October 8, 2005
State-Run Lotteries as a Form of TaxationNews
Contact David Robertson, Chairman
WYBETT, (Wyomingites for a Better Economy Today and Tomorrow)
This speech, given at the NCALG Conferences, tells the real truth
about the Lottery. The information comes from the Tax Foundation
which is politically independant.
It is important that you become truly informed about the lottery, to make
a better political decision about bringing this form of taxation to our
Although multi-state lotteries are not addressed in this presentation,
this form of lottery only exacerbates the problems addressed
Multi-state lotteries, actually end up sending more money out of state to
pay for the advertising and prizes than is gained by the state in
I challenge any of you to find a state that is better off
financially after the lottery was brought in than after. The reason
for that is obvious because the lottery doesn't create any business, it
simply shifts the money from one pocket to another.
In our case, introducing the lottery and making it available in
every community will cause far more money to be withdrawn from the state
economy than is lost from the border areas where gambling money is spent
on out of state lotteries.
The Tax Foundation
2001 L Street, N.W.
Washington, D.C. 20036
October 8, 2005
Speech given at the National Coalition Against Legalized
Gambling's 12th Annual Conference When I first started
researching state-run lotteries, like many people, I had never thought of
lotteries in terms of tax policy. For me, the lottery conjured up images
of smiling Powerball winners displaying $10 million checks for the TV
camera. Occasionally I heard of lottery players suffering financial ruin
or gambling addiction. But as I researched, I learned that in between
these two extremes is the less glamorous but equally important issue of
the lottery's effect on state finance.
Lotteries are fundamentally different from other gambling in one
important way: they are provided by the state, and only by the state.
Therefore, they raise policy questions entirely separate from issues of
morality and addiction. The lottery is more than a controversial way to
add a little money to state coffers; it is a tax and should be evaluated
as such. When we subject it to the tests of good tax policy, it fails.
We've all heard people say glibly that lotteries are a tax on the poor, a
tax on people who are bad at math, even a tax on the stupid, but most
people don't actually believe the lottery is a tax.
In 1732 Henry Fielding wrote the following:
Fielding could well have been talking about 21st century American
lotteries. His contemporaries did not purchase computer-generated lotto
tickets from the 7-Eleven, nor did they watch Powerball drawings on TV or
check the winning numbers on the internet. However, the basic public
policy issues inherent in lottery finance have remained much the same
since Fielding's day.
- A Lottery is a Taxation,
- Upon all the Fools in Creation;
- And Heav'n be prais'd,
- It is easily rais'd,
- Credulity's always in Fashion;
- For, Folly's a Fund,
- Will never lose Ground;
- While Fools are so rife in the Nation.[See footnote 1]
To understand how the lottery evolved into an instrument of state tax
policy, we must travel back almost 400 years. The history of state-run
lotteries in America is a long roller coaster ride that has veered
several times between outright prohibition and enthusiastic promotion.
It all started in 1612 when King James I of
England created a lottery in London to aid Jamestown, the first British
colony in America. The colonists enthusiastically embraced England's
lottery tradition and started their own, organizing both public and
private lotteries. Proceeds were used for various public works projects,
such as bridges, libraries, roads and lighthouses. The line between
public and private was often blurred and proceeds also benefited private
universities and churches. There were over 160 colonial lotteries before
the start of the Revolutionary War, and they even provided some of the
funding for the war.
Lotteries soon came to be seen as more of a civic
responsibility than a form of entertainment or
gambling. The colonists viewed them as a more
palatable revenue raiser than explicit taxation. And, in fact, some
people did see the lottery as a type of tax. In 1892, A. R. Spofford,
Librarian of Congress, wrote, `[The lottery was] not regarded at all as a
kind of gambling; the most reputable citizens were engaged in these
lotteries. . . . It was looked upon as a kind of voluntary tax. . . .' 
Adding to the lottery's appeal was the shortage of other sources of
public funding. Taxes were unpopular and, prior to 1790, there were only
three incorporated banks. Lotteries therefore helped fill a void in both
public and private financing.
They were especially popular during the period following the adoption of
the Constitution and prior to the establishment of effective local
taxation. From 1790 to 1860, 24 of the 33 states used them to finance
jails, courthouses, hospitals, orphanages, libraries, schools, colleges
and churches. While townships and institutions were sometimes granted
permission to hold lotteries, they were mainly the province of the
states, although there were a few dismal exceptions: between 1792 and
1842, Congress passed a series of federal lotteries to improve roads and
infrastructure in Washington, D.C. Tickets sold well, but the agents
conducting the lottery absconded with the proceeds.
The 19th century brought a proliferation of shops
that sold only lottery tickets; in 1831, in Philadelphia alone, there
were over 100 such shops. Despite their rapid geographical and financial
growth, state-authorized lotteries were not without problems. Private
firms gradually took over more of the day-to-day operations, and fraud
became rampant. Many lotteries awarded fewer prizes than advertised or
none at all. States found themselves unable to regulate the industry and
began to consider prohibition. Anti-gambling sentiment became part of the
social reform movement already underway, which included abolition of
slavery and promotion of women's rights and temperance. People began to
see gambling in general and lotteries in particular as a way of taking
advantage of the poor. States started banning them, first in the
Northeast, then in the South and West.
