Lottery Breakage

We recently wrote about how some $8 billion in gift card value goes unredeemed in a given year, representing 10% of all gift card purchases. In the retail industry, this $8 billion gift is called “breakage.”

State lotteries, it turns out, also rake in a bit of breakage. Here’s a N.Y. Times article about winning lottery tickets that go unclaimed, citing examples of a $14 million prize in Illinois in 2005 and a $51.7 million prize in Indiana in 2002. I am guessing that the states claim far less breakage than the retail industry’s 10%, but this is still serious money — especially when you are already paying yourself a very, very healthy vigorish.

I cannot find any authoritative catalog of what percent of the pot each state keeps for itself from its lotteries, but over the years I’ve seen figures cited from 30% to 70%. Even at the low end, this would mean that our state governments rake a bigger vig than any horse track, casino, or bookie on earth.

Are people who play the lottery aware that perhaps 30% of their bet goes straight into the bookie’s pocket? I doubt it. It would be very interesting to post the vig of each state’s lottery on a web site where all players could check it out. (Does anyone know if such a site already exists? Here’s a site with links to every state lottery, but on the couple of state sites that I checked out, the vig wasn’t readily visible.) I wonder how fast the players would respond to the different rates — if neighboring states, e.g., kept 30% and 45% of the pot, respectively, would lottery players from the 45% state start flooding the 30% state until their own state lowered its vig?

Now that some state lotteries may soon be privatized, it will be interesting to see how the private firms set the vig. Will they keep it high, or even raise it, knowing that few people who play the lottery know or care? Will they make it lower in order to attract players from other states?

All lottery comments welcome.


synapticmisfires

@ snubgodtoh

I'd agree that most consumers aren't too concerned with the vig. However, it simply isn't possibly to increase vig and keep payout and odds constant without raising the cost of a ticket, which I assume consumers do care about. For instance, if the state keeps more of the money, they need to take in more to keep the jackpot high. So they either have to entice more people to buy, lowering the expected payout or they have to charge more per ticket.

bjornsm

In Norway, half the money is kept by the state lottery. These money go to culture, sports and science, and the lottery is actively promoting this fact.

To say that "lotteries are a tax on people who are bad at math" is to miss the point. Lots of people understand that the expected value of a lottery ticket is less than the price, but still think it's worth to spend a few dollars on it to get the excitement.

If playing the lottery is more exciting to you than going to watch a thriller at the cinema, and cheaper as well, then it makes perfect economic sense to do it...

Nathaniel

I thought it had been shown pretty conclusively that lottery buyers don't respond to payout % as much as large jackpots. That's why many lotteries make the odds worse, so that the jackpots will get bigger and encourage more casual players to buy "just one ticket" when they normally wouldn't.

oddTodd

I'll get you started (in most cases, the percentage is one minus the prize money percentage, since the rest is broken up between various administrative costs and public spending):

Overall ranking of lottery sales:
http://www.ohiolottery.com/profits/compare.html

CA: 50%
http://www.calottery.com/NR/rdonlyres/EC9535C5-817B-4051-9F5D-CF9A2A8C9532/0/LOTTERY_ACT_010107.pdf

MA: 31%
http://www.masslottery.com/about/faq.html

WA: 39%
http://www.walottery.com/docs/pdfs/06Brochure.pdf

NY: 44%
http://www.nylottery.org/ny/nyStore/cgi-bin/ProdSubEV_Cat_333653_SubCat_337630_NavRoot_305.htm

MN: 41%
http://www.house.leg.state.mn.us/hrd/issinfo/gamblott.htm#DOLL

MI: 46%
http://www.michigan.gov/lottery/0,1607,7-110-29196-4670--,00.html

SBGamesCone

Texas is working on privatizing the lottery. Just another wonderful thing our Gov. Rick Perry is doing in addition to forcing toll roads, owned and managed by companies based in Europe, down our throats.

In Texas, the lottery was established to fund education. Not only is that not happening, I don't see how privatization of a state lottery would provide the state with any type of monetary benefit and instead potentially increase the need for higher taxes to offset the money that was previously coming into the state.

DanTilkin

I don't see how they could effectively compete on percentage vigorish. To do this, they would need to advertise, and "we only keep 25% of your money" would turn off far more people than it would attract.

snubgodtoh

I may have missed something, but I think you're barking up the wrong tree...In my eyes the number of lottery players is a function of (predominantly) pay out and probability, not what the State rakes (unless the vig is an endogenous variable that affects the former). By this rationale, I don't think the disclosure of vig variation by state would entice anyone to cross state lines for lottery purposes (holding p(win) and pay out constant) or induce any sort of "race to the bottom" strategy for state lotto commissions.

bertrecords

Lotteries are a tax on the stupid. I'd outlaw them, as the stupid people need what little money they have.

snubgodtoh

I misread the post and retract my former comment, but my conclusion is the same due to the law of diminishing marginal returns. ie: (the cost of making a lotto trip to state(i)) > {[(%vig(home)state)-(%vig(i)state)]*
[payoff(i)-payoff(home)]}*[p(win)]

It would undoubtedly entice frequent interstate commuters to buy foreign lotto tickets, but I doubt the net impact would be great. In fact, states may be the ones to benefit most from such disclosures (assuming they don't collude already). Coastal states with the great majority of their population living considerable distance from a border would surely set their vigs high assuming vigs have no affect on E of demand.

Whoops, never mind, I would guess all vigs are fairly homogeneous because of collusion. Going against the "cartelle" in the form of a vig war would go against a clear dominant strategy except for the extreme cases: HI and AK whom I would guess have higher vig rates.

