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Economics of the Lottery

If you’re reading this, chances are slim that you’ve ever won a lottery. Why? Because the odds of winning are just so low. In 2014, Americans spent $70.15 billion on lottery tickets alone. That’s more than the total spending on music, books, sports teams, movies and video games combined, according to CNN Money. What do we get for all that money spent on the lottery? That depends. 

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A National Pastime

Lotteries have a long history. They’ve been traced all the way back to ancient Rome and were used in Renaissance Europe to raise money for churches and other government projects. These days, lotteries are a controversial feature of American life. The recent Powerball lottery set records, coming in at a whopping $1.6 billion.

According to the North American Association of State and Provincial Lotteries (NASPL), 44 U.S. states and the District of Columbia offer lotteries. Over 100 other countries run lotteries. Lotteries come in a variety of forms, from the instant-gratification scratch-off cards to the number games like Powerball.

Related Article: 5 Tips for Handling a Financial Windfall

Who Benefits

While Americans are generally allergic to high taxes, the high tax rates on lottery winnings haven’t provoked a public outcry. If you win over $600 in the lottery you’ll owe federal income taxes on that money. And if you’re the lucky winner of $5,000 or more, 25% will be withheld from your check for federal taxes before you even see your winnings. Depending on how much you win and on your income, you’ll then have to pay a further 14.6% to make up the total 39.6% that’s the top income tax rate at the federal level.

If you live in a state with a state income tax, you’ll owe those taxes as well. Some states with income taxes withhold from lottery checks and some do not. If you’re the winner, be sure to budget some extra money for taxes in the April after you get your check.

State governments take in about a third of each lottery jackpot. How does this compare to revenue from corporate taxes? According to Reuters, “the 44 states with lotteries (plus the District of Columbia and Puerto Rico) get 44 cents from this form of gambling for each dollar of state corporate income tax.” At last count, there were 11 states in which lottery revenues exceeded revenues from corporate taxes. Some critics have pointed to this fact and argued that the tax burden is being shifted from wealthy corporations to poor individuals who buy lottery tickets.

Your odds of winning are better in some states than in others. Massachusetts is the state that returns the highest percentage of every bet, at 73%. According to the Tax Foundation, “state lotteries pay out an average of only 60 percent of gross revenues in prizes  (compared to about 90 percent for casino slot machines or table games).”

After paying out prize money and covering operating and advertising costs, states get to keep the money that remains. In 2010, state lottery revenue came out to $370 for every resident of Delaware, $324 per capita in Rhode Island and $314 per capita in West Virginia.

Those inexpensive lottery tickets add up to serious funds. In 2012, California, Florida and Massachusetts took in over $4 billion in lottery income. New York’s lottery income topped $7 billion. By 2014, New York’s lottery revenue was topping $9 billion.

But once a state pays out the prize money and covers lottery administration costs, it’s left with less than you might think. Of the 43 states that had lotteries in 2012, 36 of them took in revenue that equaled less than a third of total lottery sales.

To keep ticket sales robust, states have to pay out a respectable portion of sales in prize money. But of course, that reduces the percentage that’s available for state revenue and use on things like education, which is the ostensible reason for states to have lotteries in the first place.

And rising lottery revenues are no guarantee of an increase in education spending. According to the Tax Policy Center, when North Carolina’s lottery revenue increased by $23 million in 2010, the state’s education spending was slashed by $2.3 billion.

Though they’re a major source of government funds, lottery revenues are not as transparent as a normal tax. Consumers generally aren’t clear as to the implicit tax rate on the lottery tickets they’re buying. Though the question of whether to allow gambling and lotteries may come up in state elections, the question of how to use lottery revenue rarely does because the money is seen as “extra” money.

And of course, states have to pay money to operate and advertise lotteries. It’s not uncommon for states to pay high fees to private advertising firms to help them boost lottery ticket sales. Between 2003 and 2015, the state of Maine more than tripled its lottery advertising budget.

How Americans View the Lottery

The Economics of the Lottery

Gallup polls have found that state lotteries are the most popular form of gambling in the U.S., with roughly half of respondents saying they purchased a lottery ticket in the past 12 months. With prices as low as $1 or $2 per ticket, the fondness for lotteries may seem harmless. Still, some have argued that lotteries prey on the economically disadvantaged, those who most need to stick to their budget and trim unnecessary spending.

