the taxing game of lotteries in canada

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Canadian Public Policy The Taxing Game of Lotteries in Canada Author(s): John R. Livernois Source: Canadian Public Policy / Analyse de Politiques, Vol. 12, No. 4 (Dec., 1986), pp. 622-627 Published by: University of Toronto Press on behalf of Canadian Public Policy Stable URL: http://www.jstor.org/stable/3550671 . Accessed: 18/06/2014 19:29 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. . University of Toronto Press and Canadian Public Policy are collaborating with JSTOR to digitize, preserve and extend access to Canadian Public Policy / Analyse de Politiques. http://www.jstor.org This content downloaded from 62.122.76.60 on Wed, 18 Jun 2014 19:29:32 PM All use subject to JSTOR Terms and Conditions

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Page 1: The Taxing Game of Lotteries in Canada

Canadian Public Policy

The Taxing Game of Lotteries in CanadaAuthor(s): John R. LivernoisSource: Canadian Public Policy / Analyse de Politiques, Vol. 12, No. 4 (Dec., 1986), pp. 622-627Published by: University of Toronto Press on behalf of Canadian Public PolicyStable URL: http://www.jstor.org/stable/3550671 .

Accessed: 18/06/2014 19:29

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .http://www.jstor.org/page/info/about/policies/terms.jsp

.JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range ofcontent in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new formsof scholarship. For more information about JSTOR, please contact [email protected].

.

University of Toronto Press and Canadian Public Policy are collaborating with JSTOR to digitize, preserveand extend access to Canadian Public Policy / Analyse de Politiques.

http://www.jstor.org

This content downloaded from 62.122.76.60 on Wed, 18 Jun 2014 19:29:32 PMAll use subject to JSTOR Terms and Conditions

Page 2: The Taxing Game of Lotteries in Canada

JOHN R. LIVERNOIS Department of Economics, University of Alberta

THE TAXING GAME OF

LOTTERIES IN CANADA*

es gouvernements provinciaux font de

plus en plus appel aux loteries comme alternative aux formes traditionnelles d'imposition. Cet article demontre que, contrairement a ce que I'on croit communement, les loteries ne sont pas une forme volontaire d'imposition, mais cr6ent des revenus qui sont equivalents et donc qui peuvent remplacer des revenus d'origines differentes. Cet article etudie ensuite la

question de la regressivite de cette forme

d'imposition. Apr6s avoir analyse des donnees canadiennes et americaines, nous concluons que les loteries represent une forme regressive de perception. De ce fait, nous pensons que les gouvernements provinciaux devraient modifier leurs politiques quant a la tarification des loteries.

I Introduction

otteries have become big business in Can- ada in the decade or so since they were

first introduced. Nearly $2.2 billion was spent on public lotteries in the fiscal year ending March 1985. This is 65 per cent more in real terms than expenditures in 1979/80 and 130

per cent more than expenditures in 1976/77. The most avid consumers of lotteries in Can- ada are in Quebec where annual expenditures were $106 per capita in 1984/85, compared to $78 in Ontario and $50 in the Atlantic and Western Provinces. As a percentage of net

rovincial governments have been placing

increasing emphasis on the use of lotteries as an alternative to traditional forms of taxation. It is argued in this paper that lotteries are not a form of voluntary taxation, as is often believed, but generate revenues which are equivalent to, and therefore substitutable for, revenues from other sources. The paper then goes on to

investigate the question of regressivity. On the basis of evidence from Canada and the

US, it is concluded that lotteries are a

regressive means of generating public revenue. Because of this, it is argued that

provincial governments should change their

policies towards the pricing of lottery games.

provincial income, lottery expenditures in Quebec are also the highest in the country at 1 per cent, followed by the Atlantic Provinces at 0.7 per cent, Ontario at 0.6 per cent and the Western Provinces at 0.4 per cent.'

A surprisingly large segment of the popula- tion is responsible for these expenditures. More than 80 per cent of households in Can- ada have at one time or another purchased a

lottery ticket.2 According to survey data re-

ported in Livernois (1985), nearly 60 per cent of all households purchase at least one lottery ticket per month. Thus it is clear that the prov- incial governments in Canada, like many of

Canadian Public Policy - Analyse de Politiques, XlI:4:622-627 1986 Printed in Canada/lmprimb au Canada

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Page 3: The Taxing Game of Lotteries in Canada

their counterparts in the United States, have discovered and exploited a rich source of pub- lic revenue.3

