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

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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.

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

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, read the transcript, 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.


Jimmy Cracks Corn

The Rich will never go along with it....

Concerned Citizen

Some years ago, I was chatting with an acquaintance about the lottery prize at that time, which had gotten up to the $20-25 million mark, and he said, "If you ask people what their plans are for the future, for retirement, you often get a shrug or they are leaving it to chance, or just refusing to think about it."

"But if you ask them how they would spend a huge lottery win, you find they have given it HOURS AND HOURS of thought, often having very detailed and specific plans for what they would do with the money -- how they'd spend it, on what, what items they would buy, how much they'd give to charity or their kids, etc."

"So basically -- for RETIREMENT, which almost everyone will have, they have given it no thought."

"For THE LOTTERY, which only 1 in several million will ever win (and most of those, they will not win the super-large prizes), they have spent time to develop really elaborate, detailed plans."

DOES THAT MAKE SENSE? Of course not. But that is also human nature. Planning for poverty or a diminished lifestyle in retirement is no fun, so we put off doing it. And saving? denying ourself stuff NOW so we have something in 40 years? VERY NOT FUN.

But planning to spend millions on luxuries? Showing off to our friends? Now -- THAT IS SERIOUSLY FUN.

And this is why we have the systems in place for retirement we have (SSI, for example), because most people simply cannot handle planning for the future.

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Alex in Chicago

Matt: That is the perfect tax bracket for "House rich" people.

High mortgages, car payments, etc. They probably don't play the lottery, just overextend themselves for "prestige"

Jennifer

This down economy has increased the savings rate for those who are working. Those who are unemployed or sub-employed have no margin for putting anything into a savings account and, if they did, they would have to pay exorbitant fees if the account held under $100.

But savings is not where most people put their money. because it doesn't make any money sitting in a savings account. When you refer to the savings rate, are you including investments in stocks and bonds?

These "lottery" games or tricks are slightly sickening. I think the lottery itself is an absolute travesty. Neither promotes well-being or good planning. And I agree with #7, it smells like a win for the banks. Kind of like the great "success" with micro investing and now those borrowers are defaulting and facing relatively huge penalties. If the banks can't get their fees one way, they'll figure out another.

Mike

James -- Krugman's advocating that the government spend money. I highly doubt he'd have any problems with encouraging savings among poorer Americans (though I have no idea how he'd feel about this particular proposal).

steve

If you look at the math, this is not a win .- win situation. Depositors give up interest income they would normally keep in hopes of a big payoff by chance. Money is fungible, but people tend to put different dollars in specific buckets and think about it differently. If you earn interest and lose it, they think that is different from giving the principle away. Say you gave away $1 in earned interest after taxes; that is actually not different from keeping that dollar and giving away $1 in cash out of your pocket. The motive is good, encourage people to save. However, the process inflames greed, which if you have spent any time in a casino, tends to develop the opposite of savings. I suspect poor people don't bother to save because they make so little that it is too discouraging for them. The problem would be better dealt with from that angle.

steve
http://www.scarsdaleaikido.com

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Bob in Berkeley

Perhaps the reason U.S. savings are low has to do with getting an effective interest rate of ZERO; combined with even minimal inflation and various bank fees, the average joe is better off buying a necessity today than paying more for that same item tomorrow.

Pierce Randall

This is so stupid.

First, the poor would have to forgo spending on basic needs to save, since the nature of being poor is to have more needs than you can meet with your current income. Yeah, a lot of poor or seemingly-poor people use the lottery. But it doesn't follow that poor people make up the most lottery players (the middle class does), or that most poor people have gambling addictions. And anyway, if someone pays the lottery instead of the electric bill, the right answer isn't to get them to instead deposit that money into an account so that they might win the lottery (although this is still better than them buying a ticket). The right answer is that they pay the electric bill.

Second, savings rates are improving quickly in America. You know what's causing it? Fear. Americans haven't felt scared in decades, but since the recession, the risk of losing one's job has translated into higher savings.

But this is a risky venture. We really want people to do a little better at saving overall, but we're still a consumption economy. That means that, for prices to stave off deflation, we're tied to credit and borrowing for the future. Without this, there would be less consumer demand, and less growth--probably not enough growth to create the jobs needed to keep up with natural population increase. Baseline savings should increase in the US, but it would be in the public good for that to happen two or three years from now, when unemployment is below 7 or 8 percent.

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Ron Bannon

Here's what's wrong with this plan:
1. Wealth Without Work.
2. Pleasure Without Conscience.
3. Knowledge Without Character.
4. Commerce (Business) Without Morality (Ethics).
5. Science Without Humanity.
6. Religion Without Sacrifice.
7. Politics Without Principle.

Peter Baisley

Funny, yesterday I thought that a lottery / health insurance could work. You'd get a card you'd show everytime you bought a ticket, and at the end of the month your insurance would be prorated to how much you spent on the lottery.

Ben

i always liked the idea of a personal tax where 10% of all spending gets added to the withdrawal from checking and moved over to savings account. A $10 debit becomes $11 with $1 moved into savings. Privatize taxation?

JenofNJ

I don't get it. I keep hearing during this recession that Americans are being too cautious and putting too much of their money into savings because they feel uncertain about the future. Now there's a plan to increase the rate of savings?

dweb

If a lottery is a tax on "stupid people," then what do you call a savings account?

I have one. My bank requires that I keep a minimum balance of $300 in it. in order to have a checking account.
I have had the savings account for 5 years. The grand total of the interest I have earned on the account in the last two years?,,,,,,.04

That is cents by the way. It makes great "cents" for the bank because they have thousands of people who collectively effecitively give them hundreds of thousands of dollars to lend at virtually no cost.

And you wonder why savings rates are low?

Wayne Steffen

As addicted to plastic as the middle class is, I hope Gates can spare some training for us.

George Ballentine

Why not encourage state to switch to prize linked savings lotteries? If it truly helps get folks out of poverty, there are potential long term cost benefit for the states.

Ben Lowsen

As I understand it, "state" lotteries such as California's are merely state-sanctioned, not run. That task is fiefed out to contracting companies that reap massive profits while leaving only a pittance for the state. This is little more than a wealth-redistribution plan from poor to rich and should be abolished.

David Cook

How about the reverse idea: Income tax as lottery? Every pays a dollar more in taxes, and some small fraction of filers win a large cache prize. You can only win if you file, and winners are audited!

mml

matt, my guess is that those with the 100-150k are stuck in keeping up with the jones' mode. by the time you add up a mcmansion mortgage, several suvs, maid service, and private school for the kids there's not much left over to save. people with less money are, in some cases, smarter with their money and willing to spend less extravagantly. just a hunch.

Robert Fabbricatore

Why would anybody save when the rates are pathetic and the meager return is taxed at the ordinary rate. Meanwhile, Bill Gates and the other top 400 earners pay a 15% capital gain rate on their dividends and stock sales and pay little or no corporation tax. It's a rigged game. Thirty years ago, you could get 5-6% in savings and even 4% with an online savings account just a few years ago. But if the banks can get money at the Fed discount window at 0% to go back into the Big Casino, they don't need to compete with attracive rates for customers to get deposits.

catlady

13: Matt:

Making $100K-$150K doesn't mean an expense free existance. Car payments, mortgages, school and real estate tax, and overall insurance takes HUGE chunks out of a middle class income (and I assure you, $100K is middle class these days)

If we count social security as insurance, add in unemployment insurance contributions, homeowners, medical insurance, dental plan and prescription plans, as well as car insurance, most people's largest annual expense is insurance, not taxes.

Between taxes, insurance and daily expenses, sometimes it's pretty hard to come up with cash.