There was a short-lived lottery resurgence after
the Civil War. The South needed funds to rebuild, and lottery revenue
raised for Reconstruction was seen as a voluntary tax. In 1868,
Louisiana legislators accepted bribes in exchange for granting the
Louisiana Lottery Company a 25-year charter as the sole proprietor of the
state lottery, and by 1878 Louisiana had the only legalalbeit
scandal-riddenlottery in the country. It finally came to an end in 1890
when Congress enacted a prohibition against interstate commerce involving
lottery tickets, followed by a prohibition against all mail related to
lotteries. By 1894 there were no legal state lotteries and 35 states had
constitutional prohibitions against them.
There followed a 70-year period of prohibition
against lotteries, from 1894 to 1964. However, at no point were they
forgotten by the public or by elected officials. A group of New York
philanthropists founded the National Conference for Legalizing Lotteries
to support enactment of state and federal lotteries to fund hospitals and
other charitable causes. During the Great Depression, there was a flurry
of proposals for lotteries at both the state and federal levels to fund
unemployment relief, and during World War I, members of Congress
introduced lottery bills to help defray the costs of the war. Public
support for these proposals was usually high, with every poll taken after
1938 showing more support than opposition.
Meanwhile, illegal lotteries, known as `policy' and `numbers,'
flourished, and in 1930, approximately thirteen percent of Americans
participated in the Irish Sweepstakes by purchasing tickets that had been
smuggled into the country. 
In 1931 Nevada re-legalized casinos, and 33 years later New Hampshire
ushered in the modern era of state lotteries. In 1964, after 27 years of
annual lottery bills in the state legislature, New Hampshire introduced a
lottery, approved by 76 percent of the voters in a public referendum.
In the years leading up to 1964, there was not
only a growing acceptance once again of gambling in general, but also a
growing opposition to tax increases. New Hampshire had no sales tax or
income tax and relied heavily on property and excise taxes, with over
half of the state revenue coming from excise taxes on alcohol, tobacco
and horse racing. The lottery was thought to be part of a continued
resistance to a sales tax, and also a way to increase state aid to
education, and deal with the state's budget deficit.
New Hampshire paved the way for New York to establish a lottery in 1967,
followed by New Jersey in 1970. It was approved in New York, despite
considerable opposition, in part because legislators, having recently
increased the sales tax, were reluctant to increase sales or income taxes
further. Lotteries spread rapidly to other states, first in the
Northeast, and then the West and Midwest, with the South the last
holdout. In many states a referendum or initiative was necessary to
remove a constitutional ban. In the 1980s, convenience stores and private
suppliers of lottery equipment began lobbying for the passage of
lotteries and conducting petition drives among voters in states where
legislators were hesitant or opposed. Almost all of the referenda and
initiatives passed, although some states approved lotteries through
Currently, 40 states and the District of Columbia operate lotteries, with
two more soon to start. Oklahomans approved a referendum in November for
a lottery to support public education. They had rejected the referendum
in 1994 but may have been swayed this time by the expensive pro-lottery
campaign conducted by a large coalition of education groups.
North Carolina will also soon have a lottery, as the legislature approved
one in August. It has been a controversial issue in the state for twenty
years. North Carolina's road to lottery enactment was longer, more
contentious, and more partisan than many states' and highlights some of
the concerns people have long had about lotteries. Southern states have
been the most reluctant to enact them, but worries about
"losing" money to neighboring states have prompted many to
succumb. South Carolina and Tennessee recently gave in, leaving North
Carolina completely surrounded by lotteries, and the only state on the
East Coast without one.
The governor was an outspoken supporter of a lottery to fund education,
but the House and Senate had long been divided, mainly along partisan
lines. The two sides fought bitterly throughout the spring and summer,
even including a projected $425 million in lottery revenue in the state's
budget, before the lottery legislation had even been approved. Approval
of the Fiscal Year 2006 budget was delayed over a month into the fiscal
year, in part because of debate over the proposed lottery. After the
budget was approved, the House, worried that the Senate might reject the
lottery bill, sought another source of education funding and passed
a bill authorizing certain counties to raise their sales taxes.
Finally, when it looked as if the lottery bill were dead for the year,
the Senate passed it with a tie vote that was broken by the lieutenant
governor. Ticket sales could begin in as little as six months.
North Carolina Democrats largely supported the lottery, but the
North Carolina Republican Party platform states: "A state
lottery turns government into a bookie, succeeds only on the basis of
false advertising, capitalizes on broken dreams and personal
irresponsibility, and places the burden of taxation most heavily on those
who are least able to afford it."
In 1999 the National
Gambling Impact Study Commission, which was
created by Congress in 1996 to `conduct a comprehensive legal and factual
study of the social and economic impacts of gambling,' recommended a
moratorium on the expansion of all gambling in the U.S. Clearly its
advice has not been heeded, as many states are waging battles over
lottery enactment and expansion. Utah is the only non-lottery state not
seriously considering enacting a lottery, and many states are expanding
existing lotteries, ostensibly to deal with budget woes. They're joining
multi-state games such as Powerball, attempting to
sell tickets on the internet, and
installing video lottery terminals at racetracks. Legislators in states
that have recently enacted and expanded lotteries have repeatedly
stressed the need for new revenue sources to close budget gaps, but they
may be confusing a need for revenue with the desire to spend more, and
voters seem to be convinced of the need.