Are lotteries really a “tax on the poor”? A 2014 Gallup poll found that 62% of Americans consider gambling “morally acceptable.” Meanwhile, 1 in 6 Americans reported gambling on professional sports. So is the lottery different? Research shows that higher-income Americans are more likely to engage in sports gambling, while their lower-income counterparts are more likely to buy lottery tickets or scratch-off lottery cards. Across income groups, those in their 20s and 30s are the most active lottery participants.

Some play the lottery because they want to win enough money to be able to quit their jobs. Would you quit your job if you won the lottery? The answer probably depends on how engaged you feel at work. A Gallup poll found that 40% of those who feel “actively disengaged” at work would quit their job if they won the lottery. 33% of those who feel “not engaged” would quit, while only 25% of those who feel “engaged” would quit their job if they won the lottery. For the record, experts advise that lottery winners avoid making drastic life changes soon after getting their financial windfall, so staying at work is probably the smart choice (at least in the short term).

Related Article: Top Ten Ways We Waste Money and What to Do About It

Looking Ahead

The Economics of the Lottery

What has changed since 1964, when New Hampshire became the first state to establish a lottery? For one thing, spending has boomed. And as the jackpots have grown, the lure of a big pay-out has drawn more ticket-holders. You likely know at least one person who never usually gambles who bought a Powerball ticket for the January 2016 record drawing.

The $70 billion Americans spend on lottery tickets translates to roughly $230 per person, including children, per year. That’s a lot of money that’s not being saved for retirement or used to pay off credit card debt. It’s also “more than 10% of the total state revenue in states’ collective budgets for fiscal year 2014,” according to the Pew Charitable Trusts.

It’s unlikely that the lottery trend will die down. State and local governments depend on lotteries to raise revenue that they can’t raise through ordinary taxes or bond sales. In today’s anti-tax climate, why would a state choose to replace raising lottery revenue with raising tax revenue when the former is a popular game and the latter is political suicide in many places?

Another question for the future is whether lotteries will expand to all 50 states. Currently, six states – Alabama, Alaska, Hawaii, Mississippi, Nevada and Utah – do not have state-run lotteries. The states of Nevada and Mississippi still take in substantial revenue from taxes on other forms of gambling. Alaska has traditionally had enough oil revenue to keep it solvent without resorting to a lottery, but attitudes may be changing now that the state is experiencing a budget deficit.

In 2015, the 36 states that participate in the Powerball lottery voted to approve rule changes that make it harder to win each jackpot, lowering the odds of winning the biggest prize but increasing the odds of winning smaller prizes. Since the rule change, the chances of winning the jackpot have fallen to 1 in 292,201,338, from 1 in 175,223,510. The odds of wining just $4 have gone from 1 in 111 to 1 in 92.

These rule changes boost ticket sales in a couple of ways. For one thing, people who win these small prizes get a psychological boost that encourages them to buy more tickets. For another, the smaller odds of winning the jackpot mean that the jackpot is more likely to roll over and balloon in size. The size and hype of the January 2016 Powerball is proof that a big jackpot is an attraction in itself, drawing even those who don’t ordinarily gamble or buy lottery tickets.

Expect the battle over state-run lotteries to continue. Organizations like Stop Predatory Gambling will continue to question the role of the state in promoting gambling, while others will argue that the lottery is a fun, voluntary way to raise state funds for education and other programs.

The elephant in the room is the fact that “people with a household income of less than $10,000 a year who play the lottery spend $597 a year on tickets,” according to the New York Times. That has led some analysts to propose more gamification of savings – in other words, making saving for an emergency or retirement more like playing the lottery.

Update: Need a financial plan beyond just hoping to win the lottery? A financial advisor can help you make one. So many people reached out to us looking for tax and long-term financial planning help, we started our own matching service to help you find a financial advisor. The SmartAdvisor matching tool can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to three fiduciaries who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.

Photo credit: ©iStock.com/Catherine Lane, ©iStock.com/PeopleImages, ©iStock.com/nicolesy

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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