Lotteries and State Fiscal Policy

October 1, 2004

Download Background Paper No. 46

Background Paper No. 46

Executive SummaryForty states and the District of Columbia currently run lotteries and other states are considering them. State-run lotteries are the most popular form of commercial gambling in the U.S., with half or more Americans participating in any recent year. Compared to other forms of legal gambling, they are second only to casinos in terms of the takeout (consumer spending minus prizes). In Fiscal Year 2003, total consumer spending on lotteries was nearly $45 billion and per capita spending was $155.33. In FY 2002, the average American spent more money on lotteries than on reading materials or movies (theater admissions only). Approximately 31 percent of consumer spending on lotteries, or almost $14 billion, was transferred to state coffers in FY 2003, and in FY 2002 lottery funds accounted for 2.2 percent of own-source general revenue in the average lottery state.

The popularity and revenue raising potential of state lotteries raise serious tax policy concerns. First, we must ask whether the lottery is a tax. Although no government agency technically considers it a tax, it is nonetheless an implicit tax. From a revenue standpoint, lottery tickets are no different from other goods subject to excise taxes; once the funds are transferred to state coffers, they can be used in any way the legislature sees fit (even in states that “earmark” lottery proceeds). It does not make sense to consider the lottery tax to be a user fee, since the revenue raised is not used simply to cover the costs of lottery provision.

Operating costs (including vendor commissions) in Fiscal Year 2003 accounted for only 27 percent of the takeout from traditional (not including video lottery terminals) lottery games; the rest was kept by state governments as “profit”—really tax revenue—and used to fund projects that were, for the most part, entirely unrelated to lotteries.

The fact that playing the lottery is voluntary does not make this “profit” any less of a tax, as some lottery proponents have argued. A mandatory tax on a voluntary purchase is still a tax. In this respect, an analogy can be drawn between the sale of state lottery tickets and the sale of alcohol in Alcoholic Beverage Control states, where the government, rather than private vendors, sells alcohol and raises revenue from the operation of liquor stores as well as from excise taxes on alcohol. With both products the government legalized a previously illegal product, granted itself a monopoly on the sale of that product and collects revenue from the sale of the product. In both cases the revenue collected is above and beyond the amount needed to cover the cost of selling the product.

The second tax policy concern is the lack of transparency. Sound tax policy requires taxes that are transparent, or clear to taxpayers. Taxpayers should understand what is being taxed and at what rate. The implicit nature of the lottery tax makes transparency impossible. Even a taxpayer who understands that a large portion of the ticket price will be kept by the state probably does not know the percentage.

The third concern raised by the lottery is the fact that, as a tax, it is not economically neutral. A neutral tax system would not encourage the consumption of one good over another, thereby distorting consumer spending. Lotteries are singled out for a higher tax rate than other forms of gambling are, which lowers the payout rate (the amount of money gamblers win as a percentage of the money they bet).

Fourth, numerous studies have shown the lottery to be a regressive form of taxation, meaning the poor bear a disproportionately heavy share of the tax burden. The National Gambling Impact Study Commission found that in 1997, although people at all points on the income spectrum played the lottery, players with household incomes under $10,000 spent almost three times as much money on lotteries as those with incomes over $50.000. Finally, it does not appear that “earmarked” lottery funds are always used for the alleged purposes.

The majority of lottery states earmark their lottery “profits” for public education, but legislators are able to shuffle other funds so that lottery tax revenue supplants, rather than supplements, existing funds for education.


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