Wednesday, February 16, 2011


Peter Orszag, formerly of the Office of Mangement and Budget, and now of Citigroup, has come up with a brand new system for encouraging savings in America: a savings lottery. 

In the quest to raise saving rates, this allure of lotteries may be quite helpful. To be sure, most of any increase in national savings will come from a reduction in budget deficits. But a secondary priority is higher household savings, especially among lower- and middle-income groups.
This is where prizes can help. A recent paper for the National Bureau of Economic Research laid out the case for a savings vehicle coupled to the opportunity of winning a large prize. One way to think of these "prize-linked" accounts is that they can offer an expected market return, but in an innovative way. They pay a guaranteed return below market interest rates, but also provide a lottery ticket whose value makes up the difference.
To be specific, a lottery-lined savings account could offer a lower rate of interest, but also say a one-in-a-million chance of winning $1m for each $100 deposited. Mathematically, the expected return is the same, but the chance to win $1m makes the account much more attractive.

What he fails to mention is exactly who is supposed to be running the lottery.  He does acknowledge that lots of states have lotteries now, and that the expected return is well below one (on average you "win" 50 cents by buying a one dollar lottery ticket).  And he mentions that if the state is running the lottery, this amounts to a form of regressive taxation because more poor people play, and lose, than do rich folks.  But then he sort of slips a gear and proposes his altruistic scheme where the expected return is equal to exactly one -- 1 million people put up $100 each, you take the resulting $100m and invest it a 2% return, and at the end of the year, you give everyone $101 back except for one lucky soul who receives $1m.  Very tidy.

But who is running this show I wonder.  The same state that already fleeces the guy in the food stamp line every week with the current lottery?  Or some more altruistic state that runs the whole thing like a small town raffle and skims nothing off the top? 

Assume NC starts a program like this and is giving you back, on average, $100 plus 2% interest, for every $100 you save.  It proves wildly popular and NY decides to copy it.  Only they realize that they might attract more people if the prize is $2m.  Naturally, in this case, after the prize, there's no money left over to pay everyone else their interest, but they still get back the $100 they saved.  Would people be more interested in this lottery?  The expected return is lower, but the prize is bigger.  How about NJ, who decides to offer $10m in prize money, and reasons that even with this princely sum, they will still be giving $92  back to the losers for every dollar.  That's not the end of the world, is it?  And the expected return is still exactly one.  And if these lotteries prove popular why wouldn't NM perk up to a chance to change things ever so slightly and give everyone $90 back, give away $10m, and just keep $2m for the guvna?  Wouldn't people play this lottery too?  They already play ones that are much less rewarding.  

So then what prevents a state from skimming a little?  And then the next from skimming a little more?  Until we reach the point where the odds are so bad that the it limits itself, which would represent something like the market price for the gambling instinct.  I mean, if the odds were worse, fewer people would play so they would raise less revenue but pay out less, and if the odds were better more people would play but they'd have to pay out more.  Don't states already set the odds on their lotteries to raise maximum revenue?  

I was joking, but now I'm kinda curious.

Anyhow, my point was just that we already have a household savings system linked to a lottery ticket, and we call it the stock market. The odds are most definitely rigged, but people still LOVE to play.  And the house, just like the state lottery, keeps a big chunk of the kitty.  Perhaps this accounts for Mr. Orszag proposing this scheme now that he has moved over to Citigroup.  It makes me feel terribly modern to know that the government could outsource corruption.

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