The Luck of the Lottery

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Snagged Another Lottery Participant

Most forms of gambling are illegal at the federal level. Others are illegal at the state level. The FBI frequently busts participants of cyber casinos and foreign lotteries. In most places, both privately run casinos and lotteries with an entrance fee are also illegal. However, counterparts of both of these operated by the state or Native Americans are just fine. In states with a lottery, over half of its citizens have played. Sadly, a large number of those participants are below the poverty line.

Government-run lotteries have a sordid and monopolistic past. In the 1800s, lotteries were a primary source of government funding, especially for special projects. In 1821 Congress passed a bill establishing a National Lottery to raise money for the beautification of Washington, D.C. That same year, Virginia created a state lottery and banned the sale of any other lottery tickets.

Philip and Mendes Cohen were one of the more reputable lottery vendors of the day. They were charged with selling National Lottery tickets in Norfolk, Virginia, thus ignoring Virginia’s new law. A landmark Supreme Court case (Cohens v. Virginia) established the right of the Court to rule sovereignly even when one of the states was involved in the case. But it also established Virginia’s right to ban D.C. lottery tickets.

It was probably good that Virginia banned sales. In 1823 organizers of the National Lottery absconded with the money and never paid any winners.

Throughout the nineteenth century, religious groups lobbied to abolish slavery and ban alcohol and gambling. In response, many states passed laws forbidding various forms of gambling. After 1895 federal law prohibited advertising gambling through primary channels like the mail, broadcast media or interstate commerce.

In 1906 another landmark decision by the Supreme Court upheld an 1889 North Carolina law suppressing certain kinds of vicious contracts. The law prohibited the running of “bucket shops,” a term used to describe “an establishment, nominally for the transaction of a stock exchange business, or business of a similar character, but really for the registration of bets or wagers, usually for small amounts, on the rise or fall of the prices of stocks, grain, oil, etc., there being no transfer or delivery of the stock or commodities nominally dealt in.” The Court found such businesses violated the Equal Protection Clause of the Fourteenth Amendment. This ruling effectively banned gambling nationally.

The moral argument against gambling kept the government out of it for nearly 60 years. Then, in 1964, New Hampshire opened the first modern state lottery. Gradually other states followed suit. Today only a handful of states don’t have state-sponsored lotteries. In 1975 Congress exempted state-sponsored lotteries from the advertising ban.

Voters approved the Virginia Lottery in 1987. For years the money from the lottery flowed into the general budget. Politicians promise that all the proceeds have been used for public education. That only means lottery profits are swamped by the state’s education budget.

For people who don’t think like an economist, this shell game of tying specific taxes to specific expenses dupes them into believing one justifies the other. Try as they might to argue otherwise, in no state does an increase in lottery profits move the needle on state education funding.

The Virginia lottery currently employs 254 people. It spends $26 million annually to encourage those who did not pay attention in math class to spend $1.8 billion every year for a chance to win 61 cents on the dollar. After considering taxes and the time value of money, winnings for large amounts are actually closer to 17 cents on the dollar. Meanwhile, the lottery sends 29 cents on the dollar to the state.

Fortunately, each ticket includes a telephone number to call for compulsive gambling counseling. Unfortunately, the Virginia Lottery runs the gambling helpline. They voluntarily support National Problem Gambling Awareness Week by suspending advertising for those seven days.

Most lottery advertising is misleading. The real value of prizes is only about half what is advertised because of the long time periods over which the money is paid. The value is even less after accounting for annual state and federal taxes. However gambling losses are only deductible on your taxes to the extent of your winnings. That means if you win some and you lose some, you can legally not pay taxes on the winnings because you lost more. The best you can do is break even.

The average citizen believes a state lottery is free money. Conservatives support it because it is a voluntary tax. Liberals support it because it supposedly helps subsidize education. In reality, it does neither.

It is voluntary in the same way the tax would be voluntary if the government owned and operated every movie theater in the state. Yes, movies are discretionary purchases, but the government doesn’t need to operate these businesses to tax them.

The government could simply put a 30% tax on gross gambling revenues and accomplish the same ends, collecting more revenue for the state without forcing a state-run monopoly.

The argument that gambling should be discouraged also does not justify a state-run monopoly. Many activities should be opposed that are better off without a state monopoly. A lot of people want to dissuade unhealthy eating, but we are more likely to get worse foods under a state-run monopoly than under the invisible hand of the free market.

If gambling is so morally questionable that private citizens are banned from opening a business, then so should government. It is best to maintain the separation of sin and state.

Photo from TaxCredits used here under Flickr Creative Commons.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818...)

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