While lottery profits have grown more rap- idly than tax revenues generated from own sources in all provinces over the last decade, and by as much as 3 times more rapidly in some cases, they are still a relatively small

part of total tax revenue. In Quebec, lottery profits were 1.6 per cent of provincially gen- erated tax revenue in the 1984/85 fiscal year. The corresponding shares in the other prov- inces were: Ontario, 1.21 per cent; Atlantic Provinces, 1.01 per cent; Western Provinces, 0.96 per cent, or 1.20 per cent when Alber- ta's non-renewable resources tax revenue is excluded from total tax revenue.4

It is often believed that lottery profits differ from other types of tax revenue in that they are a form of voluntary taxation. If this were true, lotteries would be a harmless means of

raising revenue since a program of purely vol-

untary contributions cannot be criticized for

imposing an unfair burden on any individuals or groups in society. It will be argued in the second section of this paper, however, that

lottery profits are not a form of voluntary tax- ation but are equivalent to other types of tax revenue. The only difference is their magni- tude; lottery sales involve an implicit ad valo- rem tax which exceeds 50 per cent in some

provinces. An interesting question thus emerges regarding the incidence of this type of tax on income classes. This issue is exam- ined in the third section of this paper by re-

viewing the available empirical evidence on expenditures on lotteries. On the basis of this evidence, it is concluded that lotteries are a

regressive form of taxation, more so than other forms of taxation in Canada but less so than lotteries in the US. Conclusions and policy im-

plications are drawn in the fourth section.

II Lotteries and the Structure of the Industry

A lottery game is a consumer good. Individu- als derive utility from the consumption of the

good and are willing to pay a price for the opportunity to obtain this utility.5 The price consumers do pay is the difference between

the ticket price and the expected value of the ticket. This price would equal the minimum

average cost of supplying the good in the long run if the lottery were operated by a perfectly competitive industry. Any price above this benchmark level represents a surcharge on consumers and a monopoly rent to suppliers. Such a surcharge can be maintained over time if there are barriers to entry and collusion

among the suppliers. These are precisely the conditions charac-

terizing the Canadian lottery industry. There are five main lottery corporations in Canada, all provincially-owned, the Atlantic Lottery Corporation, Loto-Quebec, the Ontario Lottery Corporation, the Western Canada Lottery Foundation and the British Columbia Lottery Corporation. After paying out prizes, which

average 45 to 53 per cent of total sales reve- nue, and deducting costs, which average 13 to 22 per cent of sales revenue, these corpo- rations earn approximately 30 to 35 per cent of sales revenue as economic profit. The lot-

tery corporations are able to earn these profits because of their explicit collusion and the sub- stantial barriers to entry in the industry.

Collusion in the lottery industry is con- ducted primarily through the Interprovincial Lottery Corporation which is responsible for the three lottery games marketed in all prov- inces, namely Lotto 6/49, the Provincial and

Super Loto. Total profit from the sale of these

products is allocated among the provinces on the basis of relative provincial sales. Individual

lottery corporations sell additional games but

only within their own markets. Thus, the structure of the industry is very clearly one in which a cartel controls the entire Canadian market for the three national products of the industry, and in which the market is seg- mented for the purpose of selling locally spec- ialized products.

The barriers to entry in the industry are in- surmountable as far as potential privately- owned entrants are concerned. The Criminal Code of Canada prohibits organizations other than governments and charities, which must be licensed by the governments, from operat- ing lotteries.6 As far as entry by the federal

government is concerned, the de facto barriers

The Taxing Game of Lotteries 623

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Page 4: The Taxing Game of Lotteries in Canada

appear to be substantial. Prior to 1979, the federal government competed in the industry but not very successfully. In August of that

year, Ottawa agreed to withdraw from the in-

dustry and for this the Provinces agreed to pay the federal government $24 million annually in 1979 dollars, out of lottery profits. In 1984/ 85, the actual payment was over $35 million. In June 1985, Ottawa agreed not to re-enter the lottery industry in return for an additional $100 million, in 1985 dollars, to be paid over a period of three years. Thus, the federal gov- ernment is effectively a member of the cartel; by agreeing not to enter the industry it re- ceives a share of cartel profits.

Because competition has been so effectively restricted in the lottery industry, the corpora- tions are able to set and maintain monopoly prices. The monopoly profit component of the

price charged to consumers can be viewed as an implicit tax, since this is the size of the

surcharge over and above the full cost of pro- vision that governments have decided to in- clude in the selling price. Stated differently, it is the amount in excess of the competitive price that consumers are forced to pay. Thus, the monopoly profit associated with lottery sales is equivalent, in effect, to tax revenue. It is no more a voluntary tax than the sales tax or the excise taxes on gasoline and cigarettes. In all of these cases, the only way to avoid

paying the tax is to not consume the good being taxed.

