I still think the lottery is a fantastic investment for most everyone, due to what is known as the “small to big transformation.” That is, the lottery provides a vehicle through which $1 can become $5,000, or even $300 million, if you’re a lucky son-of-a-gun like this guy. The alternative is losing only a small amount of money—an amount so small it hardly makes a difference.
The lottery is just one of many so-called commitment devices, an economic institution that forces us to commit to a certain task, goal, or objective. Some of the more common commitment devices include a gift to ourselves for weight loss, a vacation after months of hard work for a promotion, etc.
Layaway, a service that many retailers are bringing back, is another commitment device. One must contribute regularly to a big purchase in order to ultimately receive the good or service he or she wishes to purchase.
The lottery is an excellent commitment device. Those who play the lottery regularly are more likely to be poor, less likely to have a bank account, and naturally less likely to save for major purchases. (The middle class can’t even be bothered to save for retirement.) The lottery presents a unique kind of savings vehicle through which one can make routine “contributions” in exchange for a large, lump sum payment every once in a while.
Thus, lotteries are actually good for poor people.
Scratch-Offs are Better than Bank Accounts
While a lottery player may lose frequently, they won’t lose much in the long-run. Many scratch-offs, for example, pay out some 60-70% of the total amount “invested.” Similar contributions to a savings or checking account may have a very similar return, since the real rate of interest is currently negative, and because major banks now charge $10+ monthly fees for checking accounts. (Bank of America currently charges $12 per month.)
If the choice was to save $40 per month in a checking account at a major banking institution, or invest $40 in scratch-offs, a saver would realize virtually similar outcomes. Each month, the $40 saved in a bank account would turn into $30 due to fees, whereas the $40 would result in $30 of winnings, on average.
However, there is a behavioral benefit to purchasing lottery tickets—the payoffs are random, and always larger than the initial investment.
Lotteries force good, but irregular spending habits. Someone with ordinarily poor spending habits would rob their bank blind at any chance to spend a few dollars. Someone with ordinarily poor spending habits cannot rob their lottery “bank account,” and can thus spend their earnings only when the lottery rewards them with a payoff. It’s all about time preference.
We know that people spend their money wisest when it comes in large quantities. Large lump sum payments (such as tax returns and stimulus checks) are more likely to be saved or spent on major purchases like washing machines, ovens, or so-called “durable goods.”
Lotteries as Free Welfare Programs
The lottery would be better used as a welfare program. Rather than seek profitability from the lottery, we should seek break even, with smaller margins.
Lotteries should be as close to zero-sum as possible, while remaining incredibly democratic in their rewards. That is to say that the pay-off should be kept as close to 1:1 as possible, and the payoffs should be smaller (1,000-$1,000 prizes instead of $1,000,000 prizes) in order to encourage good savings habits for as many people as possible.
Does it provide a real fix to the problem? No, of course not. It does not promote behavioral change, though it is likely just as effective.
Lotteries are to savings what debt snowballs are to debt reduction. Dave Ramsey doesn’t agree – he says lotteries are a tax on people who can’t do math – but the math, in this case, makes perfect sense to me.
Lotteries could be far better for the poor than a bank account.
Photo by: qnr