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egretman

No,no, SBGamesCone, you have it analysed all wrong. Since 1997, the Texas Lottery has contributed $8 billion to Texas School Fund.

Now the question is how much could Rick Perry get for a business that generates $8 billion in 9 years? Mr. "good hair" Perry might get $20 Billion plus a piece of the action. Maybe 10% royalty. That's why he might think about selling it.

The better question is this. Texas is republican. Why would republicans want to fund government? I thought the idea was that all government is bad.

A better idea is to just give it to their Republican friends. Tom Delay would have some great ideas. I, like all true Texans, would support that because it would keep it out of the evil government hands.

oddTodd

Another complicating factor: Most of the money spent on lottery tickets that doesn't go to prize money or administrative expenses goes towards public spending in the state. This isn't truly a vig because some benefit is received by the lottery player through that spending (e.g., better schools for his children). Also, there's an incentive for the lottery player to stay home so that "vig" is spent on his kids' school instead of the neighboring states' schools.

cevian

As for Montana, according to the official state lottery website (http://www.montanalottery.com/factsfigures.xsp), prizes have been only 45-50% of revenues over the past 19 years for which data are available. The state then grosses 50-55% of revenues, but has costs and commissions before "keeping" anything and calling it revenue. By state law, only 45% of revenues must be returned as prizes.

cevian

Over the past 19 years for which data are available, Montana's lottery (http://www.montanalottery.com/factsfigures.xsp) has returned 45-50% of revenues in prize money, so the vig would be 50-55% before expenses.

As a math teacher, I have always taught my students that lotteries are a tax on people who are bad at math. The education community in this state used to be the beneficiary of lottery revenue, but when the legislature wanted to put it in the general fund, we didn't argue. First of all the revenue stream is very elastic, never know what it's going to be. Second of all, how cool is it for education to be promoting and selling gambling?

Zach Everson

You might want to check the Motley Fool:

http://www.fool.com/foolu/askfoolu/2003/askfoolu030425.htm

David and Tom Gardner testified before Congress a few years back about the numerous problems with state-sanctioned monopolistic gambling.

quetranza

This would also have made a good lede: in Oregon, there is a bill pending in the Legislature that would require merchants to turn over unused balances on gift cards to the state. So much for breakage.

http://politicsupdates.blogs.oregonlive.com/default.asp?item=487339

editorguy

I tend to agree with oddTodd that calling it a vig in this sense is a stretch. It's a regressive tax, sure, but I'd be interested to see the percentages broken out into money that is ploughed back into state programs. Then take that "profit" and compare it with the financial statements of a public casino company like Harrah's or Boyd Gaming.

Whatever the case, they will only continue to grow, and as casinos spread around the country, lotteries will seem quaint. In Pennsylvania, "proceeds benefit senior citizens." Talk about your lock-boxes. No politician would be foolish enough (even in Pa.) to go near the state lottery with a 10-foot pole.

One more thing, from the "Huh?" files: In Nevada -- where casinos and bars never close, home of the all-you-can-eat buffet and cuts of prime rib the size of Honda Civics, where guns are fun and prostitution is legal in three counties -- state law forbids a state lottery.

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editorguy

In Pennsylvania, lottery "proceeds benefit senior citizens." Talk about your untouchables.

Meanwhile, in Nevada [cough, cough], state law forbids a lottery.

snubgodtoh

"Talk about your untouchables."

No kidding. The returns to investing in kids are astronomical relative to investing in old folks. Why then do we invest more in the old? Because kids can't vote and old people seemingly can't not vote.

diogenes

It's fun to say "vigorish" or "the vig," isn't it?
In casino games, video poker games and slot machines, apparently the term of art is "hold rate." The hold rate in such games is lower than in lottery games, but players tend to re-bet their winnings, especially if the hold rate is generous. Below is a quote from a report on Oregon's casinos and lottery games by ECONorthwest, a consulting firm in Portland:

Besides expanding machine capacity and outlets, the Lottery maintained aggressively low hold rates on their machines. When video poker first became available in 1992, the hold rate was over eleven percent. [The hold rate is the average percent of every dollar wagered that is lost by players. The effect of a lower hold rate is to stimulate more play by reducing the probability that players would face protracted periods of
losses. It also encourages more play, especially away from machines that might have higher hold rates.] Gradually new versions of video poker were introduced, such as Flush Fever,
which have lower hold rates. When line games cam on the market they were set with hold rates as low as five percent. By fiscal year 2005, the average hold rate video lottery games was only 6.31 percent even thought the Lottery had introduced nickel games, which traditionally
would have higher hold rates than video poker machines with minimum wagers of
a quarter. On the Las Vegas Strip, for example, the hold rate on nickel line games
averaged 10.42 percent and for all slot machines, 6.56 percent in 2005. Thus,
Oregon Lottery machines were priced even below those in the highly competitive Las Vegas Strip market in 2005.

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pkimelma

I really wonder how many lottery ticket buyers every consider or care what the State's take is. I also how many care that it goes to something worthwhile? If they used it to fund junkets for the legislators, would people buy fewer tickets?
I think it is the simplest model of very high payout relative to low throw-away cost. So, large jackpots are the lure (future benefit) and the perception of cost is very low (especially when spread out over multiple buys bundled into food/alcohol purchases). Sports betting has far lower relative payout (ratio to paid in), so requires a much larger sunk cost. Further, Sports betting implies control on the part of the better, so attracts a different type. Even casino games operate on a different plane, in part because of direct involvement (you have to be there to play, and you can easily measure your money on entry vs. on exit from the place).