The New York Lottery Role
in Financing Education

April, 1998

H. Carl McCall
State Comptroller

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Click here for a copy of Comptroller McCall's report in Adobe Acrobat format.

April 1998

To the People of the State of New York:

This report addresses an issue that is almost always the subject of a question when I meet with New Yorkers: "Isn't lottery money supposed to provide extra aid for education?"

The answer, as with anything involving government accounting and budgets, is complex. Lottery receipts are indeed deposited into a special fund, and that fund is used for education. In reality, however, the lottery is simply part of the pool of resources that is divided among various competing needs in the state budget process. This report, for example, documents past budget actions that simultaneously increased lottery receipts and yet reduced support for education.

When the lottery was approved in the early 1960s, the public was promised that it would support education. Implied in that promise was that the lottery would add to state aid, rather than merely replace it. Even today, a new lottery advertising campaign perpetuates the myth that schools receive additional resources from the lottery. The truth is that the Legislature and Governor decide how much state aid will go to local schools and the amount from the lottery is just a small part of that total. Lottery money has never supplemented state aid; it doesn't today and it likely never will.

In New York, as in many other states, lottery earnings have been earmarked for education primarily as a public relations device. The opposition that arises from the use of gambling proceeds to fund government services is deflected by pointing to the worthy purpose that the lottery funds.

The lottery accounts for a relatively small share of state resources directed to education, and it is unlikely that any budget practice could be devised that would ensure that the lottery would provide additional support. The creativity used to balance past budgets would certainly be used to thwart any such measure.

The real debate in school finance should focus on whether our school aid system is equitable and efficient. I have issued a series of reports over the past two years that document serious problems with the state's education financing policies and suggested reforms to address them.

Sincerely,

H. Carl McCall,
State Comptroller

Executive Summary

This report reviews the role of the lottery in New York's finances, focusing on its contribution to public schools. The debate on the lottery in the Legislature and the media is summarized and is put in context by reviewing the state's economic and political climate at the time of lottery authorization. The sources of school district revenue are analyzed over time to describe the shifting shares contributed by school aid, the federal government, lottery and property taxes. The use of lottery funds as a means to balance past budgets is described. Finally, the prize structure of each of the existing lottery games is described.

Lottery as a Revenue Source

The New York lottery provides an important source of revenue to the state: $1.6 billion in state fiscal year 1996-97, accounting for 3.7 percent of state funds spending. School aid spending, however, is much larger. In 1996-97, the major school aid program totaled over $10 billion, accounting for 24 percent of state funds spending.
The lottery also accounts for a small share of the resources of local school districts, contributing only 5.3 percent of all revenue sources in school year 1995-96, substantially below the 50 percent contribution of property taxes and slightly below the 6 percent contributed by the federal government.

Dedication: Supplement or Replacement?

By dedicating it to education, there is an implied promise that the lottery will increase school aid. This has never happened in New York. The legislative debates on the lottery in the early 1960s consistently described the lottery as being dedicated to education, but promises that it would actually increase the aid that schools would have received anyway were not generally made. Efforts to ensure that the lottery would serve as a supplement were not visible until after the voters had approved the lottery. Over the years, governors have consistently contributed to the popular perception that the lottery provided additional funding.

The lottery was approved during a period when state government spending and public school enrollment were both increasing rapidly. Short-sighted budget actions resulted in the need to raise revenues substantially; the lottery was approved by the Legislature after it acted to increase taxes -- including imposition of a 2 percent sales tax -- by nineteen percent.

State budgets and Lottery Division marketing materials have consistently referred to the lottery as being used "in support of education." However, there has never been a real effort in the state's school aid formula to provide that lottery funds would be a supplement, although such "maintenance of effort" provisions have been employed for other dedicated revenue sources. In fact, an examination of the aid formula demonstrates that the lottery does not affect total aid received by schools.

The evidence that the lottery is no different from other revenue sources is bolstered by examining past instances when the lottery was used to close budget gaps. These actions have been taken by at least three governors, starting in the year that the lottery was implemented. For example, in 1967, Governor Rockefeller partially funded previously enacted school aid increases with the new lottery.