The ad valorem tax rates which are implicit in the prices of lottery tickets can easily be calculated by taking the ratio of sales revenue to costs (including the cost of prizes). This ratio would equal unity at the competitive price and the implicit tax rate would be zero. The actual implicit tax rates vary considerably across provinces, ranging in 1984/85 from a

high of 55 per cent in Quebec to a low of 44

per cent in both Ontario and the Atlantic Prov- inces. In the Western Provinces, the tax rate is 52 per cent.

III The Tax Incidence of Lottery Profits

As with any type of tax, it is useful to know the incidence on income groups of the revenue

raised by lottery programs. One of the difficul- ties associated with determining the incidence of the implicit tax on lotteries is the paucity of data on expenditures on lotteries for the gen- eral population. Using the easier to obtain data for winners or players of lotteries produces a biased sample unless lotteries players are rep- resentative of the general population in all

ways, particularly with respect to income lev- els. This characteristic, however, is the very thing one wishes to test.

There are four American studies which at-

tempt to estimate the incidence of lottery profits. Spiro (1974) uses questionnaire data obtained only from winners of lotteries in

Pennsylvania and finds that the lottery is re-

gressive among that subset of the population that purchases lottery tickets. Brinner and Clotfelter (1975), Suits (1977) and Clotfelter (1979) use independent data sets obtained from surveys of the general population in var- ious states. All three studies find overwhelm-

ing evidence of regressivity. For example, Brin- ner and Clotfelter (1975) estimate that a family in the lowest income group in Connecticut

spends .55 per cent of its annual income on state operated lotteries while a family in the

highest income group spends only .06 per cent

annually. Clotfelter (1979) analyses data for two lotteries and estimates the income elas-

ticity of demand to be not only less than unity, indicating regressivity, but in one case to be less than zero, indicating extreme regressivity.

It would be useful to be able to measure the

degree of regressivity and to use this measure to make comparisons among different lotter- ies. Suits (1977) constructs a very simple measure of regressivity analogous to the Gini index of income inequality. If one constructs a

Lorenz-type curve by plotting the cumulative

percentage of total taxes paid by the total

population against the cumulative percentage of income earned, one can calculate the Suits index. If this Lorenz-type line rises from the

origin along the 45-degree line, then the tax is neutral since, for example, the lower 50 per cent of the total income in the population pays exactly 50 per cent of the total taxes paid by the population. If the Lorenz-type line lies above the 45-degree line the tax is regressive

624 John R. Livernois

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Page 5: The Taxing Game of Lotteries in Canada

since, for example, the lower 50 per cent of total income pays more than 50 per cent of total taxes. The Suits index is calculated arith-

metically by the expression 1 - (RIS), where R is the area beneath the Lorenz-type line and S is the area beneath the 45-degree line. In the case of a neutral tax, the index has a value of zero since R=S. The minimum value of the index is - 1, indicating perfect regressivity, and the maximum value is + 1, indicating per- fect progressivity. This index provides a useful means of ranking different types of taxes ac-

cording to their degree of regressivity.7 Suits (1977) estimated an index value of

-0.31 for state lotteries which makes them, he says, twice as regressive as all sales and excise taxes in the US.8 Clotfelter (1979) ob- tained a value for the Suits index of - 0.24 for the Maryland weekly lottery which indicates a somewhat lower degree of regressivity than that found by Suits for all state lotteries.

The only empirical evidence on the regres- sivity of Canadian lotteries is contained in Liv- ernois (1985). For that study, survey data were collected from a random sample consisting of 545 Edmonton households.9 Table 1 shows that the average share spent on lotteries by households that do buy tickets ranged from a

high of 1.61 per cent to a low of 0.36 per cent. The average share spent by all house- holds in the sample ranged from a high of 0.79

per cent to a low of 0.24 per cent. The income elasticity estimated from the

summary data in Table 1 is 0.72.'0 With a standard error of 0.14 and 7 degrees of free- dom, this estimate is significantly less than

unity, indicating regressivity. However, it is also significantly larger than any of the esti- mates of Clotfelter (1979). Thus, it appears that the Canadian lotteries examined are less

regressive than their American counterparts. Further evidence on the degree of regressivity was obtained by calculating the Suits index for the same data. The index value is -0.10 which again indicates regressivity, and which

again suggests a considerably smaller degree of regressivity than in those lotteries studied

by Suits (1977) and Clotfelter (1979).11 Compared to other types of taxes in Can-

ada, the implicit tax on lotteries is above-

average in regressivity. This was determined

by calculating the Suits index for all Canadian taxes combined from data presented in Gilles-

pie (1976). The resulting index value was -0.05. However, the tax on lotteries is less

regressive than the combined excise taxes on tobacco, fuel oil, alcohol and several minor commodities for which the index value is -0.17.

