Building Better Government: Finance

Will Schwarzenegger's proposal for a privately managed California lottery pay off?

by / December 10, 2007

Winning Combination? 

Whether you consider them a tax on the poor or a harmless way to spend a dollar or two, lotteries have entrenched themselves in almost every state government's operations. In California, Gov. Arnold Schwarzenegger hopes that transforming the state lottery into a public-private partnership will cure what ails the Golden State, while others contend government should not be involved with the lottery at all.

Forty-two states permit, operate or participate in one or more lotteries. Most games were established to generate revenue, usually to help perpetually feeble state programs, such as education, or to add needed cash to a state's general fund.

The odds of winning are long -- about 1 in 14 million for the traditional 6 of 49 games, and approximately 1 in 150 million for interstate games such as Mega Millions and Powerball -- but by and large, most state lotteries attract enough players to bring in money. In California, however, the lottery is a long-time underperformer. Despite a 2005 move to participate in a second lottery, the interstate game Mega Millions, the California lottery continues to generate far less revenue per capita than most states.

 
The Big Idea
Earlier this year, as part of his strategy to help mend California's budget, Schwarzenegger began floating the idea of outsourcing lottery management to a private consortium in exchange for a one-time lump sum somewhere between $12 billion and $37 billion.

"The governor is considering leasing the state lottery in order to maximize its returns and improve performance for California's taxpayers," said Schwarzenegger spokeswoman Sabrina Lockhart. "By allowing a private firm to run the lottery more efficiently and profitably, California will receive more money without giving up ownership.

"Any lease deal will protect the lottery funding our schools get now, and guarantee they'll continue to receive funding at current levels," Lockhart continued. "If the lottery performs better under leased management, education stands to get more money. This money isn't future revenues we'll bank today. These are brand-new funds from higher profits."

In a radio address earlier this year, the governor detailed why he was considering letting a private entity manage lottery operations and what he expected from such a deal.

"A leading investment firm says our lottery is worth tens of billions of dollars. Despite that tremendous market value, our lottery is only generating a little more than $1 billion a year for our schools," Schwarzenegger said. "By leasing the lottery to a private company, we would maintain ownership but turn ticket sales and marketing over to someone who could do it better. And the company that leases the lottery would pay hundreds of millions of dollars a year in corporate taxes."

 
Lucky Numbers
The governor's plan for the lottery seems like a great idea on paper.

The state would hand over lottery operations to a private organization. This as-yet-unnamed group would operate the lottery for 40 years after paying the state the estimated billions the lottery is reputedly worth.

After the transaction is made, the state would use the money paid by the private entity to set up an endowment fund -- an investment fund in which the principal is left intact while any additional monies are used to support programs -- for education, ensuring schools would receive the constant funding stream the lottery originally was set up to produce. Any money remaining after the endowment fund is created could be used to cover other expenses. If the lottery commands a selling price on the higher end of its estimated value, the governor claims schools would reap more than $1 billion annually.

And what value would there be for a private entity to manage lottery operations? Analysts claim a private firm could more effectively market the lottery and generate higher revenues

-- of which the private entity would take a significant portion.

Schwarzenegger has called the plan a "win-win" because if a private entity made the lottery more profitable, the entity would pay more corporate income tax to the state. Furthermore, a profit-sharing clause would be included in the handover of lottery operations.

According to an analysis provided to the state by Lehman Brothers, a worldwide investment firm based in New York City and a potential partner in the proposed private consortium, "If a private operator were to eventually improve performance beyond average national levels, profit sharing would then begin, though we think this is unlikely to occur for the early part of the lease.

Because private operators would earn profits in California, they would have to pay state corporate income taxes, which would generate $175 million immediately, $410 million by the end of the lease, and average $315 million in annual tax revenue during the 40-year concession.

A fact sheet prepared by the governor's office cites the California Lottery's long-term problems meeting expectations. The report noted that annual per capita spending on lottery products is $158 in states that have lotteries, and in the 10 most populous states, per capita spending is $190. In California, it's $81. Clearly, officials said, there is a lot of room to improve.

 
Jackpot?
Not everyone is keen on handing over the reins of a multibillion dollar government program to some wealthy, unnamed group.

Jean Ross, executive director of the California Budget Project, a nonprofit fiscal and policy analysis organization, said the lottery tends to exploit the poor, and other means should be pursued to guide California out of its dire economic straits.

"I think it's appropriate to ask whether the state should be encouraging more Californians to gamble more of their money," Ross said. "In particular, we know that lower-income households are disproportionately likely to engage in gaming activities. Those are the Californians who have the toughest time making ends meet.

"California has what's called a structural budget deficit," Ross continued, "which means our expenditures exceed our revenues, and selling the lottery would be a one-time fix to an ongoing problem."

However, in a response to the governor's proposal, California Senate President pro tem Don Perata, D-Oakland, said he has no problem with the idea -- noting his objection to government being in the lottery business in the first place.

"Let's face it: The lottery is like an expanded bake sale. That's all it is: It's extra money ... I don't think we should be in that business to begin with."

Chad Vander Veen

Chad Vander Veen is the former editor of FutureStructure.