I don’t anticipate a lot of “likes” on this post. As I’ve said before, stories that appeal to our human side and are warm and fuzzy get the most people hitting that button not only on my blog but on others that I regularly read. I understand that since I often make my “like” decisions based on whether I walk away smiling or thinking.
This is one of those “thinking” posts and it deals with one of the most banal of all subjects – economics. I probably wouldn’t have even gotten your attention if I hadn’t changed the title to include a reference to the lottery. But I promise to make this as painless as possible.
I have decided to use the explanation of how taxes affect productivity using the example of the lottery because for the many who have never run their own business this is an easy example for them to understand.
So what is a lottery? If you have followed for some time you’ve probably heard my definition of it that for most Americans it is one of the two ways they view becoming wealthy. The other one is filing a law suit.
The actual definition is “that it is a game of chance in which players pool their money which is then redistributed in a small number of large prizes after the promoters deduct their fees for operating the game.” I think we all understand the concept. It is nothing more or less than a scheme for wealth redistribution.
I am always bothered when I hear people say that they “invested” X number of dollars in a lottery drawing. Sadly, this speaks to the extreme lack of financial education that most Americans share. This is a “gamble” not an “investment” and I am in no way passing judgment on whether gambling is good, bad or indifferent. I mean, after all, I live in Las Vegas.
So these are the economic realities of the lottery. You buy a ticket for two dollars. The operators (the inter-state Lottery System) immediately pocket one dollar to cover profit and operating expenses. (Fifty percent of your money just disappeared when you completed your purchase). The remaining dollar gets added to the prize pool.
Now that one remaining dollar “investment” is still working for you. You have approximately a 1/175,000,000 chance of hitting the jackpot – although you might collect a smaller prize.
Fortunately for you, you were born under a lucky star and are one of the two winners of the grand prize. You and the other winner both decide to accept the lump sum option of $384 Million which is split between you. (Please note that this represents a 35% reduction from the advertised $587 Million amount you would have received if you took your prize as a 30 year annuity).
And now, of course, you owe taxes on your winnings to both the Federal government and, for most winners, to the state in which they reside. So the gross amount of your prize of $192 Million each now shrinks by an additional 35% to become $125 Million. Still, that’s more money than you had in your checking accounting the last time you balanced your bank statement so you’re a very happy camper and are probably debating which color you should choose for your new Ferrari.
If you opened a bank account with a deposit of $1,000 and got your statement at the end of the month and the bank had “charged” you $500 for opening the account, then an additional $175 for “maintenance fees” and then an additional $113.75 for “miscellaneous fees” leaving you with a balance of $211.25, you would probably be screaming at the top of your lungs that you were “ripped off” – and you would be correct.
If you do the math, of the total prize pool collected, the Federal, state governments and the Lottery wind up with well over 70% of the money that is “invested” – and the players with less than 30% of the money. That is the economics of the lottery – but is actually not the main point of this post.
When you go to your grocery store to buy oatmeal and diapers, that store is operating on a margin of only 2 – 3 %. So your twenty dollar purchase might net them a whopping $.60. And yet grocery stores by rigorously controlling costs, minimizing theft and being able to negotiate favorable contracts with wholesalers are able to survive.
They struggle but they are still able to turn a profit – which is a good thing for us because if they didn’t there would be no place for us to purchase oatmeal and diapers. Of course, they don’t pay their employees extravagant wages because if they did they would be out of business.
I wrote the last two paragraphs because of the picketing which took place during the Thanksgiving weekend at Walmart for paying its employees “low wages” and offering “minimal benefits.” They really don’t have much choice in the matter based on the economics of their business. Just for disclosure, I have no axe to grind regarding Walmart as I don’t own stock in the company and almost never shop there.
On the other hand, government doesn’t have that problem. When you consider that the lottery nets them collectively 70% of the gross revenue it generates, they can well afford to pay their employees (our employees) beaucoup bucks – and they do. When you’re swimming in cash you can afford to be careless with it – and we have been to the tune of some $16 Trillion. And yet, that still is not the point of this post.
But we have now arrived.
At the heart of the deadlock on the fiscal cliff is the question of raising taxes on “the rich.” Warren Buffett recently offered a suggestion that we should consider “the rich” as a family which earns $500,000 per year rather than the $250,000 that President Obama made a campaign theme. Those earning that or more would see an increase in the percentage of Federal Income Tax that they paid.
The Republican House has been adamant, so far, in its position that there shouldn’t be any tax increases on the “most productive members and the job creators” in our society because this will undermine our economic recovery. (This is commonly described as “trickle down economics”). Of course, this notion is pooh-poohed by their opponents in this debate.
So let’s get back to the lottery as a frame of reference to investigate the “fallacy” of this theory.
If you’ve read this post diligently and have followed the math, you are now aware that government is already collecting 70% of the revenue from lottery sales and winnings. With only a 30% return to the players people are still lining up in droves to buy tickets. If government decided to up their stake to 80% of the money spent on the lottery we would probably see some decrease in the amount of sales and at 90% an even further decline in interest in the game.
So what if they decided to raise that to 100% of the amount collected? How many people do you think would be lining up at convenience stores to purchase tickets, knowing that if they “won” they would have to turn over all prize money to their state and the IRS? And that’s the problem with “trickle up” taxation. You see, at the point where government confiscated all the profit, even someone who had invented a time machine and knew what numbers would be drawn would have no incentive to play.
Similarly, a small business owner, burdened with some of the highest tax rates in the industrialized world combined with needing to comply with regulations which in many cases serve more to provide someone a job to oversee them than to accomplish anything productive will ask himself the question – do I want to play this game anymore? Those business owners (and people who have considered opening their own new business) have looked at the way the game is structured and said, “No.” And that is why we are unable to make any serious progress in reducing our rate of unemployment.
Of course this does suggest a solution to the “fiscal cliff” debate which is ongoing in Washington. As you have seen, the Lottery is an enormously profitable scheme for the operators (making anything that Wall Street has concocted look like mere child’s play). So I would like to offer this solution to our financial conundrum which I hope will make its way to our legislators and the President.
If you want to get the country out of debt, balance the budget and have money left over to waste on who knows what, simply require that all left over money that a wage earner has at the end of a month must be “invested” in buying lottery tickets.
I can already visualize the headlines now:
“Lucky Hoboken resident splits $239 Billion Lottery Jackpot with 157 other winners.”
America – what a country!