Even states that are not experiencing fiscal crises are likely to enact
lotteries simply to avoid losing money to neighboring states. A state
whose neighbor has a lottery is more likely to enact one itself, due to
concerns that its citizens are spending money in other states, and the
pragmatic notion that people are going to gamble anyway, so they may as
well spend their money at home. Groups pushing for lottery enactment have
gone so far as to run advertisements capitalizing on the desire to keep
revenue in the state. When North Carolina was embroiled in its lottery
debate, a group called the North Carolina Lottery for Education Coalition
created TV commercials featuring a fictional South Carolina convenience
store clerk named Bubba who enthusiastically sold lottery tickets to
North Carolinians who crossed the border just to buy them. Bubba thanked
North Carolinians for spending money on his state's lottery and helping
pay for South Carolina students' education. The `loss' of revenue to
South Carolina became one of the centerpieces of the fight for lottery
enactment in North Carolina.
In many non-lottery states, it is no longer a question of whether a
lottery will be enacted, but a question of when. Twenty years ago,
researchers searched for the reasons certain states enacted lotteries.
Now the question is, Why do certain states not enact lotteries? What
unusual factors have prevented lottery enactment in Alabama, Alaska,
Arkansas, Hawaii, Mississippi, Nevada, Utah and Wyoming? In some of these
states, it is easy to pinpoint factors. In Utah, there is widespread
religious opposition to gambling. In Nevada, the casino industry has a
vested interest in preventing the competition lotteries would pose.
Alaska's and Hawaii's geographic isolation means they don't have to worry
about `losing' money to neighboring states.
In order to appreciate the debates over lottery
revenue, we need to understand the magnitude of the industry. In Fiscal
Year 2004, lotteries generated over $48 billion in consumer spending, up
from almost $45 billion in Fiscal Year 2003.
This figure is not so surprising when we consider that, in Fiscal Year
2002, the average American spent more money on lotteries than on reading
materials or attending movies.
Slightly over half of the money spent is returned
to players in the form of prizes. Part of the remainder covers operating
costsincluding vendor commissions, equipment, administration and
advertisingand the rest is transferred to state coffers. The states call
their portion `profit,' but, as will be discussed later, it is actually
tax revenue. Nationwide, in Fiscal Year 2003, 31% of spendingor almost
$14 billionwas transferred to state coffers.
The breakdown of prizes, operating costs and government transfers varies
from state to state. Nationwide, from the New Hampshire lottery's
inception in 1964 through Fiscal Year 2002, lotteries have paid 53
percent in prizes and transferred 35 percent to the state. The remaining
twelve percent covered operating costs.
In Fiscal Year 2003, the amount of money raised
by lotteries varied considerably by state, and comprised 2.3% of
own-source general revenue in the average lottery state. The amount
ranged from a high of 7.7 % in West Virginia to a low of 0.3% percent in
Montana. Many people believe this revenue helps
state governments keep taxes lower. They are mistaken on two counts.
First, the lottery itself is a tax; second, state and local taxes as a
percentage of income are slightly higher in lottery states.
Is this $14 billion really tax revenue? No governmentstate or
federallabels it as such. However, despite the lack of a formal
definition as a tax by a government agency, lottery `profits' constitute
an implicit tax. When state governments removed lottery prohibitions from
their constitutions, they did so only for themselves. Seeing lotteries as
a potential goldmine for state coffers, they maintained the ban on
private lotteries and created for themselves a monopoly and, in effect, a
source of tax revenue.
Lottery proponents argue that a tax is a mandatory or compulsory payment,
and playing the lottery is voluntary, so the lottery cannot be a tax. But
they're confusing the purchase of a product with the payment of the tax
on the product. True, the purchase of a lottery ticket is voluntary, but
the tax portion of the ticket price is not, just as a sales or excise tax
is compulsory on a voluntary purchase of alcohol, clothing or books.
Using the lottery supporters' rationale, we'd have to say that because
the purchase of a book is voluntary, the sales tax on the book is not
really a tax. Just try to buy a $20 book and hand the cashier a $20 bill,
but refuse to pay the $1 sales tax and leave the store with book in hand.
The only difference between the lottery tax and sales or excise taxes is
that the lottery tax is built into the price of the ticket, rather than
At the heart of the spurious if-it's-voluntary-it-can't-be-a-tax argument
is the assumption that, since the lottery is a recreational activity
rather than a necessity, only people who can afford it and enjoy itthose
who are willing and able to pay will participate. Presumably, government
revenue that is contributed enthusiastically and voluntarily is
preferable to revenue that is contributed under duress. This argument
seems to suggest that the lottery is akin to a sort of user fee, or a
charge paid to the government for a specific service, by the people who
use that service.
Understanding the different categories of
government revenue can shed some light on the classification of lottery
revenue. The Census Bureau Government Finance and Employment
Classification Manual, the definitive publication on classification of
government revenue, considers lottery proceeds `miscellaneous general
revenue,' and lotteries a `general government activity.'
The Census Bureau calls user fees `current
charges' and defines them as: `Amounts received from the public for
performance of specific services which benefit the person charged and
from sale of commodities or services other than utilities and liquor
stores.' Examples include the sale of postage by the U.S. Postal
Service; fees from turnpikes, ferries, bridges, public campgrounds and
public parking facilities; and tuition at public institutions of higher
The line between taxes and fees is sometimes blurry and courts in many
states have tried to create a distinction between the two. To do so, they
consider the intent of the governing body that created the tax or fee. If
the governing body's intent was simply to meet the needs of a person who
paid for a service or product, the payment is probably a fee rather than
a tax. However, if the intent was to raise revenues to benefit the
community at large, then the payment is a tax. The lottery clearly falls
into the latter category since legislators create lotteries to raise
money for projects that benefit the community at largenot to provide a
good to the public that cannot easily be supplied in the private market.
