The Inequality and Irony of State Lotteries

Someone has a fortune hidden in Middletown. It might be in their wallet. Or tucked into a book that’s fallen from the nightstand. It might even be crumpled into a ball in the car ashtray as they drive through the small Hudson Valley town, fall leaves turning to grey sky and the little scrap of paper fading on the dashboard.

With six numbers printed on it that scrap of paper is worth $326 million, New York state’s largest ever lottery win. The winner, still unknown over a month later, bought the ticket at a Valero in the small town seventy miles north of New York City. The gas station stands on a stark empty slate of pavement between a McDonald’s and a Key Bank. Its owner earned $10,000 for the selling the golden ticket. Announced November 4th, the winner has one year to claim the prize.

The coincidence that New York’s historic lottery drawing and its state elections were both won on the same day holds a certain irony. Having created the first major state lottery that currently dwarfs all other such games twofold, New York has led the nation in state-run gambling for over half a century. And it’s only getting bigger. This year, New York may be the first state lottery to break $10 billion in revenue, according to state filings. No other state plays anywhere near this level. Massachusetts is a distant second, at $4.9 billion.

However, those ten billion dollars are most likely to come from the most disadvantaged New Yorkers. According to Justin King, Policy Director for the New America Foundation’s Asset Building Program, state lotteries amount to a “user tax on your most vulnerable citizens.” Widely considered a regressive tax by academics and activists, state lotteries have come under criticism for using aggressively advertised false hope to undercut the poorest segments of society.

New York has both the largest lottery and highest economic inequality in the nation. Those two facts are not unrelated: according to a 2012 PBS report, American households making under $13,000 (roughly the state poverty line at the time) spend an average of 9% of their income on lottery tickets. One in five New York City residents fall into this category. Considering those purchases a tax, the poorest New Yorkers face an effective rate higher than the city’s actual rate on its wealthiest. Under current effective behavior, it costs the average unemployed New Yorker more to live in the state than it does for a billionaire to live in the city.

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Home of the Occupy Wall Street, the 99% Percent, and new progressive Mayor Bill de Blasio, New York places the issue of inequality closer to the center of its politics than most American cities. At a state level however, Governor Cuomo has drawn criticism for his ties to Wall Street and distance from the issue. 

That changed this fall. According to New York Public Advocate Letitia James, it wasn’t until the unexpectedly strong primary challenge from Zephyr Teachout that Cuomo “got the memo” on New York’s inequality problem. The politics of income inequality, which Mayor de Blasio called “the issue of our time,” rose from Manhattan to Albany when Cuomo finalized a re-election once hoped to be a broad mandate, but instead accepted as a firm win.

Income inequality earned its place in state politics that November 4th. Cuomo wasn’t the only win of the day though: someone in Middletown won their record lottery that Tuesday as well. Any connection however ends at the calendar. Despite the game’s broadly understood impact, the politics of inequality in New York leave the lottery to one side. 

As is the case with nearly all of the 43 state lotteries, New York commits its lottery funds directly to K-12 education. To Justin King, the often dubious education banner that lotteries operate under shields them from politics: “The cynic in me says [education] such a central focus of what states do and it’s so popular that it’s never going to change as a result.” 

New York advertises its lottery with a heavy emphasis on its merits toward state education. A 30-second spot from January of this year stages a choir of schoolchildren in a convenience store. They sing “Thank You for Being A Friend” as various New Yorkers buy lottery tickets and smile at the charismatic group of kids. The ad closes with the tagline: “The New York Lottery: Everybody Wins.”

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Of course, most people don’t win. Besides the astronomical chances of actually hitting the jackpot (according to Mega Millions, the odds of a Middletown win are one in 258,890,850), state lotteries are tied to greater inequality.

According to original analysis of the 43 such games, state lottery revenues strongly correlate with a state’s inequality (as measured by its Gini Coefficient). Shown with a statistically significant regression taking population into account, the greater a state’s lottery income, the higher its overall income inequality [t= 3.831]. Population and the log of population do not have an impact. The trend is clear in a simple plotting of the data

At this point, a definition of the Gini Coefficient is useful. Widely accepted as the holistic measure of income inequality, the Gini doesn’t compare one earnings bracket to another. It measures how far the overall income distribution is from “perfectly equal” on one side (0) and “perfectly unequal” on the other (1). The two poles are extreme scenarios. At zero, everyone earns the same amount and at one, a single person earns all the income. Few nations or states near either end.

According to CIA and World Bank data, Namibia is the world’s most unequal country with a Gini of 0.707 while the most equal is Sweden with a Gini of 0.230. The United States, whose inequality problem has become a massive political issue in the years following the 2008 financial crisis, stands as the thirty-ninth most unequal country in the world with a Gini of 0.450. Between the fifty states, Utah is the most equal at 0.419 and New York the most unequal of course at 0.499. 

