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lottery is a tax on the stupid

The Powerball lottery: is it really a stupidity tax?

A Powerball lottery form is filled out in San Antonio. The Powerball jackpot was at least $330m last night. Photograph: Eric Gay/AP

A Powerball lottery form is filled out in San Antonio. The Powerball jackpot was at least $330m last night. Photograph: Eric Gay/AP

“Don’t they know how idiotic buying lotto tickets is? Don’t they know they are just throwing their money away? It is a stupidity tax.” That quote was from a banker sitting near me at work a decade ago. He was upset that his hometown of Greenwich, Connecticut was overrun with people from New York City (especially the poorer areas of the Bronx) coming to buy Powerball tickets.

It was the early 2000’s and the Powerball jackpot had reached over $50m. At the time, that was considered a pretty decent amount. New York had yet to join Powerball (they did so in 2010), so the closest place Bronx residents, and other New Yorkers, could purchase tickets was Greenwich, just over the state border.

The Powerball mania is in the news again this week as Saturday’s drawing topped $330m.

Many Wall Street employees, like my colleague, live in Greenwich because of that proximity. It also helps that Connecticut has lower taxes than New York. Both reasons are why it is also home to some of the worlds largest hedge funds. Consequently, it is one the wealthiest cities in the US with a median family income of $168,000.

Greenwich was being overrun with people coming to buy tickets. Lines snaked for blocks around the town’s few convenience stores. The commuter rail station was jammed. Traffic, mostly cars with New York license plates, clogged the roads. Greenwich residents were not happy with the influx. Some even argued it should be illegal to sell the tickets in their town.

My colleague had a point: spending money on lotto tickets is rarely mathematically rational. The odds of winning the lotto are so badly weighted against purchasing a ticket it can be thought as throwing money away. The real value of a $1 purchase is often as low as 32 cents, with the rest of the cost going straight into the profits of the ticket sellers. Those huge profit margins are why governments have increasingly turned to lotteries to raise funds, rather than through direct tax increases.

Calling the lotto a “stupidity tax” resonated on Wall Street. That so many residents of the Bronx, where the average family income is $32,000, would willingly throw money away fits a common narrative: the poor make the wrong choices. It’s a fancier way of saying, “the poor are stupid.”

But I have a different take. The Bronx residents buying lotto tickets weren’t any stupider than those sneering at their decisions. They were playing the lotto because it is one of the only legal opportunities available to them to become rich. When you are poor, you make what others view as irrational decisions not because of “stupidity” but because of limited options. Rationality has to be viewed in the context of the situation.

The wealthy have many routes to legally make money without having to play the lotto. They can get an education from high-priced and high-profile schools and emerge debt-free with a resume made for Silicon Valley or Wall Street. They can invest their savings, often in opportunities brought to them. They have far greater access to small business loans.

When you grow up poor, you can’t easily borrow money, certainly not from family. You can go to college, but in most instances you come out burdened with huge student loans that limit your next options. So you play the lotto, which is one of the few times anyone will give you a chance to become rich. It’s a tiny sliver of hope that at just a few dollars still costs way more than it should.

I don’t play the Powerball. At the time I was a proprietary trader at a major Wall Street bank. That year I had invested $350m inside Brazil and Argentina. That money was lent to me by the bank I worked for. The bank itself borrowed that money from depositors and investors. The size of the bet I was making was pretty standard on Wall Street at the time. The result being that many banks were loaded with debt that was reaching dangerously high levels by historic standards.

I thought the bet was smart, a rational choice. I thought the odds were good that I would make money for the bank, and that they would pay me well for that. Even if I was wrong though, I was going to be OK. Losing money on Wall Street rarely comes at a personal loss. I would feel bad. I could face losing my job, but finding another one wouldn’t be that tough.

That year my bet on Brazil and Argentina worked out. I got paid a good deal of money. Nothing like the Powerball payoff, but something any resident of the Bronx or any normal person would have been very happy with.

A few years later Wall Street imploded. Our collective bets made with borrowed money soured, collapsing banks and collapsing the economy. The bank I worked for only stayed solvent because of a government bailout. We were allowed to keep our money and jobs. The cost of the financial collapse to the US economy however was huge, trillions of dollars huge. By one estimate it has cost the average US family between $50,000 to $120,000 (pdf).

That financial crisis hasn’t changed Wall Street much. A few rules have worked their way through the system, but extensive lobbying by the financial community is watering them down. The perverse compensation structure that encourages excessive risk taking is still in place. Banks are still too large to fail.

When the next crisis happens, and by the nature of markets, it will happen again, the government will do the only rational thing it can, and once again step in and save the institutions with taxpayer money. The economy will again be wrecked and the average family will again pay the costs.

