Inter–temporal Differences in the Income Elasticity of Demand for Lottery Tickets Inter–temporal Differences in the Income Elasticity of Demand for Lottery Tickets Abstract - We estimate annual income elasticities of demand for lottery tickets using county–level panel data for three states and fi nd that the income elasticity of demand (and, thus, the tax burden) for lottery tickets has changed over time. This is due to changes in a state’s lottery game portfolio and the growth in consumer income more so than competition from alternative gambling opportunities. Trends in the income elasticity for instant and online lottery games appear to be different. Our results raise doubts about the long–term growth potential of lottery revenue and have policy implications for state governments and those concerned about regressivity. INTRODUCTION eginning with New Hampshire in 1964, 42 states and Bthe District of Columbia have legalized state–sponsored lotteries. Lottery sales in the United States topped $48 billion in fi scal 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 Thomas A. Garrett & decision to adopt a lottery.1 The optimal design of lottery Cletus C. Coughlin games in terms of maximizing sales was studied by Quiggin Federal Reserve Bank of (1991), Cook and Clotfelter (1993), and Garrett and Sobel St. Louis, P.O. Box 442 (1999). Whether lottery ticket purchases are substitutes or St. Louis, Missouri complements for other consumer goods has been explored 63166 by Borg, Mason, and Shapiro (1993) and Kearney (2005). The revenue impact of cross–border lottery shopping has been National Tax Journal Vol. LXIl, No. 1 1 See Coughlin, Garrett, and Hernádez–Murillo (2006) for a literature review March 2009 of the determinants of lottery adoption. 77 NATIONAL TAX JOURNAL studied by Garrett and Marsh (2002) and with another study (another state, county, Tosun and Skidmore (2004). Similarly, city, or zip code at a point in time), but Brown and Rork (2005) examined the little evidence exists on how the income strategic interaction between state lot- elasticity of demand for a specifi c state’s teries using a model of tax competition. lottery product has changed over time. Finally, because states earmark net lottery As discussed in the next section, rising revenues for programs such as education, consumer income, the introduction of new several studies have explored whether games, and other changes in the gambling lottery revenues increase spending on the landscape suggest that the tax incidence target program (Borg and Mason, 1990; of lottery expenditures has not remained Spindler, 1995; Novarro, 2005). constant over time. The issue that has received the greatest This paper provides evidence on the attention is the tax incidence of lottery dynamic nature of the income elasticity ticket expenditures for different income of demand for lottery tickets. Using a groups (Clotfelter and Cook, 1987, 1989; panel of annual county–level data for Scott and Garen, 1994; Hansen, 1995; Far- three states that have had a lottery for rell, Morgenroth, and Walker 1999; Price 17 or more years, we estimate annual and Novak, 1999; and Forrest, Gulley, and income elasticities of demand for each Simmons 2000).2 Studies have used data state. This provides a sufficient time of various levels of aggregation, such as series to track how the income elasticity individual survey data as well as aggre- of demand for lottery tickets and, thus, gate data for zip codes, cities, counties, the lottery tax burden in each state has and states.3 The majority of research has changed over the past several years.5 We shown that state lotteries can be charac- link the trends in the income elasticity of terized as regressive taxation, implying a demand over time to possible business decreasing tax burden in relative terms cycle effects, the introduction of new lot- as incomes rises.4 Not surprisingly, this tery products, and changes in consumer tax regressivity is raised as an objection income. Our framework also allows us to state lotteries, especially in light of the to explore whether growing competition revenue maximization objective of state for lottery products from casino gambling lottery agencies. and neighboring state lottery games has In most lottery demand studies a single changed the income elasticity of demand income elasticity of demand is estimated for lottery tickets. from the sample of data, thus providing Our results shed new light on the a static look at the tax incidence of lottery dynamic nature of lottery tax burdens and tickets. The results from previous research suggest that income elasticities estimated allow a comparison of a single income from a single year of data may accurately elasticity estimate from one study (state, refl ect the income elasticity of demand county, city, or zip code at a point in time) only for a specifi c year. The degree of 2 This is not a complete list of all lottery demand studies. See the above studies for additional research. 3 Studies of lottery purchases have typically used personal income. A recent study by Coughlin and Garrett (forthcoming) fi nds that lottery purchases are most strongly infl uenced by transfer payments. 4 For example, Miyazaki, Hansen, and Sprott (1998) found 19 of 27 cases in which the specifi c lottery was regressive. Cases of proportionality and progressivity were also found. 5 Changing income elasticities provide evidence on the changing tax regressivity or progressivity of the lottery. An income elasticity exceeding one indicates that the lottery tax is progressive, an income elasticity equal to one indicates the lottery tax is proportional, and an income elasticity less than one (including negative values) indicates that the lottery tax is regressive. If the income elasticity is less than one and is declining (increasing) over time, then the lottery tax is becoming more (less) regressive. 78 Inter–temporal Differences in the Income Elasticity of Demand for Lottery Tickets lottery regressivity or progressivity is affected the income elasticity of demand time dependent. Our annual estimates is uncertain. also provide a picture of the long–term Consider how advertising expenditures revenue prospects of the state lotteries might affect the income elasticity of lottery studied here, an important issue for all demand. Increased lottery–related adver- lottery states and programs funded by tising should lead to increased spending lottery revenue. Our evidence suggests on lottery tickets; however, the effect of that the long–term revenue prospects of increased advertising expenditures on state lotteries are unfavorable compared the income elasticity of lottery demand to other sources of state tax revenue. depends on how the spending patterns of individuals change.6 The income elas- ticity could increase, decrease, or remain INCOME ELASTICITIES OVER TIME: 7 THEORY unchanged. Many advertising campaigns are targeted to certain groups, so specifi c Numerous reasons exist that suggest advertising campaigns are undertaken the income elasticity of demand for lottery with an expectation of affecting groups tickets is likely to change over time. The differentially.8 A campaign targeting most general is that consumer income has low–income players should tend to reduce generally increased over time. A consis- the income elasticity of lottery demand, tent empirical fi nding is that as income while a campaign targeting high–income rises, individuals spend a smaller share players should tend to increase the income of their budgets on lottery tickets (i.e., elasticity of lottery demand. A fi nal obser- the income elasticity is less than one). vation is that an advertising campaign is Thus, as incomes tend to rise over time, often tied to the introduction of a new the income elasticity of lottery demand game, which itself might be targeted to should decline. appeal to a certain audience. In addition to changes in income, New games may also result in chang- the competitive environment in which ing income elasticities of demand over lotteries operate is ever–changing. time. Many states have added instant and Relative to the mid 1980s, today’s envi- online games that offer higher jackpots. ronment includes different advertis- For example, many states participate ing campaigns, new lottery games, in multi–state online lottery games that more gaming alternatives (e.g., casino generate much larger jackpots than could gaming and lotteries in neighboring be offered from relying on lottery sales states), and increased information about in a single state. In addition, starting games. Precisely how these changes have in the 1990s many states began to offer 6 Because our empirical analysis uses counties rather than individuals as our unit of observation, the specifi c change must cause different percentage changes in lottery spending across counties. Such a difference does not invalidate the argument. 7 To illustrate, assume two individuals whose spending on lottery tickets and incomes are as follows: player #1—$100 spending with $10,000 income, and player #2—$150 spending with $20,000 income. In this case, the income elasticity is 0.5. Assume an advertising campaign that causes both players to spend an additional ten percent on lottery tickets.