The above chart shows the clear outlier that is New York in the top right. In both inequality and lottery revenue, the Empire State is an island unto itself. This 2012 data, the most current such data available for the most states, doesn’t even account for New York’s continual boom in lottery sales. The state earned roughly $7.4B in 2012. According to official reports though, the lottery brought in a net revenue of $9.2B for the year ending March 31, 2014. At that annual rate, the 2015 filing in three months time would show a lottery revenue of $10.3B. New York would be the first state to cross the ten billion threshold and continue to lead other states in gaming dollars.

Whether that growth in lottery revenue leads to a further growth in income inequality is yet to be seen. Despite the link between the two numbers evident in the regression results and above chart, correlation is of course not causation. However, this analysis matches academic research on the subject.

Lottery players are disproportionately low income according to a 2011 paper in the Journal of Gambling Studies and a famous 2004 paper by Cornell researchers that found:

Lotteries are extremely popular, particularly among low income citizens… [who] substitute lottery play for other entertainment… [and] may turn to lotteries in an effort to escape hardship. We… find a strong and positive relationship between sales and poverty rates.

In a 2011 paper for the International Journal of Mental Health and Addiction entitled “Lotteries as Disguised, Regressive, and Counterproductive Taxes,” economist Rick Wolff attributed the recent boom in lottery revenue to “widespread tax revolts.” As a result, Wolff claims, “state politicians have had to find disguises for—or new masked forms of—taxation. With determination and heavy promotion, they have succeeded in largely reversing the older American notion that gambling is sinful… Put simply, lotteries take the most from those who can least afford it.” 

Inherent in federal, state, and city taxation is the principle of ‘progressive’ taxation – that is, higher income brackets pay higher tax rates. A tax becomes ‘regressive’ when the opposite is true. The broad consensus of research by Wolff and other thinkers in the field, state lotteries are a deeply regressive tax. As a result, even the stark picture painted by the holistic Gini coefficient understates the picture seen at the extremes of New York’s income. The state’s massive lottery growth would impact its lowest earners the most and paint a stark contrast to its highest earners, Wall Street financiers whose incomes top the national rankings. 

If New York continues on its current path of lottery expansion, any efforts to combat inequality will face a continually uphill climb, all the more so for the state’s most vulnerable.

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In Westchester County, halfway between the conspicuous wealth of Manhattan and the still-hidden wealth of a scrap of paper in Middletown, lives Velazquez Milian. Described by his son Rudy as “the Lotto King of New York,” the retired teamster buys one hundred dollars of scratchers every day. Working as a deliveryman for a regional florist, Milian lives off his pension and puts his tips into the lotto, “hitting once every couple months or so.”

Milian’s lottery purchases are not unusual. According to a review of research by the Association for Consumer Research, “very heavy lottery players share characteristics of addicted gamblers, namely they are older, higher in income, fantasize more, and engage in other forms of gambling.”

Analysis by The Oregonian of internal government data found the vast majority of the western state’s lottery funds come from a small portion of players. In particular, video slots and poker (still considered the lottery in the state’s eyes) account for 86% of overall revenue, with each player spending an average of $2,564.  

Though it still has a ways to catch up, New York has followed Oregon’s lead and sought video lottery terminals (VLTs) as an area for further growth in lottery revenue. Found illegal in 1981 by the state Attorney General for bearing too much similarity to casino slots, the state now touts VLTs as “similar in appearance to classic slot machines or as simulated classic table games.” New York currently operates over 17,000 machines, most commonly in raceways consequently referred to as “racinos,” but approved 2,000 more this past year. With substantial research on the psychological effects of these immersive and gamified slot machines, the decision indicates that the easiest method to raising taxes in the current political environment is to enable addicts to levy costs on themselves.

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Velazquez Milian doesn’t play the video machines. A cancer survivor who spends his golden years delivering flowers mostly to funerals, Milian has a particular appreciation for living in the now. His son Rudy, a former barber for Goldman Sachs executives, worries about the thousands his father spends on tickets each month, but doesn’t begrudge him his fun. Spending floral delivery tips on scratchers is not an unreasonable source of entertainment for a recent widower of his age. His wife’s funeral, according to Rudy, was beautiful. “You should have seen the flowers - you would have thought Celia Cruz had died!” The lottery offers a bright spot for Milian, as it does for many others.

As a purely economic act, a lottery ticket (and particularly many lottery tickets over a long period of time) is almost always pure downside of course. The house, or in this case the state, always wins. According to investing advisory site Motley Fool, “for every $1 spent on a lottery ticket, a buyer can expect to receive approximately $0.44 back in "winnings." By that logic, buying a dollar in lottery tickets is the equivalent of chucking two quarters, a nickel, and a penny into a drain. But of course, lottery tickets are entertainment in a sense and the enjoyment consumers is worth something in its own right. Even then though, effectively valuing that thrill at an average of 5% of all poor Americans’ incomes (as 2012 data suggests) may be a steep price to pay.

