Several States Consider Privatizing Their Lotteries

Revenues should be used for infrastructure, not to increase government spending

Extracting value from assets has moved beyond the emerging category and into a staple of public finance. Many states are seeking alternatives to new taxes and higher fees to pay for transportation infrastructure-an effort that has caught fire in the last few years.

The trend began when Chicago entered into a 99-year lease for the operation of the city’s 7.8 mile Skyway-a terribly underperforming toll road-that netted the city $1.8 billion. Shortly thereafter deals were struck in Indiana and Virginia that have delivered transportation improvements and billions into state coffers.

The state or local governments still own the assets and private companies now operate them. The companies must perform maintenance and invest in improvements for a specified period of time, under a long-term lease arrangement called a “concession.” Once the lease is up, just like when you lease a car, the asset goes back to the original owner. Generally speaking the private company pays an upfront fee for the right to collect fees over the life of the operating agreement.

Following the successful deals in Indiana, Virginia and Chicago, several states are pursuing their own deals. High value toll roads in New Jersey and Pennsylvania are up for bid this year, with several others likely to soon follow.

More traditional asset privatization has long been used by governments; however, they’ve usually stuck to selling surplus property and underutilized property. Indeed, Indiana has raised millions in surplus sales in recent years and Ohio Treasurer Richard Cordray recently released a list of 446 state properties that should be divested.

Recently asset privatization has evolved into a new field-lotteries. Several states including Illinois, Indiana and Texas have floated plans to privatize their state lotteries. The deals themselves are not unlike toll road concessions. A long-term concession would be signed which will establish the guidelines and expectations of both parties, as well as what the state’s regulatory role will become.

The concessionaire will likely pay an upfront fee in the billions of dollars for the right to operate the lottery on behalf of the state. Some states may ask for lower upfront payments in return for an annual royalty and/or revenue sharing plan.

There is no doubt that lotteries are valuable assets. They have a fairly stable revenue stream and one that certainly can be maximized under private management. Private operators will likely introduce new, more popular games. Marketing will also be professionalized using the latest technology to target games to markets. Under this arrangement, lotteries may, for the first time, truly operate as a for-profit business function with the goal of generating more sales.

Traditionally, proceeds from toll road concessions have rightfully been dedicated to relieving debt and investing new transportation infrastructure. However, some of the proposals currently being debated in state capitals call for lottery privatization proceeds to be spent on a host of new government programs. Perhaps the most egregious is Texas Gov. Rick Perry’s plan to fund a new state health insurance program, cancer research and education with the lottery proceeds.

While privatization is a valuable exercise, and certainly an effort that every government should use for all non-essential or non-core functions, including lottery operations, privatization cannot be used as a mechanism to fund government expansion.

There are several acceptable uses of proceeds from privatization. First, proceeds should be used to pay off existing debt. States pay billions in interest each year, paying this debt off early reduces the tax burden and creates a better fiscal picture. Second, states should invest into additional hard infrastructure-e.g., roads and highways-to relieve congestion and improve the long term economic competitiveness. Third, proceeds could be used to fund a shift in the state pension system from defined benefit to defined contribution. Finally, proceeds could also be used to fund permanent tax decreases for taxpayers and businesses. Each of these options has one thing in common-a reduction in the tax burden.

Creating new programs or establishing new benefits does exactly the opposite. Rather than shrink government and lower the tax liability, it increases it.

This of course says nothing about the state granting monopoly rights for lottery operations in the state, which isn’t a good thing. The state ought to consider allowing competition, perhaps through multiple franchises. This of course will likely diminish the value of a deal-which may not be a bad thing considering how some states are proposing to spend the proceeds.

Lottery privatization can be a good thing, if done correctly. Each proposal should be judged independently to ensure that proceeds are spent wisely and serve as a benefit to taxpayers. Without a doubt using proceeds to create new government programs or expand existing ones is unacceptable.

Geoffrey Segal is director of government reform at Reason Foundation. An archive of his work is here and Reason’s privatization research and commentary is here.