Fiscal Policy: Looking at the Lottery

by Elaine Schwartz    •    Aug 11, 2013    •    1050 Views

The 14 million (or so) people who buy Powerball lottery tickets may be suffering from probability neglect. They know that their chance of winning $40 million could be 1 in 175 million. But still, they buy the tickets.

Nobel prize winning psychologist Daniel Kahneman tells us that the psychology of terrorism is the same as the psychology of lotteries. After 9/11, I became concerned that the Lincoln Tunnel, connecting NJ and NY, could be hit. Driving through it, I made sure to avoid (what I thought were) suspicious looking vans and trucks. Like winning the lottery, I knew that the probability was miniscule. But I still felt better.

Dr. Kahneman says for terrorism and the lottery, our behavior relates to an associative and uncontrollable emotional response. With terrorism we have horrible images while for the lottery they are happy fantasies. But for both they are uncontrollable associative thoughts. Our response–avoiding the van or buying the lottery ticket– ignores the probability because it makes us feel so much better.

Looking back at lottery history, I discovered that the philosopher Voltaire was a huge winner in 1729. Realizing that lottery prizes offered by individual Parisian districts were more than the total cost of their lottery tickets, he formed a syndicate to purchase all tickets in selected districts. When the syndicate won the equivalent of $116 million, he became independently wealthy for life. In addition to writing Candide (and much more), Voltaire is remembered for saying that the lottery is a tax on the stupid.

In 1730, the purpose of the French lottery was to repay municipal bonds. Thinking of the $19.5 billion that states got last year from Powerball, today also, lotteries have huge revenue potential. The only problem is that lotteries are a regressive fiscal policy tool. Just like regressive taxation, lotteries get a bigger share of what low earners take home than from those who are more affluent. To explain regressive taxes to my class, I use what we pay for gasoline. If someone who earns $100 a day pays a $2 tax when he fills his tank, he owes 2% of his daily wage. However, the person who earns $200 daily and pays the $2 tax is giving government 1% of her income.

Rather than the stupid, perhaps the lottery is a tax on innumeracy.

Sources and resources: This NY Times article provides more detail on Powerball economics but the really interesting story is about Voltaire. The ideal complement and always a good resource, Dr. Kahneman’s Thinking Fast and Slow is perfect for understanding behavioral economics.

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