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SEIFFE:  Looting The Lottery

Tuesday, May 30, 2006

By Ralf Seiffe

I suppose there is nothing wrong with selling a publicly-owned asset for more than it’s worth.  The reason governments might want to sell such an asset is the same as it is for private investors; the price a buyer offers exceeds the present value of continued ownership.  This same standard should apply to selling the Illinois Lottery but the Governor’s brazen proposal to sell it does not meet that simple test.  Instead of showing a good head for business, Blagojevich’s plan reveals venality that would shame the greediest hedge fund manager. 

Selling public assets is a little trickier than a liquidating a piece of private real estate, trading shares or selling a used car.  Publicly owned assets like roads, bridges and schools have a communal purpose and it's hard top value the welfare such public property provides. The Lotto is a different story, however.  It’s not a necessary, and some say it is not a desirable, function of government. Buying a lottery ticket is completely voluntary so it cannot be considered a tax other than a tax on innumeracy. 

From the state’s point of view, the lottery is more like owning an insurance company; customers pay “premiums” for the uncertain but rare win while the state knows with absolute certainty what the aggregate payout will be. 

In fact, owning the lottery is better than being in the insurance business.  No one can foresee the next Katrina or know what effect Bird Flu will have on middle-aged mortality.  These random, uncertain events clobber insurance companies’ earnings.  Not so with the state; it knows exactly what the “losses” will be before the first ticket is sold. 

Indeed, this is such a good business that before the state got in it, the service was provided by organized crime.  When The Outfit ran their version of numbers, they called it the “policy” business for good reason.  

So, while it’s easy to see why a private company would want to run the Lotto, the more significant question is whether private investors would be willing to pay what it’s worth.  To decide that question, our leaders should recognize that the lottery is a business owned by the state of Illinois .  In this transaction, the citizens of Illinois are the current stockholders of the business.  That means our leaders have a fiduciary responsibility to their shareholders to realize the highest value possible, not necessarily the highest price. 

For two fundamental reasons, selling the lottery makes no sense. 

The most evident reason is that the Lotto will always be worth more to the citizens of Illinois than to a private investor.  That’s because the state does not pay income taxes.  Consider this: news reports tell us the Lotto provides the state’s treasury with a $660 million annual annuity.  A new private investor would have to assume he’ll get the same pre-tax return because the “lotto category” is mature and there are competitive lotteries. That means that it’s unlikely the new owners will be able to grow the lottery to increase revenues or change the prize structure significantly to increase profits. The new owner might also find their costs actually increase as the media begins to charge for televising the drawings and distributing the winning numbers.  They should also think about the progressive tax the Illinois legislature has imposed on riverboats after they became successful.  

This all means that the private company operating the lotto might not get the $660 million the state now enjoys.  And, even if it did, the federal and state income taxes would diminish that by at least 40% to just under $400 million. 

The obvious conclusion is that moving the lottery to the private market from the public means one has to believe that the $400 million private shareholders will earn is more valuable to them than is the $660 million the stockholders of Illinois now enjoy.  That’s a lot of arbitrage to swallow. 

The other reason not to sell the Lotto is that we cannot trust the sellers to do the right thing with the money.  Springfield politicians will squander the money a potential sale would bring because they keep their books in a fundamentally dishonest way.  Instead of forthrightly recognizing the state’s increasing pension liabilities and operating costs, Illinois lies to itself and produces balance sheets which would be actionable if released by a publicly traded company.  The “off-balance sheet” liabilities Illinois hides in its financial footnotes are fundamentally no different than those that will probably send the now-convicted Enron executives to jail for the rest of their lives. 

Without the discipline of honest financial statements, the pols will see the sale as a cash windfall and spend it.  They actually admit their plan is to snatch $4 billion immediately and put the rest into a sinking fund.  How long until some future legislature invades that fund?  

©2006 Ralf Seiffe

Ralf Seiffe advises business start-ups and product launches from Chicago, Illinois and is a political analyst and columnist for the Illinois Leader and Illinois Review.