Courts also ask, How is the revenue from the tax
or fee used? Is it put into a special fund that covers regulatory or
other costs of providing the good or service in question? In that case,
the payment is probably a fee. Or is it put into the state's general
fund, as lottery revenue often is? If so, and if the amount of revenue
generated is more than the amount needed to provide the good or service,
and if the revenue is used to fund unrelated government activities,
courts are likely to consider it a tax rather than a fee. The National
Conference of State Legislatures, in its Guidelines for User Charges,
states that user fees `should cover the cost of the services provided.
They should not be used to generate excess revenues that are diverted to
unrelated programs or services.' Using these criteria, we can see that
lottery profits clearly do not constitute a user fee.
In Fiscal Year 2003, after lottery agencies paid
winners their prizes, the majority of the remaining moneycalled the
`takeout'was transferred to state coffers. Operating costs accounted for
only 27 percent of the takeout; the rest was kept by state governments as
`profit' and used to fund unrelated projects. If all of the takeout were
put back into the operation of the lottery, with no `profit,' then we
could consider the revenue to be a fee rather than a tax. However, the
whole point of the lottery has always been to raise money for unrelated
public projects such as education, roads and parks, or simply for
states' general funds.
Clearly, then, lottery revenue is not a type of user
fee. Does that necessarily mean it is tax revenue rather than
miscellaneous revenue, as the Census Bureau claims? There is no reason to
put any type of revenue in a miscellaneous catch-all category if it would
fit better in a more clearly defined category. Lottery profits certainly
fit the Census Bureau's definition of a tax, which is:
`Compulsory contributions exacted by a government
for public purposes, other than for employee and employer assessments and
contributions to finance retirement and social insurance trust systems
and for special assessments to pay capital improvements.` There is
nothing in this definition that excludes lottery revenue. One example the
Census Bureau provides in the tax category is pari-mutuel sales tax.
Pari-mutuels include horse racing, dog racing and jai-alai, and there is
no reason lottery proceeds could not be treated the same way the
pari-mutuel gambling proceeds are treated; it would simply require
legislators who are wiling to call the lottery profit what it isa tax.
Another way to examine the question of whether
the lottery is a tax is to compare lottery sales and alcohol sales in
Alcoholic Beverage Control states, in which the sale of alcohol is
limited to and regulated by the government. In control states, the
government raises revenue (which it considers non-tax `profits') from the
operation of liquor stores, as well as from license taxes and alcohol
excise taxes. The Census Bureau and state revenue departments do not
consider profits from the sale of alcohol to be tax revenue, but they
do classify alcohol excise taxes as tax revenue. Tax-wise, what, really,
is the difference between lottery profits and alcohol excise taxes in
control states, other than bureaucratic semantics?
With both lottery tickets and alcohol, the
consumer purchases a product from the government and pays a price above
and beyond what it costs the government to provide the product, with the
`profit' going to the state. In both cases 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. A private
vendor could easily sell lottery tickets and, in many states, private
vendors do sell alcohol. With both lotteries and alcohol, the government
has granted itself a monopoly on the sale of a product that does not need
to be sold by the government. There is nothing inherent in lottery
ticketsor alcoholthat mandates it be sold exclusively by the government
and taxed heavily, with profits going to unrelated government programs.
The state of Maine clearly recognizes the similarity between these
products: there is a Maine
Bureau of Alcoholic Beverages and Lottery Operations, as well as a
and Lottery Commission.
Because the government has a monopoly on both
products, the total price can be set at any amount the state chooses, and
the rate can easily be raised or lowered to raise revenue or even to
discourage consumption. In the case of lotteries, the takeout rates are
increased to raise revenue since the state does not want to discourage
lottery consumption, although excise taxes on any form of gambling could
in theory be raised to discourage participation. If the rationale of the
heavy implicit lottery tax were simply to discourage consumption (as is
sometimes said to be the case with tobacco taxes), then the government
would not advertise the lottery. The National Gambling Impact Study
Commission recognized the similarity between lotteries and products like
alcohol and tobacco when it correctly referred to the lottery as a `sin
We have established that the lottery is a tax, but why does it matter
whether it's a tax? Lottery supporters counter that, regardless of the
tax implications, lotteries are a voluntary activity in which the
majority of consumers wish to participate, and, as such, should be
allowed to continue. This argument may be plausible when applied to
private gambling, but it simply doesn't work for state-run gambling.
Suppose the state outlawed the sale of bread at private grocery stores
and started selling bread itself at $20 a loaf? What if the state started
selling and advertising cigarettes to raise money for public schools? The
purchase of bread and cigarettes would still be voluntary, but people
would be outraged. The voluntary nature of state-run lotteries does not
absolve them from the same scrutiny to which we subject other government
activities. Lotteries are a government enterprise and a source of tax
revenue, and must be evaluated as such.
So, let's turn to tax policy. What exactly is a good tax?
First, a good tax is simple, easy to understand and easy to comply with.
