John List Explains Why Lotteries Are in Fact a Good Fund-Raising Mechanism

(Photo: Jason Kessenich)

We recently ran on a post on a reader’s query about the economics of a 50-50 fund-raiser. John List, the University of Chicago economics-of-charity wizard (related podcast here), wrote in with a comment:

The intuition of the reader is slightly off.  Although not directly a 50-50 charity drive, we have explored the efficacy of lotteries both theoretically and empirically.  As John Morgan (from Berkeley) has elegantly shown, under standard assumptions (no risk-loving or lottery-loving behavior is necessary), lotteries outperform the simple ask (what we call a VCM).  Lotteries obtain higher levels of public-goods provision than a voluntary contributions mechanism (VCM) because the lottery rules introduce additional private benefits from contributing.

Here is the intuition:  in the standard VCM, there is a free-riding tendency (people do not contribute as much as we would like because they do not fully recognize how their gifts affect others — i.e., they do not fully recognize the positive externality they impose on others).  In this case, people give too little to the charity compared to what is best for everyone.

When you introduce a lottery — for example, for every dollar you give you receive one ticket for a $1,000 prize — this free-riding effect is counteracted.  This is because when you increase your level of giving by a dollar your chances of winning the lottery increase.  But, at the same time everyone else’s chances decrease.  In this way, by giving one more dollar you impose a negative externality on others through the lottery.  This effect you do not account for when giving.  

So, in the end this negative externality can help to offset the positive externality, leading the level of giving to increase when you introduce a lottery.  Of course a love of gambling, etc., can increase this effect.  

List’s theory and field experimental paper can be found here; a more accessible discussion of that paper and broader findings (along with some recent charity statistics) is here.

Furthermore, List writes to say: 

Note that lotteries are patriotic too! The first lottery in America was held in 1612 in Jamestown with the proceeds providing half of the town’s budgeted operating expenses.  George Washington used a lottery to assist in the funding of the Continental Army and purchased the first ticket for a federal lottery— sponsored to finance improvements in Washington, D.C. — in 1793.


JoelP

How are you imposing a negative externality on others by donating to a 50:50 raffle? You are decreasing their odds and increasing their jackpot by the same percent. Every dollar has an expected return of $0.50 regardless of how much others contribute.

Spencer

@JoelP I think the assumption is that the lottery is for a fixed reward, so buying a $1 ticket doesn't add anything to the pool of winnings.

Addison

JoelP is talking about a 50-50, not a fixed reward lottery. He is correct about it. The expected value of every dollar contributed is half a dollar. This piece is talking about a fixed reward lottery, though, and they are a bit different situation

Jason

This fails to address the fact that lotteries tend to act as a regressive tax (i.e. poorer people buy more lottery tickets than wealthier people).

Michael Peters

This is not about a general lottery for a state's education fund or something like that. It's a fundraising mechanism for charities. So it's not poor people trying to get lucky, it's people with extra money who might have donated anyway but are now pushed over the edge by a small chance they'll win something for themselves.

Chris Clegg

Not sure what you mean by "good" funding mechanism - effective? yes; ethically acceptable?, I would argue no!

In behavioral economics there are 2 key concepts about the human limits of rationality - 1. frames can change decisions (Kahnemann Tversky 1974), 2. Individuals are not good at managing their own decisions over time (Laibson 1994). I interpret lotteries as profiting from both of these human weaknesses.

Rather than just being a benign form of gambling or a simple tax on stupidity, the lottery industry is rife with corruption and unethical practices, specifically targeting the poor and children, and resulting in high incidences of (gambling) addiction and a wide range of undesirable social/political outcomes. Here is a summary of this literature: http://www.saneok.org/files/Socio-Economics/LotteriesinUS-overview.pdf

One of the most recent steps forward in behavioral economics is Libertarian Paternalism (Sunstein/Thaler 2008) who suggest that public policy does and should guide choices, without compromising individuals rights to choose irrationally. I would like to see some of this thinking applied to the problem of lotteries and reducing (not increasing) the incidence of lotteries.

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Jason2

I think the article is arguing that we are also irrational in our analysis of charitable giving ("people do not contribute as much as we would like because they do not fully recognize how their gifts affect others"), and, therefore, the lottery makes up for that gap by promoting an irrational behavior in the other direction. Is that what you mean by "public policy does and should guide choices, without compromising individuals rights to choose irrationally"? Or is this actually a case of trying to make two wrongs equal a right?

Ike

@ Jason: but the poorer half already pay zero Fed Income tax, or net to zero. Why is it bad if they throw $5 towards a lottery? The taxes the rich pay are compulsory... don't whine about regressive taxes that are voluntary.

Enter your name...

Why is it bad for them to throw $5 at a lottery? The same reason it's bad for them to throw $5 at any transitory entertainment: those $5 would be better spent on healthful food, medicine, housing, clothing, transportation, and education. The low-income people throwing away $5 on a lottery ticket are the same people who tell you that they can't afford to buy milk or vegetables.

Ike

Jason: but the poorer half already pay zero Fed Income tax, or net to zero. Why is it bad if they throw $5 towards a lottery? The taxes the rich pay are compulsory... don't whine about regressive taxes that are voluntary.

Eric M. Jones.

This is patently absurd on the face of it.

John List, the University of Chicago economics-of-charity wizard (no Las Vegas grant money there...) Will waste some of your time and tell you why, what is clearly bad for society is really good for society.

Yawn...I think I'll call my Gamblers Anonymous buddies and have a slumber party.

Chris Clegg

@Jason I think the author is referring to studies that have been done about advertising strategies for charitable giving namely that people give more for an individual cause/person than for a group of people or animals etc. No this is not a nudge (Sunstein/Thaler) in the school of libertarian paternalism I believe.

@Ike Prima facie I agree that there should be a distinction between voluntary vs compulsory taxation in lotteries vs income tax. However, I also think that there are higher order issues which should not be ignored. First the size of the tax: Clotfelter Cook (1988) found that the implicit tax in state lotteries is 40%, much higher than in other sin taxes (alcohol, tobacco). Second, how "voluntary" these taxes are is questionable when considering the nature of addiction (see Becker Murphy 1988 or Bernstein 1993 or O'Donohue Rabin 2000). Third, the fact that lotteries are addictive leads to questions of social fairness - I believe this is the issue of our time. Fairness should be understood in 2 dimensions - cultural e.g., Occupy Wall Street is certainly also about regressive taxation of all types, and also re: groups. Reciprocal conflict game studies show that fairness is often the equilibrium position amongst participants esp. with disclosure. (see Charness Rabin 2000 for reciprocal dictator games or Fehr Fischbacher 2003 for altruism in dictator and public good games). My point is that we can not ignore social fairness in equilibrium, which means that OWS may be around for a while.

@EMJ hope you've got some alcohol for me at that Gamblers Anon party...

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Josekin

In Hong Kong, gambling is only legal via the Hong Kong Jockey Club, which offers gambling odds on horse racing (obviously), football, and mark six, THE lottery in Hong Kong.

The HKJC, in practice, is Hong Kong's largest charity organization as it pays a special gambling tax to the government as well puts most of its proceedings (after expenses, I would assume) to helping the less fortunate. In fact, it's vision is to become Hong Kong's "premier charity and community benefactor"

http://corporate.hkjc.com/corporate/vision-mission/english/index.aspx