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A Costly Tax: State Lottery is Inefficient Way to Collect Revenue

Dr. Roy Cordato
Feb. 27th, 2001
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Gov. Mike Easley has moved the issue of a state lottery to the center of North Carolina policy debate. However, what is often overlooked in debating a lottery is the very high cost of administering the program when compared to other ways of raising the same amount of money. Indeed, 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.

First it needs to be pointed out that a state lottery which is, in reality, a state-created gambling monopoly whose gross sales are taxed at a rate of about 33 percent will not raise state revenues by the $400 million to $500 million suggested by Easley.1 In fact the net proceeds from a state lottery will likely be about $285 million.2 The bulk of the difference between the governor's estimate and ours is accounted for by administrative costs of the program, which the governor completely ignores.
Graph of breakdown of annual gross sales, NC lottery

We projected that a North Carolina lottery would gross about $933 million in sales each year. About 50 percent of this amount will be returned to players in prize money.3 This would reduce the state's take to $467 million, approximately the amount suggested by the governor. But a lottery is costly to administer. In their legislation Reps. Bill Owens and Joe Tolson recognize this by allowing for administrative costs of as much as 16 percent of gross sales.4 These costs are associated with advertising, payments to retailers who sell the tickets, and equipment purchases. This reduces the governor's estimate by $149 million to $317 million. We arrive at our net revenue estimate of $285 million by also deducting an estimate of sales, income, and other taxes that would be lost as money spent on the lottery is diverted from other purchases. We have estimated this amount to be $31.7 million.5 This is an opportunity cost that doesn't appear on any ledger line in calculating net state revenues.

The administrative costs of the lottery are usually expressed as a percentage of the gross lottery sales, but for analytical purposes this is not very useful. What is important is not how much it costs to raise a dollar in gross revenues but how much it costs to raise a dollar in spendable net revenues.

In reality, the $149 million that would be incurred in administrative costs should be measured against the $285 million in usable revenue to the state. When this is done, the administrative cost is not 16 percent but 52 percent. This means that for every dollar raised for the state by a lottery an additional 52 cents must be taken in to pay the expenses of raising that dollar.

This can be compared to the administrative cost that the state now incurs to raise money through other forms of taxation. Using the total budget of the state's Department of Revenue, which was $75 million in FY 2001,6 as an estimate of the administrative costs associated with raising the state's $13.2 billion in tax revenues,7 the average dollar that the state receives costs under one cent to collect. In other words it costs more than 50 times the amount to raise a dollar of disposable state revenue through the use of a lottery than it does through the use of the existing tax-collection apparatus.

It could be argued that a lottery is more than simply a vehicle for raising revenue. In fact, the lottery would provide a valued form of entertainment to those who enjoy gambling. If we take this perspective, then clearly not all of the administrative costs of the lottery should be allocated to revenue raising. It could be argued then that the $467 million in prize money is a benefit to those who play the lottery, so part of the administrative costs are associated with providing this benefit. Subtracting the $149 million in administrative costs, lottery proceeds are divided 62 percent to 38 percent between prizes and net state revenues. If the same percentages are applied to the administrative cost, then $92 million would be allocated to running the game and $57 million to raising state revenues. Such an allocation would reduce the cost per state dollar raised to about 20 cents still more than 20 times the cost of raising a dollar through the existing tax structure.

"Providing a gambling service" is clearly not part of the stated mission of lottery proponents. A lottery is typically seen as strictly a revenue raiser. As stated in House Bill 1 "The lotteryshall be operated to maximize new revenue to the State."8 In spite of this, the only reason why it is able to raise revenue is because it provides a service that is valued by customers. So it is perfectly legitimate to allocate the lottery's costs to its different functions. While doing so significantly decreases the costs per dollar of revenue raised, these costs are still quite high when compared to other methods of raising state revenue.

This discussion should not be construed as an argument in favor of general tax increases to raise revenue for new state spending. Indeed, there is no convincing case to be made for any new taxes. The state government should reduce its overall size, increase the efficiency by which it provides government services, and reduce spending.

Dr. Roy Cordato, Vice President for Research

Notes

  1. Gov. Mike Easley, State of the State Address," prepared text, February 19, 2001, p. 6.
  2. Dr. Roy Cordato, Easley's Lottery Myths: Potential Revenue, Loss to Other States Inflated," Spotlight, No. 187, Feb. 21, 2001.
  3. General Assembly of North Carolina, Session 2001, HB 1, "Lottery for Education/Infrastructure," p.1.
  4. Ibid.
  5. Op. Cit. at note 2.
  6. Overview: Fiscal and Budgetary Actions, Fiscal Research Division, North Carolina General Assembly, 2000 Session,
  7. Financial Highlights Fiscal Year 2000, North Carolina Office of the State Controller, www.state.nc.us/OSC.
  8. Op. Cit. at note 3.

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