It's certainly easy enough for a lottery player to comply with the tax by
purchasing a ticket, but the administrative burden of operating lotteries
makes the tax system overall more complex and less efficient. The problem
is compounded in states that use lottery revenue specifically to lower
other taxes. The Wisconsin
Lottery Web site states that, since 1988, $2 billionor 32% of
revenuehas been returned to eligible Wisconsin taxpayers in the form of
property tax credits. In addition, when retailer commissions, prizes, and
property tax relief are added together, at least 95% of total lottery
revenue has `gone back to the people of Wisconsin.' The Web site boasts
further, `That money stays in Wisconsin's economy for the good of
everyone.' Is that really something worth bragging aboutthat the money
stays in the state's economy? A private business could keep that revenue
in the state's economy just as easily. A state-run gambling enterprise is
not necessary to keep money in the state. The only thing the Wisconsin
lottery really accomplishes is a redistribution of some of the tax
burden, shifting it from property owners to lottery players. Perhaps some
people think homeowners as a group are more deserving of a tax break than
gamblers are, but the tax code should not be used to impose such moral
The second test we can use to judge taxes is
regressivity. A regressive tax is one that is paid disproportionately by
low-income people. Lottery supporters often misunderstandperhaps on
purposethe meaning of regressivity. If a low-income person pays more tax
than an upper-income person, as a percentage of his income, then the tax
is regressive. Some lottery agencies and associations claim to study
regressivity when in fact they focus simply on rates of participationhow
many people in each income bracket play the lottery, and how often, which
has nothing to do with regressivity. They cite studies showing that the
poor spend less money on lotteries than the middle class and wealthy do,
but this also is not a true measure of regressivity since it does not
take into account money spent as a percentage of income. They claim that
regressivity is an issue only with regard to taxes, not with voluntary
activities like lotteries, and they are content to rely on meaningless
statistics that show, the poor play the lottery less often than the
middle or upper class in certain states, or that the majority of a
state's lottery consumers are middle-income. What good are these figures
if we don't know how much people spendand how much they earn? $500 worth
of lottery tickets in one year may be a drop in the bucket to an
upper-income person, but it is a significant portion of a poor person's
Extensive evidence shows that lotteries are
regressive. The National Gambling Impact Study
Commission determined that, during the time period studied, not only were
lotteries regressive, but the poor spent more as a dollar amount. Other
studies show that the poor do not spend more as a dollar amount, but they
do spend more as a percentage of income. The level of regressivity seems
to vary depending on the type of game and location, but there is a
consensus among most researchers that state lotteries are indeed
There are also concerns that states actively market the lottery to the
poor. In 1986, the Illinois Lottery placed a billboard in a poor Chicago
neighborhood that read, "From Washington Street to Easy
Street." Even though similar billboards were placed around the city
with different street names, angry Chicagoans boycotted the lottery,
alleging it was taking advantage of the poor. Some even claim the
billboard read, `Your Ticket out of Here,' although the Illinois Lottery
denies that. Regardless of the exact wording, there was widespread
sentiment that the lottery was taking advantage of the state's most
Lottery proponents counter the regressivity claim by arguing that the
poor spend a disproportionate amount of their income on other consumer
goods as well, but this argument fails to take into account that, unlike
other consumer goods, lottery tickets are sold and advertised by the
government. Should the government be in the business of selling,
marketing and profiting from an item on which the poor spendalbeit
voluntarilya higher percentage of their income?
The third tax policy concern with lotteries is that they are not
economically neutral. One principle of sound tax policy is that the tax
system should not favor the consumption of one good over another, or
distort consumer spending. Neutrality, in a broad sense, means fairness:
the tax code should treat all goods and services the same, and, since tax
revenue pays for general public services, it is important that taxes be
levied as broadly as possible rather than on a subset of the population
who happen to enjoy a particular product or service. Singling out one
product for a high tax rate is economically inefficient. Consumers will
likely shift away from that product and find less highly taxed
substitutes. This distortion of consumer behavior ultimately damages the
Other types of commercial gambling are taxed, but the high government
`profit' rate on lotteries makes the payout rate (the percentage of
spending returned to players as prizes) lower than in other forms of
gambling. The higher the government's cut, the lower the payout and the
higher the implicit tax.
Politicians, reluctant to make the politically unpopular move of raising
income or sales taxes, reason that voters will be more accepting of a
high tax on a recreational activity like gambling--especially one that
many people consider immoral or unhealthy. The same rationale applies to
other types of `sin taxes,' like high excise taxes on alcohol and
cigarettes, but how much of a sin do legislators really believe the
lottery to be, given how heavily they advertise it?
Because the lottery tax is built into the price
of the ticket, the rate is not easy to calculate and varies from year to
year and state to state, but it's always staggering. In Fiscal Year 2003,
31 cents of every dollar spent on lottery tickets was kept by state
governments. This translates to an implicit tax rate of 45%far higher
than any state's sales tax and higher than the effective tax rate on most
states' casinos. In 2003, ten states had implicit lottery tax rates
over 50%, and the average resident of a lottery state paid $55 in lottery
Another principle of sound tax policy is transparency. The tax system
should be as clear and simple as possible; taxpayers should understand
what is being taxed and what the tax rates are. Transparency, simply put,
is honesty. The policymakers who write tax laws should not attempt to
hide the cost of taxes from the public.
