New And Bad Tax
November 7, 2017Featured, Life and Family, Policy Research, Spending and Taxes
Lotteries tend to be popular with the public because they conjure up dreams of easy money and the good life. Indeed, Mississippi voters approved the concept of a state lottery in 1992 when they repealed a constitutional ban on lotteries. That same year, Mississippi’s first dockside casino opened. While many forms of gambling are now legal in Mississippi, state law still prohibits the operation of a lottery and the in-state purchase of lottery tickets.
In evaluating whether Mississippi should legalize the lottery, lawmakers should realize, first and foremost, that the lottery is a kind of tax – and that, in particular, it is a regressive, or unfair, tax that has negative social impacts.
The Lottery is a New Tax
The primary purpose of a state-monopolized lottery is to generate revenue for the state. This reality is not well understood. There are essentially two types of lotteries: those operated by private vendors; and those controlled by government. Because private lotteries have historically been plagued by corrupt practices (and not infrequently government-run lotteries as well), states have sought to control their own lotteries.
Currently, all but a handful of states have state-controlled lottery monopolies. These monopolies are unique insofar as they are not “natural monopolies.” Road building, sewerage provision, and until recently, mail delivery, are examples of natural monopolies typically presumed to be properly controlled by government. In the case of the lottery no overriding financial or logistical reason justifies a government monopoly.
The state’s monopoly over the lottery allows it to charge a price for the lottery ticket that is well above what a private lottery might charge. This excess charge is essentially a tax. The tax is around 27 percent, but it varies in every state. This 27 percent surcharge is what in gambling parlance is called “the vig.” It’s what “the House” gets regardless of the outcome. In the case of the lottery, the House is the state – and it has a big edge. After the government gets its take, the rest of the money generated by the lottery will go toward winnings and administration. Then, the actual winner has to pay state and federal income taxes on top of that.
It might seem strange to think of the lottery as a tax. The Tax Foundation explains:
Lottery revenue meets all three tests for defining a tax. Current U.S. Supreme Court Justice Stephen Breyer laid out the criteria for defining a tax when he decided the San Juan Cellular case for the First Circuit Court of Appeals in 1992. Breyer argued that a judge should consider who imposes the assessment, who pays the assessment, and what the revenue is spent on.
In the case of a lottery, the Mississippi legislature would be imposing the assessment – just like any other tax, as opposed to a targeted fee imposed by a state agency. Likewise, lottery ticket buyers represent “a broad swath of the public,” rather than a “narrow group that benefits from a particular government service.” In its application, the lottery thus functions like a tax, rather than a fine or fee. Finally, lottery revenue is generally fungible, or at least spent on a “broadly defined benefit.” In short, the lottery meets all three legal tests for defining a tax.
The following statements by lottery proponents confirm this conclusion:
“The Legislature is not passing any revenue (tax increase). That (lottery revenue) is money available for education – should be spent on education.” – Mississippi Attorney General Jim Hood
“When you’re looking at some of the challenges that we’re having and you see a revenue bill that would generate somewhere between 50 and 60 million dollars – just an estimate – I think that’s something that needs to be taken seriously by the members of both the House and the Senate.” – Mississippi Governor Phil Bryant
“I think it should go to education. But in as much as when we earmark money, sometimes we take that money from that department, so with that in mind, the best thing would be to just put it in the general fund.” – State Rep. Alyce Clarke
In summary, the lottery is a “revenue bill” that will be passed with the intention of generating money for the General Fund, or at least, for a broadly defined purpose, such as education. In other words, it meets the legal definition of a tax.
Lottery proponents often balk at defining the lottery as a tax, asserting that buying a lottery ticket is voluntary. Because the state would hold a monopoly over the lottery, however, the tax is not voluntary at all. In order to purchase a lottery ticket, consumers must pay the lottery tax. True, participating in the lottery is not mandatory, but neither is purchasing a car, earning income, or doing all manner of things that are taxed. As long as the primary purpose of the lottery is to generate revenue, and as long as a significant portion of lottery profits are collected as revenue, the lottery is a tax.
Under Mississippi’s joint legislative rules (rule 18), all bills generally related to revenue must be accorded a 3/5 vote by the legislature. Because the lottery is a tax (and, at a minimum, related to raising revenue) any bill that would create a state-controlled lottery must pass by a 3/5 vote in the Mississippi legislature. Otherwise, the lottery will be challenged in state court.
Because the lottery is a tax, its fiscal impact must also be evaluated in light of other forms of taxation. While all taxes influence behavior in some way, economists generally agree taxes should have low compliance costs, be fairly applied and minimize negative social impacts.