Lotteries in Quebec and the Atlantic Prov- inces transfer profits into the general tax rev- enue fund. In all other provinces, lottery prof- its are used exclusively to support designated recreational and cultural activities and pro- grams. Lotteries in these instances result in a direct transfer of income from consumers of lotteries to consumers of the designated activ- ities and programs supported by lottery prof- its. Thus, it is important to examine the ex-

penditure incidence of lottery profits in these

provinces. Livernois (1985) estimates, on the basis of

national survey data on expenditures on rec- reational goods and services by households, that the expenditure of lottery profits benefits

high income groups slightly more than low in- come groups. The Suits index value for the incidence of these benefits is 0.05. Thus, in total effect, lottery programs in Ontario and the Western Provinces result in a direct trans- fer of income from low to high income groups.

IV Conclusions and Policy Implications

It has been argued in this paper that lottery programs in Canada involve an implicit tax with ad valorem rates ranging from 44 per cent to 55 per cent across provinces. It was also shown that these lotteries are a regres- sive means of generating tax revenue. To the extent that regressivity in any single tax source is undesirable, then provincial governments should alter their policies regarding lotteries.12 There are two possible policy changes which will be considered here. The first concerns the explicit cartelization of the industry; the sec- ond concerns pricing policy.

Contrary to what the logic of Section II

might seem to imply, it does not necessarily follow that breaking up the provincial cartel in

The Taxing Game of Lotteries 625

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Page 6: The Taxing Game of Lotteries in Canada

Table 1 Summary statistics

(1) (2) (3) (4) (5) (6) Percentage Average share Average share reporting spent on lottery spent on lottery

No. of Average lottery tickets by all tickets by ticket Income group observations income purchase in group buyers ($'000) ($'000) (%) (%)

1. 0-10 55 5.98 32.7 0.53 1.61 2. 10-14 31 12.22 54.8 0.79 1.44 3. 14-20 37 17.00 59.4 0.60 1.01 4. 20-26 59 22.93 64.4 0.77 1.20 5. 26-34 43 29.79 79.1 0.44 0.56 6. 34-40 32 36.87 75.0 0.47 0.62 7. 40-50 55 44.95 76.4 0.38 0.51 8. 50-60 32 54.22 68.7 0.24 0.36 9. 60+ 43 71.05 27.9 0.46 0.66

SOURCE: Livernois (1985).

lotteries would be in the public interest. There is convincing evidence of the existence of economies of scale in the industry. Deboer (1985) comes to this conclusion using pooled time-series data on state lotteries in the United States. Similar evidence exists in Canadian data. When the logarithm of average cost is

regressed against the logarithm of total sales

using data for three Canadian lottery corpora- tions from 1980/81 to 1984/85, the estimated

elasticity of the average cost function is -0.1.'3 Thus, it was undoubtedly cost-effi- cient for the lottery corporations to have com- bined to form the Interprovincial Lottery Cor-

poration. In fact, one could argue that even

greater cost efficiencies could be achieved by expanding the domain of the cartel so that all

lottery games are centrally produced. An alternative to public ownership of lotter-

ies is private ownership combined with a spe- cial provincial tax on ticket purchases. This could prove to be in the public interest if there were sufficient competition and entry of new firms in the industry to erode excess profits. However, the finding of extensive scale econ- omies indicates that such an industry probably would evolve into one with a very small num- ber of large firms. If this were to happen, there

is no guarantee that profits, and the effective

prices paid by consumers, would be any lower than under the existing arrangements. The in-

dustry could be regulated by provincial gov- ernments but there is little reason to suspect that this arrangement would result in any effi-

ciency gains compared to the current system of public ownership.

While it may be rational to endorse the car- telization of the industry which has occurred, and even to encourage more of the same, one cannot endorse the monopoly pricing policy that has been practised by the provinces. Prices (ticket price minus the expected value of the ticket) should be lowered so that the

implicit tax rate is more in line with what is levied on other goods. This could be accom-

plished either by lowering ticket prices or rais-

ing their expected values, or some combina- tion of each.14 By reducing the amount of revenue raised by lotteries and replacing it with revenue raised by a conventional device with an average degree of regressivity, the overall level of regressivity in the tax system would be reduced. In addition, because lottery prof- its are equivalent to, and therefore substituta- ble for other forms of tax revenue, they should be transferred into the general tax revenue

626 John R. Livernois

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Page 7: The Taxing Game of Lotteries in Canada

funds of all provinces. In this way, the special programs currently funded by lottery profits would be subject to the same funding criteria as all public programs.

