Inter-temporal differences in the income elasticity of demand for lottery tickets.

INTRODUCTION

Beginning with New Hampshire in 1964, 42 states and the District of Columbia have legalized state-sponsored lotteries. Lottery sales in the United States topped $48 billion in fiscal year 2006 (roughly $160 per capita), of which state governments retained nearly $17 billion (about one percent of total state government revenue) for spending on education, infrastructure, and other social programs. The preceding sales and tax revenues suggest an average tax rate of 35 percent, an average rate much higher than that of other state excise taxes (Clotfelter and Cook, 1987). The growth in lottery sales over the past several decades is not only a result of more state lotteries, but also of an ever-evolving product line that is designed to attract and retain customers through higher jackpots, some reaching several hundred million dollars.

The growth of the lottery industry has sparked much research. Numerous studies, including Filer, Moak, and Uze (1988), Davis, Filer, and Moak (1992), and Alm, McKee, and Skidmore (1993), have explored the determinants of a state's decision to adopt a lottery. (1) The optimal design of lottery games in terms of maximizing sales was studied by Quiggin (1991), Cook and Clotfelter (1993), and Garrett and Sobel (1999). Whether lottery ticket purchases are substitutes or complements for other consumer goods has been explored by Borg, Mason, and Shapiro (1993) and Kearney (2005). The revenue impact of cross-border lottery shopping has been studied by Garrett and Marsh (2002) and Tosun and Skidmore (2004). Similarly, Brown and Rork (2005) examined the strategic interaction between state lotteries using a model of tax competition. Finally, because states earmark net lottery revenues for programs such as education, several studies have explored whether lottery revenues increase spending on the target program (Borg and Mason, 1990; Spindler, 1995; Novarro, 2005).

The issue that has received the greatest attention is the tax incidence of lottery ticket expenditures for different income groups (Clotfelter and Cook, 1987, 1989; Scott and Garen, 1994; Hansen, 1995; Farrell, Morgenroth, and Walker 1999; Price and Novak, 1999; and Forrest, Gulley, and Simmons 2000). (2) Studies have used data of various levels of aggregation, such as individual survey data as well as aggregate data for zip codes, cities, counties, and states. (3) The majority of research has shown that state lotteries can be characterized as regressive taxation, implying a decreasing tax burden in relative terms as incomes rises. (4) Not surprisingly, this tax regressivity is raised as an objection to state lotteries, especially in light of the revenue maximization objective of state lottery agencies.

In most lottery demand studies a single income elasticity of demand is estimated from the sample of data, thus providing a static look at the tax incidence of lottery tickets. The results from previous research allow a comparison of a single income elasticity estimate from one study (state, county, city, or zip code at a point in time) with another study (another state, county, city, or zip code at a point in time), but little evidence exists on how the income elasticity of demand for a specific state's lottery product has changed over time. As discussed in the next section, rising consumer income, the introduction of new games, and other changes in the gambling landscape suggest that the tax incidence of lottery expenditures has not remained constant over time.

This paper provides evidence on the dynamic nature of the income elasticity of demand for lottery tickets. Using a panel of annual county-level data for three states that have had a lottery for 17 or more years, we estimate annual income elasticities of demand for each state. This provides a sufficient time series to track how the income elasticity of demand for lottery tickets and, thus, the lottery tax burden in each state has changed over the past several years. (5) We link the trends in the income elasticity of demand over time to possible business cycle effects, the introduction of new lottery products, and changes in consumer income. Our framework also allows us to explore whether growing competition for lottery products from casino gambling and neighboring state lottery games has changed the income elasticity of demand for lottery tickets.

Our results shed new light on the dynamic nature of lottery tax burdens and suggest that income elasticities estimated from a single year of data may accurately reflect the income elasticity of demand only for a specific year. The degree of lottery regressivity or progressivity is time dependent. Our annual estimates also provide a picture of the long-term revenue prospects of the state lotteries studied here, an important issue for all lottery states and programs funded by lottery revenue. Our evidence suggests that the long-term revenue prospects of state lotteries are unfavorable compared to other sources of state tax revenue.