The average American spent more on lottery tickets in 2002 than on reading materials or movies, according to “Lotteries and State Fiscal Policy,” a study by Tax Foundation policy analyst Alicia Hansen released on December 15.
More than half of Americans play state lotteries in any given year, according to Hansen, making state lotteries the most popular form of gambling in the United States. She contends state lotteries are contrary to sound state tax policy. While Hansen does not offer recommendations for change, the Tax Foundation generally recommends that flat, broadly based taxes with few exemptions should be used to raise whatever funds the state must collect.
The virtues and defects of lotteries have become more important as states have increased their reliance on lottery revenue.
Oklahoma voters approved a lottery referendum on November 2, making their state the 41st to sell lottery tickets.
Many existing state lotteries are expanding into new forms of gambling, such as video gaming devices. In fiscal year 2002, South Dakota raised more than 7 percent of its own-source revenue selling paper and video lottery tickets. The nationwide average in states with a lottery was 2.2 percent of own-source revenue (a figure that excludes money from the federal government).
In fiscal year 2003, total spending on lotteries was almost $45 billion, or $155 for every man, woman, and child in the United States. Roughly 31 percent of this, or almost $14 billion, went into state coffers. Winnings, advertising, and administration account for the remaining funds.
Hansen finds the increasing popularity of state-run lotteries and other forms of gambling as government revenue sources disturbing. State legislators looking to boost tax revenue would do well to consider other sources more consistent with principles of sound tax policy, she argues.
“State-run lotteries make state tax systems more regressive, less transparent, and less economically neutral,” said Hansen. “For all these reasons, the lottery is an example of poor tax policy.”
Not a “Voluntary” Tax
The study addresses what it describes as a common fallacy used to promote lotteries: the idea that lottery revenue is not actually tax revenue because playing the lottery is voluntary.
“A mandatory tax on a voluntarily purchased lottery ticket is still a tax,” said Hansen, “just as any sales tax or excise tax is a mandatory tax on voluntarily purchased goods and services.”
The U.S. Census Bureau assigns lottery revenue the innocuous designation “miscellaneous revenue” in its reports on state taxation. As a result, state lawmakers establish and expand lotteries without admitting they are raising taxes, Hansen notes.
Government or Private Enterprise?
States call their lottery revenue neither taxes nor miscellaneous revenue, but “profits.” This term from the business world reflects a common perception among lottery officials that lotteries are more like a business than a government agency.
Although some lotteries are run by regular employees of the state’s revenue department, many are run by independent agencies, and some are only quasi-public. This independence is allegedly necessary to maximize “profits,” and it sometimes includes private-sector-level salaries. For instance, the Tennessee Lottery CEO’s salary is $350,000 plus bonuses that, contingent upon ticket sales, could bring compensation to $752,500–more than the governor’s salary.
Aggressive advertising campaigns for lotteries are unique in state government operations. Although lotteries themselves were illegal until 1964, and advertising them was banned until 1975, advertising now has made lotteries one of the most visible activities of state governments. In addition to the free advertising lotteries get when TV stations and newspapers report each day’s winning numbers, lotteries spend significant sums promoting new and existing games–$400 million in 1997.
“Lotteries are unique among government agencies in that they actively encourage participation in an activity that they prohibited only 40 years ago,” Hansen points out. “This raises the question of whether profit-maximization is compatible with the goals of responsible government.”
Violating Sound Tax Principles
Hansen argues that lotteries, like other forms of taxation, should adhere to basic principles of sound tax policy, such as transparency and neutrality. According to the study, lotteries violate those principles.
“Taxes should be transparent, that is, clear to taxpayers,” said Hansen. “Taxpayers should understand what is being taxed and at what rate.”
Because state governments refuse to identify lottery “profits” as taxes and advertise the lotteries as recreation, not tax collection, the tax is implicit and transparency is impossible, she said.
Hansen calculates the 2003 lottery tax rate for each state. She explained, “Imagine a state converted from private sales of liquor to a state-controlled system. What used to be tax revenue would suddenly be called ‘profit,’ and ‘taxes’ would go down.
“The successful pressure not to raise taxes,” she continued, “has resulted in a boom in ‘non-tax revenue,’ such as lotteries.”
Lottery taxes are not economically neutral, Hansen points out. A neutral tax system is one that doesn’t encourage the consumption of one good over another, thereby distorting consumer spending. According to Hansen, lottery tickets are singled out for a higher tax rate. This causes economic distortion, according to the study, and lowers the payout rate–the amount gamblers win as a percentage of the money they bet.
A third problem with lotteries is that they’re regressive, meaning the poor bear a disproportionately heavy share of the tax burden.
“Numerous studies have shown the lottery to be a regressive form of taxation,” said Hansen.
In a study of 1997 lottery participation, the National Gambling Impact Study Commission found that, although people of all incomes played the lottery, players with incomes under $10,000 spent almost three times as much as those with incomes over $50,000.
William Ahern ([email protected]) is director of communications at the Tax Foundation.
For more information …
The full text of Alicia Hansen’s December 15, 2004 report, “Lotteries and State Fiscal Policy,” is available on the Tax Foundation Web site at http://www.taxfoundation.org/bp46.pdf.