The lottery tax, however, is a hidden tax. The
state creates a monopoly for itself and builds the tax into the price of
the tickets, then advertises the lottery as a recreational activity
rather than a revenue-raising activity. The government never has to admit
that the money it keeps is tax revenue. Lottery agencies are willing to
provide consumers with information on the breakdown of profits, prizes
and administrative costs, but they do not call the profit `tax revenue.'
This simple choice of words is what creates the lack of transparency.
Minnesota does consider part of its ticket sales to be an
`in-lieu-of-sales tax' of 6.5 percent. But this simply creates more
confusion, implying that the rest of the government's share is not tax
Lottery agencies can raise or lower the implicit tax rate in numerous
ways: by introducing new games, by changing the percentage of the ticket
price that ends up in state coffers, by increasing the ticket price, or
by introducing an entirely new type of product, like video lottery
terminals. Ticket prices are set based on the amount of revenue desired,
not on a market price.
Politicians often try to create a false dichotomy
between lotteries and taxes. They talk about having a lottery to keep
taxes low or to avoid a tax increase, not realizingor refusing to
acknowledgethat the lottery is a tax. In the recent North Carolina
lottery battle, the governor proclaimed, `It's either going to have to be
lottery, a lottery for education, or it's going to have to be a tax.'
 And the following headline from a lottery
trade publication says it all: `Governor Lays it on the Line, Choose Tax
or Lottery.' States could make the implicit lottery tax explicit simply
by acknowledging that it is a tax, and by requiting lottery vendors to
give customers receipts clearly itemizing the tax portion of the ticket
price. Or lotteries could be run privately and taxed by state governments
the same way casinos and pari-mutuels are.
There are several reasons legislators and lottery officials would rather
not label the lottery a tax. It would be politically unpopular: a
legislator who wants to create a lottery would be `raising taxes' rather
than `raising money for education.' They want the money to spend, without
having to admit to raising taxes. The lottery lets politicians have their
cake and eat it too. Legislators often give the impression that a lottery
will cause money for education or other worthy causes to simply
materialize out of thin air, as if the state will be richer without any
citizen being made poorer. Regardless of what we call lottery revenue, it
still has to be paid by someonesomeone who will have a few dollars less
in his pocket afterward.
If lottery proceeds were officially labeled tax
revenue by the Census Bureau and by state revenue departments, anti-tax
sentiment might stem the tide on the growth of lotteries. State revenue
departments would have to take the first step, as the Census Bureau will
not classify as a tax any payment that does not pass the `visibility
test': a payment must be visible to the taxpayer in order to be
considered a tax, and if a state government does not itemize a payment as
a tax, the Census Bureau will not consider it a tax. If more people
viewed the lottery as a tax, perhaps it would lose some of its luster. Of
course, pro-lottery legislators do not want to see this happen, as it
would mean they would have to explicitlyand honestlyraise taxes or cut
If the lottery were properly labeled a tax,
lottery agencies would also be subject to greater oversight and scrutiny.
In many states, they are not bound by the same rules that other
government agencies must follow. Some lottery agencies are part of a
department of state government, usually the department of revenue.
However, the majority of states have established separate agencies, which
do not have to abide by all of the rules that govern other state
agencies. In a few states, the lottery agency is independent and
quasi-public. It is argued that this independence is necessary for the
lottery to operate as a business and generate as much revenue as
possible. This means, in a few states, paying managers salaries
comparable to those in the private sector but not generally allowed for
government employees. The Tennessee Lottery recently came under fire for
paying its CEO $700,000 in salary and bonuses in her first year on the
jobmore than the governor makes. She has since received a pay cut, and
her compensation is now a more modest $577,000.
Lottery officials and pro-lottery legislators have a vested interest in
maintaining the current system, and, because they have a monopoly on
lottery provision, they're able to. They do not make explicit the true
nature of the lottery tax because, quite simply, they do not have to.
The lack of transparency is a problem with traditional lotteries, but
video lottery terminals, or VLTs, are even worse. They often resemble
casino games so closely that players may not realize the games are
runand taxedby the state lottery agency. When we think of "playing
the lottery," we think of buying a ticket and waiting days to find
out whether we won, not playing slots at the track.
Last year New York added racetrack video gaming machines (VGMs) to its
lottery line-up. Lottery officials were careful to distinguish their
video slot machines from traditional slot machines, which are
unconstitutional in New York, although the difference was mainly a
technicality. Even after the machines were installed, there was concern
that they would be found unconstitutional. In July 2004, a New York
appellate court ruled that the machines are lottery games rather than
traditional slot machines, and therefore constitutional. However, the
fact that the issue had to be resolved in court speaks volumes.
The uses of lottery proceeds pose yet another fiscal policy concern. Most
states earmark, or allocate, lottery revenue for specific programs. (The
rest simply transfer the proceeds to the state's general fund.) Proceeds
have been earmarked for programs as diverse as parks and recreation,
senior citizens programs, salmon restoration, and pension relief funds
for police officers and fire fighters, among other things.
The most common program for which revenue is earmarked is education.
Twenty-three states earmark all or part of their proceeds for public
education, including elementary, secondary, college and vocational
education. While lotteries have ostensibly raised a large amount of money
for education, it is not clear that the funds are always used for
education. Skeptics say that earmarking is at best ineffective and at
worst a misleading political tactic to persuade voters to approve lottery
referenda and play the lottery. Legislators can simply shuffle funds;
lottery revenue allows them to use the money that would have been
allocated for education for other purposes. Voters and consumers,
however, may be under the impression that lottery funds will
significantly increase the total amount of money spent on education.
