be aware of transactions and to collect. Is there a better explanation for why law looks the other way in the presence of an enormous volume of gambling on football and poker? Just to be clear, I am not advocating that gambling laws (or income tax laws with respect to gambling gains) be enforced, rather a bit puzzled regarding the equilibrium in which there is much that remains illegal and enforced as such, alongside a great deal of virtually identical activity that is commonly accepted.