Lottery buyers line up to pay a tax

Editor's note: Scott Drenkard is an economist at the Tax Foundation, a Washington-based tax research organization.

(CNN) -- Friday morning, many Americans lined up outside their local convenience stores, hoping to pick the lucky numbers that would win the record-setting $640 million jackpot offered by Mega Millions. The curious thing about this fervor is not that the odds of winning are 1 in 176 million, but rather that in effect, Americans are anxiously lining up to pay a tax, even if it is wrapped in attractive clothing.

While no government actually labels its lottery a tax, the games properly fit the definition of one. After lottery winnings are paid out and administrative costs have been covered, the leftover money is transferred into state coffers to pay for state programs. This is a tax.

State governments have developed a strong reliance on these lottery "profits" over the years. In 2010, states collected an average of $58 per capita in implicit tax revenue from their lottery programs. Delaware, which had the heaviest reliance on lottery revenue, collected a stunning $370 per capita.

Scott Drenkard

This increasing reliance on lotteries to fund state governments is troubling, as these taxes disproportionately fall on low-income individuals.

A slew of studies in the past two decades has found that low-income people spend a greater portion of their income on lottery tickets than do high-income individuals, meaning lotteries are a regressive way to collect tax revenue.

Many have argued that while lotteries are indeed taxes, they are not so bad, because people pay them voluntarily. But people only buy government lottery tickets voluntarily because private lotteries are not allowed to operate.

State lotteries only pay out an average of 60% of their gross revenues, a payout vastly inferior to those of slot machines and table games, which offer payouts in many cases above 90%.

People only buy state-run lottery tickets because tickets with better odds are choked out of the market. So while the purchase of the ticket itself is voluntary, the portion of that ticket sale that goes to state revenues is not, much in the same way that a sales tax paid on a book is not voluntarily paid.

The curious relationship between state-run lotteries and taxes does not end there though. Even when someone wins the lottery, the winnings are subject to special withholding taxes at the state and federal levels. If someone wins the $640 million jackpot, they would be immediately subject to a 25% federal withholding and state withholding rates as high as 12%. Their total income tax burden on the winnings might be more depending on how they invest that income and what credits and deductions they take next April.

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The opinions expressed in this commentary are solely those of Scott Drenkard.