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State lotteries don’t just make money. They spend it as well. Of New York’s $9.4B in lottery revenue, $4.4 billion (roughly half) went to the winners and $1.7B (18%) went to other expenses to administrate the lottery, leaving $3.2B (or one third) remaining for its “required allocation for aid to education.”

The education contribution is typical of state lotteries, but according to analysis by economist Rick Wolff, New York’s pays out at an amazingly low rate and spends a high portion of the revenue to administer itself. With the normal payout range of 50-70% according to Wolff, New York’s 48% shortchanges even those players that do beat the astronomical odds. With expense ratios running between 10 and 20%, New York is on the high end with 18%.

Three billion dollars spent on schools is not insignificant, but critics of the system like Justin King take issue with education as a motive behind state-sponsored gambling.

"I’m skeptical that that’s the driving force behind lotteries. Education is a public interest and ought to be paid for in sustainable ways. But public goods ought to be purchased via public means. Levying a user tax on your most vulnerable citizens is just the wrong way about it. Better for us states citizens if those structures were progressive."

Considering government as a division of resources, state lotteries are a woefully inefficient process for that division. New York effectively taxes those nine billion from its disproportionately poorest residents, gives most of that back to a small number of them, takes another two billion off the remaining amount, and then gives that to schools. 

With many institutions of public education in dire need of funding, the argument inherent in the state lotteries appeals to many voters. However, King disputes that the money is additive. After a half century of a committed revenue stream, the state budget has adapted to assume in the lottery revenue: “Policymakers look at the lottery and they see free money. Folks are aware of the really obvious and pernicious aspects of gambling. But for the most part, policymakers see it as free money. And they don’t know what to do if it’s taken away… There’s no organized opposition to it.”

Attempts to speak on the record with any New York State Gaming Commission officials were rebuffed and referred to a process of written letters that has yet to receive a response.

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The history of New York’s lottery, and by extension the history of the lottery in the United States, is one of many eras. Dating back to sixteenth century Italian “policy shops” that grew most notably in New York City, the “numbers game” was deeply rooted in organized crime. Funding the mafia and other criminal outfits, the lottery was considered "the lowest, meanest, worst form ... [that] gambling takes in the city of New York,” in the judgment of an 1875 committee for the New York State Assembly. 

After decades of battling against the mob-controlled policy shops, activists and state authorities essentially accepted gambling as human nature and decided to make the best of it. “The lottery is the state’s co-oping of organized crime's numbers racket,” in King’s estimation. “It was the precursor to state lotteries, which create a legal structure around popular and lucrative activity. In that era, I think they decided that sunlight’s the best disinfected for a market that human need to take chances and have fun.” 

After the comparably tiny New Hampshire lottery, the Empire State’s lottery was the first in the nation in 1966. With auspices of funding education, the new broadened the base of the numbers racket as New Yorkers came out to support their schools. That system existed in relatively low revenue numbers for decades. 

The New York lottery’s modern form was born in a midnight session of the legislature in October 2001. Governor George Pataki made video lottery terminals legal and joined New York into the cross-state Mega Millions lottery, calling the change a “necessity” given the terrorist attacks only weeks earlier. Though instituted as emergency revenue provisions following 9/11, those two tax sources have become central to the growth of New York’s lottery. Cross-state lotteries like Mega Millions, responsible for that record $326M winning in Middletown, have grown and expanded into other brands like Powerball.

Now, as with the previous century, critics of the system like King and the New America Foundation have come to accept the lottery as an extension of human nature and put its inevitability to use. The ‘asset building’ or ‘thrift’ community has created the concept of prize-linked savings (or PLS). Instead of offering a direct lottery, the system offers savings accounts whose interest rates effectively play the lottery for the saver. The community hopes to turn the “anti-thrift institutions” that perpetuate a “lottery class” into forms of the “pro-thrift institutions” that support an “investor class,” in the terms of a joint report entitled For a New Thrift, by King’s predecessor at the foundation.  

The ills of modern lotteries do not face the scrutiny that the mob-run numbers racket did a century earlier. However, state lotteries have a more pernicious and far-reaching impact on income inequality than their bygone ancestor. New York still leads the pack though, selling more lottery tickets and hosting more income inequality than any other state by far. Now, perhaps, the next stage in the experiment of American gambling is at hand with PSLs just as changes to New York lottery could be at hand with the new state emphasis on income inequality.

Anti-gambling advocates oppose PSLs on the grounds that they simply offer another vehicle for players to bet their money. No major financial institutions have offered the accounts yet, but numerous states have involved themselves in this potential new chapter of state lotteries. With legislation pending in New Jersey and Pennsylvania, a pilot program running in Michigan, and Wisconsin ruling on their legality, PSLs may be the next iteration of mass gambling. A PSL legislation passed the House several weeks ago, but died before the end of the Senate session. The legislation appears DOA for the next Congress, but passed unanimously in its last session, which in King’s words “means we’re either doing something really right or really wrong.”