Financing Public Goods by Means of Lotteries

Abstract

When viewed as taxes, lotteries are routinely criticized as being both inequitable and inefficient. But is this an entirely fair comparison? Frequently lotteries are used in lieu of voluntary contributions by private charities and governments when taxes are not feasible. When heterogeneous individuals with quasi-linear preferences participate in lotteries whose proceeds will be used to fund a public good, we find that, relative to voluntary contributions, wagers in the unique lottery equilibrium (a) increase the provision of the public good, (b) are welfare improving, and (c) provide levels of the public good close to first-best as the lottery prize increases. For more than 500 years, governments, private charities, and civic groups have turned to lotteries as a means of financing public goods. This, despite the fact that, over the same span, alternatives to the use of lotteries became cheaper, more sophisticated, and more efficient. Governments devised significantly more effective methods of tax collection and deficit financing, while private charities benefitted from advances in marketing and communications, which opened many new channels for fund-raising. Today global lottery revenues amount to $75 billion annually. By any standard, lotteries are a huge industry and show no signs of being completely usurped in favour of other methods of financing public goods. In current economic research, however, there remains extensive debate about both the equity (see Clotfelter and Cook (1987) and Karcher (1989)) and efficiency (see Borg and Mason (1991) and Gulley and Scott (1993)) of lotteries as fund-raising instruments. Much of the analysis of these questions examines lotteries relative to other tax instruments. By this criteria, researchers have largely concluded that, viewed as tax instruments, lotteries do not appear to be a particularly equitable or effective means of revenue generation. But is this an entirely fair comparison? Lotteries are often held by private charities lacking tax power. Currently in Britain, private charities raise about 8% (or ?500 million) of their income through lotteries.' In the U.S. in 1992, among 26 reporting states, about $6 billion was raised by private charities through lotteries.2 Among state governments, legal restrictions such as Proposition 13 in California and the Headlee Amendment in Michigan as well as popular resistance to tax increases of any sort place both de jure as well as de facto limitations on the taxation schemes available to states wishing to increase revenues. Thus, lotteries may not be a substitute for confiscatory tax schemes when these