Finally, it may be advisable to make the im-

plicit tax on lotteries explicit so that con- sumers are fully aware of the extent to which

they are being taxed when they purchase lot-

tery tickets.

Notes

* I gratefully acknowledge the helpful comments of the referees and the editor, but I remain responsible for

any errors or omissions in the paper. 1 These figures were calculated from 3 sources: the

1984/85 annual reports of the lottery corporations, Statistics Canada 91-201, and Statistics Canada 13- 213.

2 Statement made in the 1984/85 annual report of the Ontario Lottery Corporation.

3 According to Deboer (1985), 17 states and the Dis- trict of Columbia operated lotteries in 1984.

4 These statistics were calculated from data contained in the 1984/85 annual reports of the lottery corpora- tions and the annual budget reports of the provinces.

5 When a lottery game is viewed this way, there is no

mystery and no irrationality associated with the fact that individuals purchase lottery tickets which have a very low expected pay-off.

6 I am indebted to an anonymous referee for this point. 7 The ranking is unambiguous only if the Lorenz-type

lines do not cross. 8 Interestingly, he reports an index value of 0.19 for the

individual income tax. 9 I am indebted to the Population Research Laboratory

at the University of Alberta, under the direction of Leslie W. Kennedy, for generously agreeing to include a section on lottery expenditures in its annual survey of Edmonton households.

10 For purposes of comparison the double-log functional form used by Clotfelter (1979) is used here. The de- pendent variable is the log of shares in column 5 and the independent variable is the log of average income in column 3. For more details and more estimation results, see Livernois (1985).

11 The only other Canadian data that appear to be avail- able are expenditures on lotteries and raffle tickets by families in different income classes in the 1976, Urban Family Expenditure, (Statistics Canada 62-547) and the 1978, Family Expenditure in Canada, Volume 2 (Statistics Canada 62-550). These survey data do show declining expenditure shares on lottery and raf- fle tickets in the higher income classes, and therefore offer support for our regressivity findings.

12 An alternative view, suggested by an anonymous ref- eree, is that provincial governments already tolerate taxes which are more regressive than lotteries, confi- dent that the overall system of taxation is reasonably fair. Thus, the fact that lotteries are less regressive

than the combined excise taxes on tobacco, fuel oil, alcohol and several minor commodities might make lotteries a more attractive device for raising revenue. However, since lotteries represent the latest addition to the set of tools used to raise revenue, and since they are more regressive than the average of all taxes combined, then they clearly raise the average degree of regressivity and, in this sense, make the overall system of taxation less fair. It is for this reason that I view the regressivity of lotteries as being undesirable.

13 The standard error is 0.03 with 13 degrees of free- dom. The cost data are taken from the 1984/85 an- nual reports of the lottery corporations of Ontario, Quebec and the Atlantic provinces, and converted to real terms using the Consumer Price Index.

14 The lower price would also have the effect of increas- ing consumers' surplus. For a general analysis of the efficiency and equity aspects of lotteries, see Johnson (1976).

References

Brinner, R.E. and C.T. Clotfelter (1975) 'An Economic Appraisal of State Lotteries,' Na- tional Tax Journal, 28:3:395-404.

Clotfelter, C.T. (1979) 'On the Regressivity of

State-Operated "Numbers" Games,' Na- tional Tax Journal, 32:4:543-548.

Deboer, Larry (1985) 'Administrative Costs of State Lotteries,' National Tax Journal, 38:4:479-487.

Gillespie, W.I. (1976) 'On the Redistribution of Income in Canada,' Canadian Tax Journal, 24:4:417-450.

Johnson, J.A. (1976) 'An Economic Analysis of Lotteries,' Canadian Tax Journal, 24:6:639-651.

Livernois, J.R. (1985) 'The Redistributive Ef- fects of Lotteries in Western Canada,' De-

partment of Economics Research Paper No. 85-23, University of Alberta, Edmonton.

Spiro, M.H. (1974), 'On the Tax Incidence of the Pennsylvania Lottery,' National Tax

Journal, 27:1:57-71. Statistics Canada. Estimates of Population for

Canada and the Provinces, Catalogue #91- 201.

Statistics Canada. System of National Ac- counts: Provincial Economic Accounts, 1969-84, Catalogue #13-213.

Suits, D.B. (1977) 'Gambling Taxes: Regres- sivity and Revenue Potential,' National Tax Journal, 30:1:19-35.

The Taxing Game of Lotteries 627

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