Tonight’s Powerball is expected to total $900MM. But you won’t really get $900MM. Most winners choose the lump sum payout option which, in this case, will amount to $558MM. This is probably the smart move for a savvy saver in a low interest rate environment who will wisely allocate the cash in a diversified portfolio expecting to beat the rate of return that the winner would otherwise earn with the 30 year annuity option. But since most winners aren’t savvy investors, this is usually a bad option (in my opinion). The annuity forces the winner to be more disciplined which, given the life changing sum of money, is probably a good thing for most people.
But let’s not focus on the “winner” here because the real winner of the lottery system is not the person who buys the winning ticket. The real winner of the lottery system is the government who taxes the winners. The government automatically withholds 25%, but the winner will be bumped into the highest marginal tax bracket in the case of the lump sum. In addition, they will very likely pay a state tax as well (usually ranging from 4-9%) and perhaps even local taxes. While the Powerball will be marketed as a $900MM prize the actual payout to a winner in, say, Washington DC, will be just $289.6MM – a full 68% less than advertised.
Importantly, the revenue from the lottery is itself a type of tax often termed the “poor tax” given that the lottery has a disproportionately negative impact on the poor. Typically, about 25% of the revenue goes to fund state programs, but according to Duke Econ professor Charles Clotfelter, author of the book “Selling Hope: State Lotteries in America”, there’s little evidence that this has any meaningful positive economic impact. Sadly, a whopping 15% of the revenue goes to financing the marketing of this gigantic economic drag. So, the lottery system actually looks a lot more like a massive backdoor tax scheme than anything else.
I find the whole lottery system rather disturbing. It preys on our behavioral biases and irrational understanding of money. So, while the media will widely tout the “winner” of tonight’s drawing the real winners will be the governments who spend millions to promote a program that does little public good and hurts those who need the money most.
* Corrected for the tax rate.
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