The bankers won’t suffer much, not personally. That’s the real stupidity tax, and we are all paying.

<p><strong>Chris Arnade:</strong> Most people view lotto tickets as throwing money away, but the poor don't have many legal options available to get rich</p>

A Tax on Stupidity?

Topic: Human Interest

Image used with permission: iStock/RobMattingley

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A Tax on Stupidity?

The French philosopher, Voltaire, is reputed to have said that “lotteries are a tax on stupidity.” While it’s hard to find evidence that Voltaire actually said this, I’ve always loved the quote nonetheless.

Like going to the casino, if one analyzes the probability of success on the purchase of a lottery ticket the expected outcome is negative. Or so a self-styled rational being like me thinks. This simple view of the world was upset recently by a fascinating article in the Huffington Post that was brought to our attention by our friends at Northwood Family Office. It’s the story of Jerry and Marge Selbee.

It may surprise some, but lotteries have been around for centuries (as the sarcastic comment from Voltaire suggests). In Colonial America churches, universities and even government bodies sold lottery tickets as a means of generating revenue to pay for roads, schools, or the military. Despite the fact that most players understand that buying a lottery ticket is a “sucker’s bet”, the thrill of the game spurs them on, just as the slot machine does in a casino. As early as 1762, however, lawmakers in Pennsylvania noticed that poor people bought lottery tickets more frequently than the rich. It was apparent, even then, that in many ways the lottery was a tax on the poor.

Today, 44 U.S. states conduct lotteries that generate a staggering $80 billion in ticket sales. By comparison, the U.S. movie industry sells about $11 billion in movie tickets. Eleven states generate more revenue from lottery ticket sales than they do from corporate income tax. And the ugly truth of the lottery remains: it is a regressive form of taxation. Lower income households are disproportionately active lottery players. Yet it is easy for governments to generate revenue through lotteries, and the revenue is impossible to resist.

The story of Jerry and Marge Selbee, however, is that buying a lottery ticket is not necessarily a tax on stupidity. It turns out that in certain circumstances it can be financially rewarding.

Jerry Selbee was a Kellogg’s factory worker and, later, a convenience store owner who had a knack and passion for puzzles and math problems. In 2003, a new lottery in Michigan called “Winfall” caught his eye. It was a game where a player picked six numbers. If you got all six correct you won the jackpot, which was guaranteed at least to be $2 million. You got a lesser prize if you picked five, four, three or two of the numbers. If no one won the jackpot for a few draws then money available for the jackpot swelled. When it crossed the $5 million mark there was a “roll down” where, if no one picked the six correct numbers at the next draw, the payouts increased to those with five, four, three, or two of the correct numbers. What Jerry noticed was that in a roll down, the odds of winning changed dramatically. So long as no one hit the jackpot with six correct numbers in the roll down, playing the lottery in this special circumstance was not a “suckers bet”. It was an investment with a positive expected return! (See the article for more details.)

It took more than Jerry’s mathematical insight to push this story along. In order to benefit from the odds that were in their favour, Jerry and Marge needed to buy lottery tickets in large volume. A single ticket produced a random event. In fact, several statisticians had observed anomalies in various lottery formats in the past. But most were not interested in the grunt work that would be required to exploit it. In order to turn Jerry’s mathematical insight into profit, the effort Jerry and Marge put into their scheme was extraordinary.

At the end of their run, Jerry and Marge were going to separate convenience stores and spending 12 straight hours per day printing out $2 lottery tickets. They spent as much as $720,000 buying 360,000 individual tickets. After each lottery draw it took a full 10 days of 10 hours a day to sort through their tickets and figure out their winnings. But Jerry’s insight proved to be correct. The only time they didn’t profit was when another player claimed the jackpot with six correct numbers. When they stopped playing in 2012 they had grossed nearly $27 million over nine years, and netted $7.5 million before taxes.

The full Huffington Post article is long, but we think it is worth the read. The larger question to ponder is whether there was anything ethically wrong with what Jerry and Marge did? There is little evidence they harmed anyone. And as Jerry said, “if you figured it out and you could do it, would you do it?”

Jerry and Marge were brilliant rather than stupid, but their brilliance could only be rewarded through extraordinary effort. For most of us, lotteries and casinos must remain in the category of entertainment, with a cost attached to it. For reward, most will be better served by entrusting their excess funds with Nexus!

A Tax on Stupidity? Topic: Human Interest Image used with permission: iStock/RobMattingley Print & Share A Tax on Stupidity? The French philosopher, Voltaire, is reputed to have said ]]>