The Savings Lottery

Perhaps millions of Americans play state lotteries because they are dreamers or, more prosaically, just mathematically challenged. A good libertarian might argue that policy makers should simply shrug and let people spend money as they choose. It's a free country, after all. The rich have portfolios, stockbrokers, and shrinks; the middle class have stocks, computers, and online day-trading. Why can't the poor have lottery tickets, forecasters, and fortune-tellers?

Maybe, but there are three realities about lotteries that policy makers must address. First, the odds are dismal. Second, the poor spend disproportionately. And third, the sponsor and beneficiary of lottery sales is the state itself. Our elected officials make the rules for these games, advertise them lavishly, and attract players with promises of great riches while government keeps nearly half of every bet. Government-sponsored gambling would be a dirty little secret—if it were little. But state-run lotteries have become a familiar part of neighborhoods, present when we buy a newspaper, pick up a carton of milk, or fill the gas tank.

The most striking fact about legalized gambling in the United States is how rapidly it has grown over the past 25 years. State-sponsored lotteries are only part of a much larger trend toward more gambling. The same activities that were illegal in all states, save Nevada, in the early 1970s are now routine parts of most local landscapes. In 1973, seven states had state-sponsored lotteries. Today, 37 do, plus Washington, D.C. In 1997, the lottery take for all states grew to $11.2 billion, or about 2.2 percent of direct state revenues. In some states—Georgia, Massachusetts, Michigan, Texas, New York—lotteries are an even larger revenue source.

The state is uniquely important to gambling in general, not only because government has legitimized it, but also because gambling is dependent upon government permission to be in business at all. And despite the spread of legalized gambling, in most parts of the country such permission is still restricted. Gambling operations often are so profitable exactly because competition is limited.

It is no coincidence that the expansion of gambling has paralleled the spread of antigovernment and antitax political rhetoric. The increasing number of governors and legislators who make promises to hold the line or roll back taxes do not want to face the fallout that comes from cutting programs. Instead, they find clever ways to buy time with more state debt, raids on state pension funds, and—even in the good economic times of the 1990s—new excursions into gambling. In the annual budget crunch that affects so many states, lotteries often look like free money: Add another game such as Powerball, increase the number of lottery machines, proliferate "instant-winner" games, and fill a budget gap. For politicians, this source of revenue has proven irresistible.

Most public officials extol the happy consequences of more gambling in their jurisdictions. It is, they claim, good for the economy; it pays for schools and other public goods; it attracts tourist dollars. All of these claims cannot mask the core reason that state-sponsored lotteries and, more broadly, state-sanctioned gambling, have grown so fast: How else can legislators induce voters to pay a "voluntary tax"? But what does this tax really buy? Lotteries may be described by advocates in entirely benign terms—as sources of support for education, the elderly, health care, the handicapped: good causes all—but in fact, money is fungible. Careful studies indicate that no more is spent on these activities because of gambling than would have been spent otherwise.

One place more money is being spent, however, is on gambling referenda and political campaigns. With more than $13 million in contributions in recent years, gambling interests have become an important source for financing campaigns for both major parties.

Lotteries are perhaps the hardest form of gambling to justify in terms of their costs and benefits. Although there is surprisingly little good research on gambling, the best studies all point in the same direction: Lotteries prey on the poor and the undereducated. Among lottery players, 5 percent of ticket buyers purchase more than 50 percent of the tickets. Heavy buyers include residents of low-income neighborhoods and those with limited education. A recent study of more than 400 winners in the Massachusetts lottery found that none had earned more than $50,000 in the year before their jackpot. Winners—a random sample of ticket holders—had bought an average of about 4.5 tickets in the game they won. A 1999 study concluded that households with incomes below $10,000 per year spent more than 5 percent of their incomes on lottery tickets, roughly 10 times the share of the budget of middle-class households. Through the lottery, we are taxing those least able to pay and encouraging their delusions in order to reduce the tax rate for the rest of us. It's not a pretty picture. If the lottery were an overt rather than a hidden tax, its blatant inequity would prevent its enactment by even the most conservative legislature.

Since states keep almost half of lottery receipts, the games offer the worst deal of almost any legal bet. By contrast, slot machines and casino table games pay out 80 to 90 percent to customers. In effect, this high retention by the "house" means that, after income taxes on winners, the effective tax rate imposed by a lottery can be as high as 70 or 80 percent.

Most states promote their lottery games aggressively. They provide little or no information on the payout rate, and they don't offer much help to pathological or problem gamblers. Thirty-five states use the Internet to promote their lottery games, but only a third of the sites offer payout information. Typically a site encourages visitors to gamble; some sites also post a warning about the dangers of problem gambling, but more than 40 percent have no cautions at all.

Why are lotteries so popular? Partly because people like the instant action. It also helps that lottery tickets are available in so many locations. The hyped media coverage of big jackpots and winners builds lottery lust. But lotteries have an added advantage: They are exempt from advertising restrictions. States therefore promote lotteries in what is nothing less than a massive bait-and-switch form of consumer fraud, promising something—a win—that is actually available to only a tiny fraction of customers.

Still, it is hard to dispute the appeal of lotteries. The marketing and publicity efforts are selling to a receptive public. Any effort to curtail lotteries, in the name of the people who buy losing tickets, would most likely encounter strong resistance from this very group. Government can take the people's money, but it better not mess with their dreams.

As a practical matter, new public policies toward lotteries accommodate the popularity of gambling. This constraint need not block all reform.