A number of studies have attempted to prove or
disprove the suspicion that earmarked funds are fungible and tend to
simply replace rather than supplement education
expenditures, but of course it is impossible to
know how much money would have been spent on education in the absence of
lottery funds. However, there is not much evidence that these funds add
significantly to the total amount spent on education. In 1999 the
National Gambling Impact Study Commission concluded, `When expenditures
on the earmarked purpose far exceed the revenues available from the
lottery, as is the case with the general education budget, there is no
practical way of preventing a legislature from allocating general
revenues away from earmarked uses, thus blunting the purpose of the
Lottery agencies are aware of the potential for
misallocation. South Carolina, for example, states in its 2002 lottery
legislation: `[P]roceeds of lottery games must be used to support
improvements and enhancements for educational purposes and programs as
provided by the General Assembly and . . . the net proceeds must be used
to supplement, not supplant, existing resources for educational purposes
and programs.'  There is, however, no reliable way to enforce this
The Montana legislature is keenly aware of the
perils of earmarking. In 1995, after nearly twenty years of earmarking
proceeds for education, the state legislature began transferring revenue
to the general fund instead. The president of the Montana Education
Association stated that it was an `illusion' that lottery funds
significantly benefited public schools.
Georgia, which earmarks funds for its HOPE scholarship program, revealed
in 2003 that $1.8 billion worth of lottery proceeds that should have been
used for education had instead been spent on other projects, including
museums, security fences and metal detectors, and renovations of historic
Clearly, the lottery fails the tests of good tax policy. However, no
state has abandoned the lottery in the past century and, unfortunately,
none is likely to do so soon. If they did, however, they would improve
their tax systems by increasing accountability, transparency and economic
neutrality, as well as decreasing regressivity. Legislators would find
that they do not truly need the tax revenue raised by lotteries; they
would either get by without it or raise it through explicit taxation
enacted legislativelyand honestly. They could allow lotteries to
continue in the private market or even ban them entirely. In either case,
the cessation of state-run lotteries would result in more principled
state tax systems.
1 Henry Fielding, The Lottery (London: J. Watts,
1732), Scene 1, quoted in Charles T. Clotfelter and Philip J. Cook,
Selling Hope: State Lotteries in America (Cambridge, MA: Harvard
University Press, 1989), 215.
2 164 lotteries are mentioned in John Samuel Ezell,
Fortune's Merry Wheel: The Lottery in America (Cambridge, MA: Harvard
University Press, 1960), quoted in Louis Jordan, `Colonial Currency,'
Robert H. Gore, Jr. Numismatic Endowment, University of Notre Dame
), and Jordan notes that more have been discovered
3 Clotfelter and Cook, Selling Hope, 20.
4 A. R. Spofford, `Lotteries in American History,'
Annual Report of the American Historical Association, 1892 (Washington,
DC: Government Printing Office, 1893), 174-175, quoted in Clotfelter and
Cook, Selling Hope, 35.
5 Spofford, 190, quoted in Clotfelter and Cook,
Selling Hope, 37.
6 I. Nelson Rose, `Gambling and the Law: Pivotal
7 Clotfelter and Cook, Selling Hope, 43.
8 Ibid, 38.
9 David Weinstein and Lillian Deitch, The Impact of
Legalized Gambling: The Socioeconomic Consequences of Lotteries and
Off-Track Betting (New York: Praeger, 1974), 14-15, quoted in Clotfelter
and Cook, Selling Hope, 142.
10 Public Law 104-169, 104th Congress, available at
11 See Alicia Hansen, `Internet Lottery Sales: Click
Here to Pay Higher Taxes,' Tax Foundation Commentary, March 18, 2005,
http://www.taxfoundation.org/research/show/409.html; Dennis Cauchon,
`Lotteries may gamble on Internet,' USA Today, April 21, 2005,
; and Georgia General Assembly, House Bill 346,
12 North American Association of State and
Provincial Lotteries, `Fiscal Years 2002, 2003 and 2004 lottery sales and
(Puerto Rico's lottery revenue has been subtracted.)
13 For calculations and graph, see Alicia Hansen,
Tax Foundation Background Paper, No. 46,
Lotteries and State Fiscal Policy' (October
14 North American Association of State and
Tax Foundation calculations. (Puerto Rico's lottery revenue has been
15 Teresa LaFleur and Bruce LaFleur. LaFleur's 2003
World Lottery Almanac (Boyds, Maryland: TLF Publications, 2003), 19.
16 For a full list of states, see Alicia Hansen, Tax
Foundation Background Paper, No. 46,
Lotteries and State Fiscal Policy' (October
17 For a list of state and local tax burdens by
18 U.S. Census Bureau, `Government Finance and
Employment Classification Manual,' published December, 2000,
19 U.S. Census Bureau, `Government Finance and
Employment Classification Manual,' published December, 2000,
20 National Conference of State Legislatures, `The
Appropriate Role of User Charges in State and Local Finance,' (July
21 The only use of profits that is relevant to the
operation of lotteries is the gambling addiction treatment and education
programs that some states run, using a small portion of the profits.