The Lottery is a Bad Tax
In comparison to other taxes, the lottery is particularly bad policy. To begin with, the lottery is an inefficient tax with high administrative costs. Observes economist Dr. Roy Cordato: “To raise a dollar’s worth of state revenue through a lottery could cost anywhere from 20 to over 50 times more than it would cost to raise the same dollar through other forms of taxation.” These administrative costs are thought to range between 15 percent and 20 percent and go toward advertising and paying retailers who sell lottery tickets.
In addition, the lottery is an unfair, or “regressive” tax. Generally speaking, “a regressive tax imposes a greater burden (relative to resources) on the poor than on the rich.”
In 2015, Americans spent $73 billion on lottery tickets. That’s about $630 for every household in the United States. It’s also about the same amount spent on the SNAP (Food Stamps) program annually. According to the Associated Press, Americans spend more on the lottery than on “movies, video games, books, music and sports tickets combined.”
Every American household, however, is not spending $630 on the lottery. Generally, the poorest one-third of Americans buy more than half of all lottery tickets. Even the North American Association of State and Provincial Lotteries, an industry association group, acknowledges 25 percent of lottery players earn less than $25,000 annually.
A report from Harvard’s Shorenstein Center on Media, Politics and Public Policy reviews some of the academic literature demonstrating the regressivity of the lottery tax:
A 2012 report in the Journal of Gambling Studies finds that “those in the lowest fifth in terms of socioeconomic status (SES) had the ‘highest rate of lottery gambling (61%) and the highest mean level of days gambled in the past year (26.1 days).’”
A 2011 study, also in the Journal of Gambling Studies, concludes the “poor are still the leading patron of the lottery.”
A 2010 report in the Journal of Community Psychology observes that “lottery outlets are often clustered in neighborhoods with large numbers of minorities, who are at greatest risk for developing gambling addictions.”
Likewise, a 2009 survey commissioned by the South Carolina lottery found that those earning less than $40,000 a year constitute the majority of lottery players, even though they make up less than one-third of the state’s population. Another 10-year study that looked at lottery sales data in 39 states found “a strong and positive relationship between sales and poverty rates” (but not a similar relation between poverty and movie ticket sales, movies being an alternative form of inexpensive entertainment). The authors, however, conclude that “the poor are relatively more likely to see the lottery as a financial investment, and relatively less likely to play for entertainment.” Similarly, other research suggests lottery ticket purchases are financed by forgoing basic necessities. Generally, the breakdown is a 3 percent reduction of spending on food; and a 7 percent reduction on rent and other items.
Again, all this is to say that the lottery is a regressive tax disproportionately paid by low-income people.
In terms of tax policy, it’s also helpful to consider what kind of behavior a lottery tax encourages or discourages. The real question here is whether a state lottery would encourage more gambling or whether it would merely capture gambling that is already occurring via other lotteries in neighboring states.
The answer is complex. Clearly, Mississippi is hoping to both capture a market that exists (and is being diverted to other states) and also develop a new market. The strongest argument for a state lottery is that the state is losing lottery tax revenue to other states when Mississippi residents buy lottery tickets in other states. Interestingly enough, the two states immune to this dynamic – Alaska and Hawaii – do not have state lotteries.
Clearly, for many Mississippi residents, travelling to another state to buy a lottery ticket constitutes an investment of time and money – what economists call an “opportunity cost.” Some evidence suggests that, all things being equal, large jackpots are necessary to attract middle-class and out-of-state customers to buy out-of-state lottery tickets. When the jackpot is high enough, people will drive to another state to buy a lottery ticket. These same customers are more likely to play the lottery as a form of entertainment.
By contrast, low-income players disproportionately favor scratch-off (instant win) lottery cards; and the largest segment of lottery revenue (as high as 80 percent) comes from scratch-off games. For this reason, scratch-off cards represent the worst, and most regressive, form of lottery taxation. While the state is likely “losing” some revenue to players who cross the border to play scratch-offs, the spontaneous nature of such play suggests the loss is minimal. No doubt, a legalized lottery will see targeted advertising aimed at creating new players for these games. As in other states, much of this advertising will appear in low-income neighborhoods. As in other states, every year will see new marketing plans aimed at attracting new players. As in other states, new and more games will be developed with the hope of increasing frequency of play. In order to keep generating revenue from the lottery tax, the government will become the foremost proponent of gambling in Mississippi.
Some readers will note that this brief is silent about the ethics of a lottery. From an economic perspective, a lottery is destructive because it is a nonproductive activity. As stated above, the lottery, at best, is a form of entertainment; at worst, it is encouraging poor financial decisions by those who can least afford to gamble away their resources. In terms of tax policy, the lottery constitutes a high new tax with a regressive impact on the majority of players.
Jameson Taylor PhD is Vice President for Policy at the Mississippi Center for Public Policy.