Lottery Money Hurts School Funding

Published September 1, 2007

Prior to the adoption of the North Carolina state-run lottery in 2005 by a controversial, razor-thin vote margin (two senators were conveniently absent at the final vote), supporters loudly proclaimed the many merits of a government-sponsored numbers game–especially financial help for public schools.

They emphasized that prior to the gaming law, hundreds of millions of North Carolina taxpayers’ dollars were being gambled away in neighboring states–money that could be kept at home through the adoption of its own state lottery.

That vision sounds good, but the reality is different. Lottery money ends up hurting education funding over time.

Big Business

For many years I served as a consultant to local school boards as they developed their policy manuals. Each contains a policy prohibiting gambling and other games of chance to raise money for schools–but under a lottery, the state can do what others can’t.

Forty years ago, New Hampshire introduced the nation to a plan for generating revenue for education, allegedly to avoid a tax increase. Since then, 40 other states and the District of Columbia have approved state-run lotteries–and more are in the works.

Twenty-three of these states earmark portions of the lottery earnings for public school spending. States including Michigan, Missouri, New York, and Vermont claim to plow 100 percent of their lottery gains back into public education.

State-sponsored gambling is a big business. The 40 state lotteries combined bring in an excess of $14 billion per year (fiscal year 2002).

Bad Idea

One would think the 23 states that use lottery profits for education would enjoy a school funding advantage over states that do not give gaming money to schools. Such is not the case, however. According to a 2005 USA Today article, when states first pass lotteries, there is an initial surge in spending for schools, but after that the benefit declines sharply.

“In a few years, the initial flush of lottery funds into the state’s education programs had been eaten up, and the states lagged those that didn’t rely on lottery-generated funds,” the USA Today authors wrote.

How could this happen? According to the article, “The problem is not that lotteries are going belly-up. In most states, lottery-generated revenue has continued to grow. But the politicians can’t resist using lottery funds to replace rather than add to existing sources of education funding. Governors and legislators then use money that once had been earmarked for education on tax cuts, new programs or debt reduction–but not for schools.”

Pending Deal

North Carolina is headed in the same direction. Already, the formula for distribution of lottery funds is being manipulated, and politicians are looking for ways to tap education lottery funds for other special interests. When Republican legislators unveiled their $2 billion bond package for roads, universities, and other infrastructure needs in June, they presented an attractive price tag: No new taxes needed!

However, unknown to the average taxpayer, the complicated plan involves reducing the general fund (from which school funds are distributed) to pay for roads. Although lottery income would still go to the schools, it would be offset by reductions in the general fund, resulting in a wash for the schools.

This same trick has been played out many times in other states with “education” lotteries.

Nothing prevents state funds previously earmarked for education from being reduced by the amount made available from lotteries. According to a 2006 article in the Journal of Economic Issues, in some instances as lottery revenues rose total state spending on education fell.

In North Carolina, the problem is exacerbated by the fact that income from the state lottery is lower than expected. Some are predicting a $75 million shortfall. Because of this, the state will likely break its promise to limit the amount of lottery income devoted to advertisements designed to seduce citizens to gamble.

Not a Tax?

Beginning in the 1960s, financially pinched states, always on the lookout for new sources of revenue and unwilling to raise taxes, camouflaged the fact that state lotteries are in essence just another excise tax.

In an attempt to make this point, a group represented by the North Carolina Institute for Constitutional Law sued the state in December 2005, asking a judge to block the lottery, arguing it is partly a tax and that the legislature breached the state’s constitutional requirement to pass tax legislation in both chambers on three separate days. In March 2006, a judge ruled the lottery is not a tax and the bill was constitutional.

The case was appealed, and arguments before the court of appeals started on May 21 of last year. One of the factors the judges may take into consideration is an amicus curiae brief submitted by the Tax Foundation in January of this year arguing lottery profits are tax revenue.

The Tax Foundation’s amicus brief notes, “The 35 percent assessment collected from the sale of each lottery ticket is a tax, because it is mandatory payment imposed by the General Assembly to raise revenue for the education of all school children in North Carolina. Because the Wake County Superior Court improperly focused on the issue of voluntariness and neglected to consider the primary purpose of the assessment, which is to raise revenue, it did not conduct a proper balancing analysis.”

Uncertain Prospects

If the court rules North Carolina lottery profits constitute a tax, it will not necessarily spell the end of lotteries in the state. However, the lottery would have to make its way through the legislature again, this time explicitly as a tax bill.

Some close to the issue think a lottery would not pass under those conditions.

Richard G. Neal ([email protected]) writes from North Carolina.

For more information …

“State Lotteries: Using State Power to Fleece the Poor,” by Jon D. Wisman, Journal of Economic Issues, December 2006: