Could a Lottery Be the Answer to America’s Poor Savings Rate?

DESCRIPTION Kirit Prajapadi (center) at World Books/Carlton Cards in Penn Station, the No. 1 lottery outlet in New York State, selling more than $8 million in tickets per year.
Podcast
Freakonomics Radio

Is America Ready for a “No Lose Lottery?”: A lottery-linked savings account might do wonders for our sad savings rate.

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The Gates Foundation has just pledged $500 million to a cause that seems quite different from typical problems like disease, famine or illiteracy. That $500 million is going to help poor people learn to save money.

“We think really that poverty stops where savings starts,” Chris De Noose of the World Savings Bank Institute told the L.A. Times.

The new Freakonomics Radio podcast (download/subscribe at iTunes, get the RSS feed or listen live via the link in box at right) explores an idea that the Gates Foundation may want to look into: Prize-Linked Savings (PLS). In a nutshell, PLS is a kind of savings account that pools some of the interest from all depositors and pays out a big lottery prize every month or so. It combines the thrill of the lottery with the safety of a savings account. It’s sometimes called a “no-lose lottery,” since a depositor is automatically entered into the lottery but can’t lose the original money she deposits.

And while PLS might play well in the poorest parts of Africa and Asia, there’s a group of researchers who feel that PLS is very badly needed right here in the U.S.

Peter Tufano is a Harvard Business School professor who specializes in consumer finance. He recently helped conduct a survey in several countries, including the U.S., which asked people if they could come up with $2,000 in 30 days if they had to. It turns out that nearly half of Americans couldn’t – “which means,” Tufano says in the podcast, “that they stand only one emergency or crisis away from really quite dire circumstances. This isn’t picked up in the national economic statistics.”

What if there was a way to win a big jackpot without having to risk losing anything at all? (Photo by JOEL SAGET/AFP/Getty Images)

The facts are simple. Americans have a low savings rate; and Americans love to play the lottery. Last year, we spent more than $58 billion on lottery tickets, or roughly $200 per person. As entertainment goes, the lottery is pretty cheap – a dollar and a dream and all that. But as an investment, it offers a dreadful return. States typically withhold about 40 percent of the ticket money from the prize pool for overhead costs and, often, education funds. That’s a far worse return than casino gambling or horse race betting. Which is why the lottery is sometimes called “a tax on stupid people.”

That’s why people like Tufano and University of Maryland economist Melissa Kearney are interested in bringing PLS plans to the U.S. (Here’s their paper on the topic, well worth a read.) PLS accounts have been successful in other parts of the world for years. In the podcast, you’ll hear from Tufano and Kearney, as well as from the folks who started a successful PLS program in South Africa – and the folks who got that program shut down.

Why? Because the National Lotteries Board of South Africa sued the bank that offered the PLS. It turns out that the biggest obstacle to offering a lottery payout with a savings account is … the state-run lottery.

And that may be the biggest barrier to making PLS happen in the U.S.: it is, for the most part and in most states, illegal.

DESCRIPTIONDave Trumpie of Trumpie Photography Billie June Smith, the first big winner in Michigan’s “Save to Win” program.

There is, however, one exception already – in Michigan, where the “Save to Win” program has been offered among several credit unions, and recently paid out its first $100,000 prize (to an 87-year-old woman who had deposited $75). You’ll hear about the Michigan program in the podcast as well.

Melissa Kearney sums up the argument best:

“So we know Americans like gambling. They always have, the majority of them do it, and they’re going to keep doing it. And so what we do is take seriously the idea that people want some small chance of winning a large sum of money. That market, that asset is missing from the American landscape. Low-wealth individuals, the only asset available to them that gives them some chance of accumulating a large amount of money is the state lottery. In fact, a recent national survey of a thousand adults, one in five American adults said their greatest chance of accumulating hundreds of thousands of dollars is through the lottery. That number jumps to forty percent for folks making less than twenty-five thousand dollars a year. So a lot of Americans think the lottery is their only chance at winning big sums of money, why don’t we take that appetite for gambling, for a product like this and attach it to a savings vehicle that offers some positive return? It’s a win-win situation.”

Except, of course, for state lotteries.


Drill-Baby-Drill Drill Team

Your Savings Account, IRA and Home Investment are now Kaput.

Yes, at this time, your best hope for Retirement is WINNING THE LOTTERY.

Leo Piccioli

I think it is a great idea.
Let me add that, during hyperinflationary times, in Argentina people used lottery ("quiniela") to save their money's value against the constant price increases.
They simply bet every week the minimum amount (which grew with inflation) and periodically won (this is a low payout - high probability lottery) an "indexed" price.
Yes, 30% of that went to the state. But for many it was much more efficient than a savings account. And extremely more fun!

Larry Lard

So is this the same as the UK's (state-run, effectively) Premium Bonds? The capital is guaranteed safe by the state, the prizes give an average interest rate of 2.5% tax free, but the prize structure means most people get less than that.

Jesse

This isnt going to happen in the US we have too much stock in taxing poor people without them realizing it while giving tax breaks to the upper quartile. If stupid people dont pay for public services who will?

Dan

Tax Breaks to the upper quartile? Give me a break, would you get off the class warfare rhetoric?

The statistics are all available, the upper earners pay the majority of taxes. Plain and simple, and don't bother to pull out that useless "Warren Buffet pays a lower rate than his secretary" BS.

Charlie

Obviously, the upper brackets of the wealth distribution pay a larger share of the taxes, but is it a proportional share? Absolutely not. If you account for 25% of the nation's income, then you should account for 25% of the nation's income tax revenues. Unfortunately, this is not how it works out under our current tax system. The top 1% and and top 0.01% pay an incredibly disproportionately low share of their income (once factoring in non-wage income) in taxes.

Our tax system is anything but fair. It places a disproportionate tax burden on the middle and lower sections of the wealth distribution.

For example, sales tax is a tax that (unintentionally) targets the poor. Because low and middle class individuals spend a larger portion of their incomes on consumption (out of necessity), they pay a larger share of their income to taxes. If I spend 100% of my income on consumption and the sales tax rate is 10%, then 10% of my income is spent on taxes. On the contrary, if i spend 50% of my income on consumption with a tax rate 10%, then only 5% of my income is spent on taxes.

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James

Now I'm really puzzled, 'cause that Nobel Prize-winning economist guy in the next column over keeps saying that the problem is that Americans are saving too much, and need to go back to their old borrow-and-spend ways to create jobs, I guess so the newly-employed can start borrowing and spending too.

Clancy

Another good argument for the abolition of state lotteries.

It seems to me that the proliferation of state lotteries (which are probably one of the worst ways for a state to fill budget gaps) is an unintended consequence of the conservative lust for lower taxes. It has gotten to the point where even the mere suggestion that taxes might sometimes need to be raised (or even loopholes closed) means a swift end to your career as a politician. So, when faced with a buget deficit, state lawmakers can either cut popular/necessary spending programs or find some sneaky way to bring in revenue that won't be called "increasing taxes" in thier opponent's attack ads.

If you really need to raise taxes, just raise them. Lotteries and other scams are just as much, if not more of a drag on the economy as any income tax, sales tax or excise tax and holds back those who can least afford it.

Brian

Last time I checked, this is America and these lotteries that citizens participate in are voluntary. I'm supprised that the Obama regiem hasn't mandated any citizens earning over $250,000/yr must "buy" $5 in lottery tickets each week to ensure that those "rich" SOBs play their "fare share." This would be huge windfall for the state bearuecrates so they can continue to grow public sector union membership. I better stop, I'm giving them too many ideas.

SHG

This is a win for the banks, instead of paying 0.5% interest on saving now and 2% in good times rates will stay low because savers will be looking for the big win not better rates.

Individual savers may win, but collectively they are losers and the banks will win.

Justin James

One thing to keep in mind, is that lottery is dirt cheap. Yes, it offers worse yield than a casino or a racetrack. How many people live near a track or have OTB available? And even if you did live near a track, what about the gas to drive there, the time spent being there, etc? Likewise, last time I was in Atlantic City, minimum bet on a hand of blackjack (your best bet to win money in a casino) was a whopping $25. Lottery tickets are $1 each.

I used to think that lottery was a "tax on stupid people" too. Now, I like to think of it as a high yield, high risk junk bond. By buying lottery tickets, I am investing in my government and have a chance of striking it rich too. For most Americans, not only is it the only way they'll ever get rich, but it's the only one they can afford even if there were other options.

Playing Powerball or MegaMillions with the multiplier costs $4 a week for one draw. Honestly, how much is someone going to save up at $4 per week? What mutual fund, IRA, or other financial product would accept an investor putting in $4 a week without murdering them on fees?

J.Ja

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Derek Kerton

J.Ja: What you say is true, $4 a week doesn't add up to much. But you've missed the point of the discussion.

The idea is not to convert somebody's $4/wk into a savings vehicle, it is to create a savings vehicle that 'satisfied the demand for gambling'. People have indicated they want to have the feeling of 'having a shot at making big money', and a PLS could give them that...and not confiscate their principle.