Introduction

New York is one of 37 states that operates a lottery. In New York, the lottery generated $1.6 billion for education in state fiscal year 1996-97, or 3.7 percent of state funds spending. The lottery provides about the same level of resources as the state's corporate tax on utilities and telephone companies, and slightly less than the amount collected from the cigarette and motor fuel, real estate transfer, and highway use taxes combined.

In short, the lottery is an important state revenue source and its absence would result in significant budget reductions or tax increases.

An important issue with the lottery is how it benefits education funding in the state. New York, like most of the other states that operate lotteries, dedicates proceeds to a specific use.⁽¹⁾ Although dedicating lottery proceeds -- to education in most states and New York -- is an effective means to gain public approval for lotteries, there is no conclusive evidence that the activity thus funded benefits.⁽²⁾ The central question in New York is whether the lottery actually supplements what schools would otherwise receive or whether the lottery merely supplantsspending that would have gone to schools.

Although the lottery is a significant source of revenue, spending on aid to public schools is much larger. In 1996-97, school aid totaled $10.2 billion, or 23 percent of state funds spending. The lottery accounted for only 16 percent of the funds needed for school aid.

This report will describe how the lottery operates in New York; review the historical setting that surrounded the debate over permitting a lottery in the mid-1960s; review the contribution of the state, the lottery, and local school property taxpayers over time to school spending; describe how the state budgets lottery proceeds; and analyze recent changes to the lottery statute to determine legislative intent behind the changes.

The Historical Setting for Lottery Approval

A lottery was approved by New York's voters on November 8, 1966 by a 3 to 2 margin. The Legislature had first approved the amendment in 1965 and gave it second passage early in 1966 before it was put to the voters. An understanding of the state's financial condition in the mid-1960s is important to understand the policy debate that accompanied approval of the lottery.



Spending and Revenues

Spending on public schools was increasing rapidly in the early 1960s, driven by both sharp increases in enrollment and reforms in the state's school aid formula. The 3.1 million enrolled pupils in 1964-65 represented a 19 percent increase over the 2.62 million in 1958-59.⁽³⁾ Growth in enrollment in the early 1960s was much greater than any period since: it far outpaced the growth during the second half of the 1960s. In contrast, enrollment declined for most of the 1970s and 1980s and has been growing relatively slowly in recent years.⁽⁴⁾

State spending in 1961-62 and 1962-63 grew by over 11 percent in each year, followed by 7 percent growth in 1963-64 and 4 percent in 1964-65. The growth in 1964-65 was only possible by accelerating the timing ("spinning up" or "one-shot" in 1990's revenue raising parlance) of corporate tax collections.

Because the acceleration did not recur in 1965-66, a number of revenue raisers were proposed and adopted in Governor Rockefeller's budget for that year, including imposition of a new 2 percent sales tax, increasing cigarette taxes by 5 cents per pack, and doubling motor vehicle registration fees. The value of these tax and fee increases totaled $530 million, or 19 percent of then current-law's revenues.⁽⁵⁾

First passage of the constitutional amendment occurred in June 1965, during the same legislative session that required the nearly 20 percent tax and fee increases to bring the budget into balance.

The Lottery Debate

Was there a promise that lottery would provide additional support for schools? The record of the legislative debate and press coverage is not conclusive. Clearly, the primary focus was on whether the lottery -- a form of gambling -- was an appropriate source of revenue for government. Two editorials in the New York Times prior to legislative adoption of the proposed constitutional amendment focused on the moral issue.⁽⁶⁾

The Regents publicly announced opposition to the lottery in August 1966.⁽⁷⁾ Their position was reported to stem from the moral question of gambling and from opposition to the concept of dedicating revenue to specific uses. They must also have expressed concern that the lottery would replace existing General Fund support; a New York Times editorial from February 1967 -- after the amendment had been approved -- took issue with plans to use the lottery to replace existing funding. The editorial stated that the Regents had cited this as a concern before the referendum was adopted.

Lottery Revenues and School Aid Payments

From the inception of the lottery, certain calculations have been employed to distribute lottery payments to schools. In actuality, however, none of these mechanisms has really been used to apportion aid, they have only served as an artificial accounting device. This happens because the lottery revenues are simply deducted from the general revenues flowing to schools. The decisions about how much aid to allocate and how to apportion it among school districts are simply not impacted by the lottery earnings.

