Lottery Privatization Options for Virginia

Leasing out rights to operate the state lottery could generate a steady income stream, reduce revenue risks

As states across the nation seek ways to cut costs and avoid tax and fee hikes to address growing budget shortfalls, the idea of privatizing state lotteries is gaining steam. Over a dozen states – including Virginia, Vermont, and New York – are currently considering proposals to lease state lotteries to private sector investors. Given the upside potential, this idea deserves serious consideration from Commonwealth lawmakers.

Just this month, Del. David Poisson, D-Sterling, introduced HB 292, which would require the State Lottery Board to complete an implementation study on privatizing administration of the state lottery and report its recommendations by the end of 2008. The report would include an implementation plan to complete the privatization by July 1, 2010.

The proposals under consideration in a number of states involve leases, not sales, of lottery systems. A long-term concession agreement (generally on the order of 30-40 years) would be signed between the state and private investors to establish the guidelines and expectations of both parties. The private investors would operate the lottery on behalf of the state, while the state would still own the lottery and retain a strong regulatory role, maintaining strict controls over prize payout ratios, the types of new game products, and how games are marketed.

Lottery privatization makes sense in a number of ways. First, it’s difficult to argue that running a lottery is a core function of government. Put simply, businesses are best at running businesses, and governments are best suited to a regulatory and oversight role to ensure that the public interest is protected.

Next, state lotteries have a fairly stable revenue stream which can be maximized under private management. Private operators would have the incentive to introduce new, more popular games. And since lotteries are retail- and sales-driven enterprises — not areas of public sector expertise — private sector operators would more experienced and adept than government at using the latest technologies to target games to markets and generate more sales. With Virginia’s constitutional mandate that lottery proceeds be dedicated to education, this could mean more funds flowing into education with a reduced need to supplement them with state and local tax dollars.

Lastly, privatization would provide a means to transfer significant risks to private sector operators, most importantly the risks from competition with lotteries in adjoining states, casinos, and internet gaming.

There’s a great deal of flexibility in how a lottery concession could be structured. For instance, investors could give the Commonwealth a large upfront payment (possibly in the billions of dollars) in exchange for the rights to the lottery’s future revenues over the term of the term. According to press reports, one alternative under consideration in New York Gov. Eliot Spitzer’s privatization proposal could involve investors granting the state up to a $45 billion upfront, lump-sum payment in return for all lottery revenues over the lease term. The upfront payment would be placed in trust funds, the interest from which would be used to finance education.

An alternative structure that may be more politically palatable would be to structure a concession in which the Commonwealth collects a modest upfront payment and a guaranteed portion of the lottery’s annual revenues. For example, the lottery concession discussed in Indiana last year would have involved a $1 to $2 billion upfront payment and a guaranteed $200 million revenue-a-year stream over the 30-year life of the lease to fund college scholarships, pay down public pension obligations, and support capital projects.

Revenue sharing provisions are also an option if policymakers want to ensure that the state benefits if lottery revenues exceed certain thresholds in boom years. This option would give the state a share of upside revenues in boom years; the greater the upside, the larger the share.

While a number of states have begun to explore lottery privatization, no state has yet moved to implementation. However, the success of lottery privatization around the world – in Greece, England, and a number of Australian provincial governments, for example – has demonstrated that private sector skill and efficiency can extract more value out of lottery assets.

This is not to say that lottery privatization would be easy. It would require due diligence, detailed legal and financial analyses, and a carefully negotiated concession agreement that preserves a strong, state oversight role while maximizing the value of the asset. But with Virginia’s budget crunch, it’s more imperative than ever to get government out of the business of business and back to focusing on its core, essential functions. Lottery privatization would be a good step in that direction.

Leonard Gilroy is director of government reform at the Reason Foundation and Senior Fellow for Government Reform at the Thomas Jefferson Institute for Public Policy. An archive of Gilroy’s work is here. Reason’s privatization research and commentary is here. This column originally appeared in Bacon’s Rebellion.