There is an element of hypocrisy to a state profiting from a product
whose use necessitates state-run addiction treatment programs.
22 U.S. Census Bureau, `Government Finance and
Employment Classification Manual,' published December, 2000,
23 State-run liquor store profits and lottery
profits are misclassified in the same way: Profits from the operation of
state-run liquor stores (money that is left over after operating costs
and taxesincluding excise, sales and license taxeshave been subtracted)
go into the general fund or are earmarked for specific programs. (For
.) Liquor store profits end up in the same place and are, for the most
part, used in the same way as alcohol excise taxes. Why, then, should
they not both be labeled tax revenue? (As with lotteries, some states use
a small portion of liquor store profits for addiction education programs;
Mississippi even levies an `alcohol abuse tax' on liquor.) See
for classification of state-run liquor store
24 Many lottery proponents argue that lotteries must
be government run to be fair. According to the North American Association
of State and Provincial Lotteries, `[T]he public has a right to demand
both the security and integrity of lotteries, to ensure that everyone
stands an equal chance of winning, that all advertised prizes are in fact
paid out, and that the lottery does not resort to unscrupulous business
why should consumers have a greater right to security and integrity with
lotteries than with any other business transaction? With private
lotteries, consumers would have legal recourse in the case of fraud, as
they do with other businesses, andas with any business transactionthe
buyer must beware. Why should the government guarantee the integrity of
gambling, of all things? Lotteries are, after all, a gamble, and gambling
in any form involves risk.
25 National Gambling Impact Study Commission Final
Report (Washington, DC: Government Printing Office, 1999), ch.2, p. 3,
26 See, for example, North American Association of
State and Provincial Lotteries, `Demographic Study Highlights,'
http://www.naspl.org/demograf.html, and `Who plays lotteries?'
27 See, for example, National Gambling Impact Study
Commission Final Report, ch.7; Clotfelter and Cook, Selling Hope,
222-230; Mary O. Borg and Paul M. Mason, `The Budgetary Incidence of a
Lottery to Support Education,' National Tax Journal 41 (March, 1988):
75-85; Clotfelter and Cook, `State Lotteries,' 12; Christopher Cornwell
and David B. Mustard, `The Distributional Impacts of Lottery-Funded Aid:
Evidence from Georgia's Hope Scholarship,' unpublished paper, University
of Georgia (2001); and Virginia Lottery, `Who Plays the Lottery,' (1997),
quoted in Charles T. Clotfelter, `Do Lotteries Hurt the Poor? Well, Yes
and No,' Duke Policy News (Summer 2000) (summary of testimony given to
North Carolina House Select Committee on a State Lottery, April 19,
28 National Gambling Impact Study Commission Final
Report, Executive Summary, 14,
29 To calculate the implicit tax rate, divide tax
revenue (profits) by the value of the ticket (prize money plus
administrative costs). The implicit tax rate is the state government's
tax on ticket sales and excludes income taxes subsequently collected on
winnings. For a chart of each state's implicit tax rate, see Alicia
Hansen, Tax Foundation Background Paper, No. 46,
Lotteries and State Fiscal Policy' (October
31 Gary D. Robertson, ` North Carolina Governor
Brings in Georgia Officials to Talk up Lottery,'Lottery Insider (July 4,
32 Gary D. Robertson, `Governor Lays it on the Line,
Choose Tax or Lottery,'Lottery Insider (June 18, 2001),
33 The visibility test: `One important feature of
tax revenue is the need to pass a ‘visibility test.' That is, the tax
levy must be visible to the taxpayer as being a tax and not buried under
the guise of another revenue. Take, for instance, a tax on utility
services provided by the government levying the tax. If the utility bill
does not itemize the tax but incorporates it into its user charge rate
(therefore being invisible to the customer as a tax), then that so-called
'tax' is reported as a utility revenue for Census Bureau purposes.' U.S.
Census Bureau, `Government Finance and Employment Classification Manual,'
published December, 2000,
34 Skip Cauthorn, `Lottery adjusts Paul pay,' The
(Nashville, Tenn.) City Paper, November 30, 2004,
35 See, for example, Charles J. Spindler, `The
Lottery and Education: Robbing Peter to Pay Paul?' Public Budgeting and
Finance 15 (Fall 1995): 54-62, quoted in Charles T. Clotfelter, Philip J.
Cook, Julie A. Edell and Marian Moore, `State Lotteries at the Turn of
the Century: Report to the National Gambling Impact Study Commission'
(Washington, DC: Government Printing Office, 1999), 6; Noel D. Campbell,
`Do Lottery Funds Increase Educational Expenditure?: Evidence from
Georgia's Lottery for Education,' Journal of Education Finance 28 (Winter
2003): 383-402; Donald E. Miller and Patrick A. Pierce, `Lotteries for
Education: Windfall or Hoax?' State and Local Government Review 29
(1997): 34-42; William N. Evans and Ping Zhang, `The Impact of Earmarked
Lottery Revenue on State Educational Expenditures,' working paper,
University of Maryland (November 2002); and Clotfelter and Cook, Selling
36 Clotfelter and Cook, `State Lotteries,' 6.
37 South Carolina Education Lottery, `How Education
Wins,' May 13, 2004,
38 Evans and Zhang, 30.
39 James Salzer, `Special projects shrink lottery
proceeds,' The Atlanta Journal-Constitution, November 11, 2003,