In New York, state aid is apportioned to school districts through a complex web of formulas. In all, there are more than 40 formula and grant programs, many of which are altered annually in the budget enacted by the Legislature.⁽⁸⁾ Each year the aid allocation is driven by negotiations about the size of the increase overall and regional shares of aid. The legislators themselves and the Executive typically only focus on the broad figures, and the annual alterations to the formulas are carried out by a small group of technicians who are conversant with the mechanics of the aid distribution. Although the lottery revenues partially support each year's aid, there is no direct relationship between these revenues and either the overall amount of aid allocated, or its distribution among individual school districts.

This situation is not always readily admitted, however, and some descriptions of the aid system, while being technically correct, nevertheless provide an incorrect impression that the lottery earnings really do influence the amounts of aid school districts receive.⁽⁹⁾ For example, the Division of the Lottery annually publishes lists of lottery aid amounts received by each school district. Although these listings correctly reflect the lottery aid calculations specified in law, they provide a misleading impression because they do not include a description of how the amounts so calculated are simply deducted from the aid distribution calculated under the balance of the school aid formula system.

Two mechanisms are used to apportion lottery receipts to individual school districts, a textbook aid calculation and a general formula allocation. These are the figures reflected in the Lottery Division's publications, and both are of longstanding use in connection with lottery revenues.

Reimbursement for textbook purchases is provided through a formula which provides up to $40.90 per pupil for textbooks purchased and used in public schools or loaned for use to private school pupils. A portion of this reimbursement equal to $15 per pupil is provided through lottery revenues. The remainder, $25.90 per pupil, is paid from General Fund resources. However, the overall amount of money provided for textbooks is driven by the $40.90 maximum allocation -- the fact that a portion of this funding is provided through lottery revenues really doesn't change anything for school districts.

The preponderance of the lottery funds are funneled through an obscure "lottery formula" which theoretically calculates the aid amounts going to school districts based on an aid ratio, the number of pupils in each district and the lottery funds appropriated overall. In actuality, however, this formula has no impact on aid received because the amounts calculated through it are literally deducted from the amounts calculated under other aid formulas. In every case, this aid calculation equals an amount less than the sum of the other aid formulas, and the lottery aid calculation thus has absolutely no impact on the annual aid allocation each district receives.⁽¹⁰⁾

Further evidence that the lottery has no impact on aid distributions is supplied by the aid tables and computer runs distributed by the Education Department and the Executive. These publications do not make distinctions between lottery revenues and General Fund aid in the central tables describing the aid distribution; the amount of aid to be funded through lottery revenues is only a technical issue for those concerned with the state fiscal year appropriation needs or the most detailed levels of the payment schedule.

Another portion of lottery funds is provided explicitly for the education of blind and deaf pupils (these funds do not, however, flow to school districts directly). Similar to the case for textbooks, however, this linkage between lottery revenues and the program is not real. The aid for textbooks and blind and deaf pupils would be provided with or without the lottery revenues. In New York State and other states, lottery revenues have been tied to education in an attempt to counterbalance the negative image of funds earned from profits on gambling. Textbooks and blind and deaf students are an extension of this effort, for it is difficult to imagine more worthwhile expenditures to offset the negative impression many citizens have of governmental revenues derived from gambling.

The purpose of this section has been to describe the seemingly contradictory facts that while actual calculations involving lottery aid are made, they do not affect the overall aid going to school districts. The purpose is not to suggest that some different formula approach would solve the problem. For example, even if lottery receipts did flow through a completely separate (and operating) supplemental school aid formula, the budget negotiators each year would look at how much was going out through that formula and where it was going, and then they would decide what to do with the remaining formulas. School aid decisions have always been made apart from the lottery revenues and it is unlikely that any sort of statutory or constitutional amendment would change this.

The Lottery as a Revenue Raiser

New York's lottery has often been tapped as a source for closing budget gaps, a practice which makes it very clear that the lottery does not act as a supplement for state aid to schools. The most recent example of this occurred in Governor Pataki's 1995-96 budget when a new game was proposed, QuickDraw. Despite an increase in lottery revenues that would result from the new game, the Executive Budget proposed cutting school aid by $90 million.