Suppose, for example, more and more of the lottery monies were paid right back to the gamblers, instead of financing other state outlays. Over time, the states would lose the incentive to promote existing games and add new ones. And suppose that in addition to bigger payouts, there were a savings scheme tied to the lottery, something specifically tailored to the needs of an aging population. An insurgent candidate for state office might build this idea into a politically attractive, as well as socially useful, program. Instead of funneling bettors' losses into general revenues, government could use the money to support people in their old age. A "savings lottery" plan would guarantee that whenever someone bought a lottery ticket, some of the outlay would go into a savings account in the player's name. So even perennial losers would always be partial winners.

How it would work

Lottery prizes would be set as they are now. After prizes are paid, the remainder of the price of a lottery ticket (in excess of the cost of administering the lottery and a "privilege tax" to pay for programs for problem and pathological gamblers) would be credited to a special savings account on behalf of the lottery ticket buyer.

Over time, lottery machines would be replaced or modified so that every lottery ticket sale would be matched, if the buyer elected, to his or her Social Security number, to ensure proper crediting. Alternatively, players could fill in their Social Security numbers on used lottery tickets and, periodically, turn them in for credit.

The lottery savings fund would be managed by existing state pension operations, with parallel oversight and restrictions. Overhead costs could be kept very low. After all, Social Security operates with less than 1 percent overhead. The Federal Thrift Program and well-managed state pension funds also function at a much lower cost than most private-sector retirement vehicles.

Owners of lottery savings accounts above a minimum size would receive annual reports on their accumulation.

Access to the lottery savings fund would be limited until the owner turned 65, at which time the owner would be issued either an annuity or a lump-sum payment equal in value to the accumulation in the account. (If the owner died before age 65, the money would go to heirs.)

After distribution, any income or reduction in principal from a lottery savings account would be treated as taxable income.

The notion of a savings lottery was presented to the National Gambling Impact Study Commission by one of the authors of this article. In the words of the Associated Press, the "idea died fast, but Leone had made his point." That point was to ignite a serious discussion—by liberals and conservatives alike—about how to wean states away from their growing dependence on gambling. If that is too steep a hill to climb right now, can't we at least make government's role in the business a little more respectable?

In fiscal terms, the timing for such a transition from heavy reliance on the lottery is excellent. Since 1992, state revenues have grown by more than 6 percent a year. As long as the current boom lasts, reducing dependence on gambling should be easier and more practical than in the past. Moreover, a savings lottery could be phased in over four or five years, softening the impact on state budgets.

Even with the best timing, of course, it will not be easy to induce states to break the lottery habit. The federal government could help a lot by creating financial incentives for states that create savings lotteries. In the same way that IRAs, 401(k)s, and the proposed USA accounts represent a subsidy for savings, a federal savings lottery program could replace at first, say, 75 percent and then a declining share of state lost revenues. There might even be a bonus arrangement, with the feds paying a higher percentage and for a longer period of time to groups of states that join in congressionally sanctioned interstate "compacts." These agreements by adjoining states to forgo old-style lotteries and create new savings vehicles would go right at the booming market for multistate Powerball games. It's important, however, that any federal subsidy program expire after a transition period. After all, part of the point of the savings lottery is to eliminate the states' incentives to promote gambling. Our hunch is that over time, without the revenues, the advertising budgets will wither away.

Still, cynics stress that gambling reform is unlikely given the popularity of gambling with the public as well as with government. They point out that, in a fair share of referenda over the past 25 years, Americans have voted directly to permit gambling (although these contests often were hardly "fair fights," since the pro-gambling side tends to have much more money to spend). And, in state legislatures and Congress, the explosion of campaign contributions from gambling interests has been highly correlated with decisions that have allowed gambling to expand.

Yet even with big money on their side, pro-gambling forces are facing a tougher fight in their efforts to expand gambling. In recent years, gambling has been the losing side in most referenda and major legislative battles. This shift may suggest saturation or just a slowing of the previously rapid growth. It also implies that the appetite for new ideas, including the savings lottery, may be greater than cynics believe.

Granted, the savings lottery is neither the most elegant nor the most efficient way to build up a nest egg, and it raises significant operational questions, but it is a good deal better than grabbing as much money as possible from poor and poorly educated citizens determined to squander their incomes on million-to-one shots. It is offered here not as a model program but as a starting point for an effort to put government back where it belongs: as regulator, not promoter, of legalized gambling and as educator, not exploiter, of the citizenry.

Of course, it won't be easy to transform state lotteries. Recent gubernatorial elections in Alabama and South Carolina, for example, involved winning campaigns that heavily featured support for more gambling. Still, there is the possibility of a political strategy that depends on jujitsu—using the very popularity of lotteries to curb the insatiable appetite for lottery-generated revenues. We believe that a savings lottery would be very attractive to the public. Candidates who campaigned on a promise to transform lotteries in this way ("it's your money after all") would put advocates of the current setup at a disadvantage, reversing the current state of political debate on this issue.

Finally, we should face the reality that gambling participation is inversely correlated with education. That is why we believe that, at a minimum, a spirited political fight about something like a savings lottery might do a lot to enhance public understanding of just how bad a deal lotteries are. The nation's experience with bad news about smoking and warning labels for cigarettes teaches us that when Americans learn more about the downside of a particular behavior, they are less likely to engage in such behavior. So while the savings lottery is surely a long shot, it could be one of the few bets worth making.