To Avoid Massive Tax Hikes, Privatize State Lotteries

Today my colleague Leonard Gilroy and I published a piece on Real Clear Markets entitled, “To Avoid Massive Tax Hikes, Privatize State Lotteries.” The piece begins:

As states continue to grapple with ongoing fiscal pressures, some are beginning to explore an innovative new lottery privatization model with the hopes of increasing revenue. To the extent that this trend could prevent tax hikes or cuts in core programs, it is worth applauding.

The piece goes on to highlight several noteworthy developments towards privatization at the state level, including New Jersey, Pennsylvania, Indiana and Illinois. We initially focus on Illinois because it is pioneering this trend, writing:

(Illinois) handed over its lottery operations to Northstar Lottery Group, a private manager, last year. The result? A $36 million boost in net lottery revenues to the state in the first year with hundreds of millions of additional dollars expected over the next five years.

Why is Northstar doing so much better than the government? It’s not by scamming customers or cheating. State authorities continue to exercise control and oversight over all of Northstar’s significant business decisions because Northstar has to submit its annual business plans for state approval.

Lotteries are unique and many observers are unfamiliar with how they operate. However lotteries are no different than a number of other state-run services that can be adequately, or even better, provided by the private sector. The piece continues:

What privatization does is recognize that lotteries are essentially businesses that are better run by professional firms that have the right mix of incentives, skills and technology to maximize the value of this ultimately state-owned asset. It hands over to the private operator management of day-to-day operations, marketing and other functions in exchange for a portion of revenues (subject to an overall cap).

The upshot is not just increased efficiency but expanded product lines, improved marketing to attract new types of players, and new outlets for lottery ticket purchases across the state, all of which boost the bottom line.

Lotteries are lucrative businesses that generate profits even when not run super efficiently. Hence, even state-run lotteries produce revenues. However, public agencies face very few incentives to maximize efficiency since they don’t have to focus on a bottom line and, are rarely held to performance standards.

We go on explain the details of the agreement in Illinois, specifically covering financial terms of the contract between Northstar and the state. We also highlight caveats that will impact similar deals in other states. For example, some states have strict constitutional language limiting the use of lottery revenue. The piece concludes:

Although every state has something different to gain from privatizing lottery management, to the extent that money is fungible, by relieving fiscal pressure on some programs, lottery revenues can relieve the overall pressure for tax increases. And its far better that the state pursue new revenue from people voluntarily playing lottery games instead of taking more of taxpayers’ income involuntarily through tax hikes and the like.

What’s more, many states are saddled with debt and legacy obligations (pension and retiree healthcare costs) that they don’t have the funds to pay for. Many of these promises were reckless and should never have been made. But the fact is that governments can’t write them all off. They’ll have to find a way to pay for some of them. And lottery and other privatization efforts offer one such way without massive tax hikes.

Implementing privatization, like any policy tool (and like playing the lottery itself), is inherently risky. But all risk is not created equal, and ongoing fiscal woes suggest the risk of maintaining the status quo in government may be far greater.

It seems far more sensible for policymakers to avail themselves of every opportunity to maximize the return from the state’s existing revenue-generating assets through more efficient management, creating another option for cash-strapped states beyond just higher taxes and cuts in core services. Thus far, Illinois’ experience partnering with the private sector to increase lottery revenues suggests that maybe privatization isn’t such a risky gamble after all.

Read the full piece available online here. For more on privatization and other reforms at the state level see Reason Foundation’s State Government Research Archive.