Of course, people would be encouraged to put in more money than $4/wk. If people can scrape together more, they can build up some real savings. Naturally, some can scrape together more, some can't. But even then, at least you would have $208 dollars at the end of they year. You and I might scoff at $208, but for the person who can barely scrape together $4/wk, $208 is a lot of money. It's all relative.

Remember the article's original question, "How many Americans can scrape together $2,000?" This is seen as an essential buffer to pay the rent and heat in case of a layoff, or to pay for a broken arm in case little J.J. falls off the stairs.

Therefore, you should not ask if PLS will create the next Rockefeller, but rather if PLS will
1) satisfy the desire to gamble, take risk, and 'have a shot at making it big'
2) increase the number of people who have some kind of savings buffer.

Derek Kerton

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Peggy Sapphire

If getting rich is the American Dream, then "the only people who believe that are asleep" - George Carlin.

Greg

I am one that can come up with $2,000 in 30 days. I play the lottery. I play when the prize get up to 30 million or more. I don't really miss the money. I know it is terrible odds, but it is the only game in town where if I win I can retire.

I say if people are too dumb to build up an emergency fund then the heck with them.

SHG

The problem is if the economy stumbles all the people without a emergency fund loose there homes, creating a housing crash.

Eric M. Jones

Gates plan is genius.

I can certainly afford to play the lotto, but I discovered many years ago that the real cost is the squandered time when I am dreaming about how I might spend the money that I surely not win. This seems evil to me, or at least preposterously stupid and likely to cause an accident, especially to the person in front of me at the mini-mart who is doing his "financial planning" while my ice cream is melting.

I figure that chance they will sent the Powerball winnings to me by accident are the same as winning them. Exactly the same, zero to six decimal places....

BYW: 58 Billion? That is small change compared to the 850 Billion (and more) we sent to Wall Street.

Matt

I have a hard time believing one statistic from the podcast:

Peter Tufano says that about half of Americans can come up with $2000 with 30 days notice. At the same time, only 25% of those making $100K-$150K could come up with that sum.

So does this mean that the poor have significantly greater access to liquidity than the rich? Or perhaps Tufano's sample size was too small, and the rich ones he surveyed are disproportionately loaded down with huge mortgages?

Something doesn't add up. Anyone have any insights?

jdiec

A better question should be why other countries don't need to resort to institutionalized bribery to get their populations to be more responsible with their finances.

Sandy

I have a revolutionary way to increase savings, and it would influence savers at all income levels:

PAY A REASONABLE RATE OF INTEREST. The pittances that are given now are insultingly low. The only way to do worse is to stuff your money in a mattress - and at that, the mattress won't eat you alive with fees.

Charlie L

Maybe a lottery could be the answer to the budget deficit too.

In addition to the Presidential Campaign check off box, why not have a $5 box (or more?) to enter an "American Dream" lottery where the Treasury would make some fixed number of Americans millionaires? I bet this would increase tax compliance and make money for the government....

Dan

Matt:

Lower-income folks tend to have all or the vast majority of their net wealth in cash. The wealthier you are, the more likely you are to have a complex portfolio including real assets that are harder to convert into cash.

Also, it actually makes sense to me that 100-150K earners would be in the toughest cash position. That's the range where you are paying a good chunk of your income in taxes, and you probably have kids and/or a mortgage and/or multiple car payments. You may also still have a decent load of student loans. If you and your kids are older you'll find you don't qualify for financial aid at a lot of colleges, but you can't actually afford to pay full tuition. You're also probably in a social sphere that has a strong "Keep up with the Joneses" mentality - meaning you constantly feel peer pressure that makes you live beyond your means. All of which make the debt pile up, your ability to get reasonably-priced short-term loans diminishes, and your checking account feels more and more like a direct wire to your creditors.

Just some thoughts,
Dan

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bill

Well, maybe, but its still a tax on stupid people, because with states keeping 40% of the take, people would presumably still be better off putting the money into a regular savings account. On the other hand, people seem to relish paying the stupidity tax, so letting them pay it is fine with me.

akira

On the surface this is great...sounds like a win-win situation so to speak. :-) But what is sad is that once again, it seems like the only incentive that might be able to get SOME people to understand the importance of saving, is to include with that the possiblity of their 'hitting the lottery'?

What about just teaching people some common sense...of showing them the hard numbers of how much they spend on average per year on the lottery....and if they were to take that same money and invest it, how that might ammortize over time? And reminding them of the miniscule chanve they have of hitting it big, and how often times 'hitting it big' doesn't imprpve your life, but can actually creater newer, bigger problems.

moonwell23

In "Faust", Goethe wrote of monkeys playing Lotto. The centuries have not taught us much.