In 1996-97, the Executive Budget proposed reducing school aid by $117 million.⁽¹¹⁾ The budget also assumed that QuickDraw, which would be operational for a full year, would contribute to an estimated $69 million increase in net lottery receipts.⁽¹²⁾ Despite this projected increase in lottery revenues, the Executive Budget proposed a school aid decrease.

The combination of increasing lottery receipts and proposed cuts in school aid is not a recent phenomenon. In 1991-92, Governor Cuomo's Executive Budget proposed legislation altering the prize structure of certain lottery games that would increase net receipts by $10 million.⁽¹³⁾ At the same time, aid to public schools was proposed to be reduced by $891 million.⁽¹⁴⁾

The notion that the lottery was a source of revenue to support education spending, but not necessarily supplementing previous commitments, was expressed during the first year that the lottery became operational. The state budget for 1967-68 was constrained by a $284 million increase in local assistance that had been adopted the previous year but whose implementation was delayed by one year. Although the aid increase was put in place without certainty that the voters would approve a lottery, and without being contingent on the lottery providing funds, the lottery was seen as a means to pay for the previous commitment, rather than as a source of supplementing the existing formula.

Governor Rockefeller's 1967-68 Executive Budget stated that "the Lottery funds will help to finance a part of our greatly expanded educational costs."⁽¹⁵⁾ Assembly Speaker Travia suggested a similar use for the lottery, when he identified it as a means to fund the prior commitment to increased school aid.⁽¹⁶⁾

School Finance Trends

In order to measure the role of the lottery in school finances, two sets of historical information were prepared for this report.


State Share of Resources to Public Schools

Table 1 documents state spending between fiscal years 1960-61 and 1996-97. The table includes:

• Total General Fund spending. Although this is not a complete measure of state spending, because it excludes federal funds and dedicated state revenue sources, it is the only data that can be constructed consistently over a long time period.

• Expenses for administering the lottery; note that these figures were inconsistently reported in financial documents and are not available for many years.

• General Fund School Aid. This column contains disbursements in each state fiscal year (which does not coincide with school years). Spending from the Educational Assistance Revolving Account (EARA) and the Local Government Assistance Corporation was added to the General Fund figure. EARA was used to put aside funds for school aid payments to be disbursed in the following year. LGAC accelerated the timing of payments.

• Lottery Aid to Public Schools. This column contains funds from the lottery special revenue fund that were disbursed to public schools. This amount should be added to the Local Assistance to Public Schools column to determine total school aid.
  

The last three columns calculate the share of various components of spending.

• General Fund School Aid as a percent of total General Fund Spending calculates the share of total General Fund spending that went to school aid. It excludes lottery spending.
  

Analysis of the trends in this column show that school aid accounted for about 35 percent of General Fund spending prior to the introduction of the lottery. After the introduction of the lottery, school aid's share of General Fund spending declined until the mid-1980s, when it was a low of 23 percent of spending. It has since increased to about 28 percent. The figures in the early 1990s show some large swings as the timing of payments was modified. These year-to-year changes should be ignored.

• General Fund School Aid + Lottery as a Percent of General Fund and Lottery Spending takes total school aid spending (both the General Fund and the lottery amounts) and calculates their share of General Fund and lottery receipts.

When compared to the General Fund-only data, this column shows a less pronounced decline in the share of spending allocated to school aid. Because this column includes lottery, this suggests that the lottery served to replace existing aid.

• Lottery's Share of Total School Aid. This column calculates lottery as a percent of total school aid (General Fund and lottery).

A significant problem with this series of data is that it does not adjust for the many changes that have taken place in state finances since the early 1960s. For example, with the expansion of the State University system and state assumption of a portion of CUNY funding, spending on SUNY increased from 2.4 percent of General Fund spending in 1960-61 to 1996-97's 6.2 percent that went to SUNY and CUNY. Health and Mental Hygiene accounted for 17.6 percent of spending in 1960-61 and 21.2 percent of spending in 1996-97. There were many other changes over the period, including state assumption of local courts and growth in public assistance caseloads, that represented structural shifts in state finances. As a result, as the number of functions that state government performed increased and school enrollment declined, it could be expected that the state would not necessarily dedicate the same share of spending to school aid.

The lottery's contribution to school spending was relatively modest until the early 1980s, when lottery revenues began to grow substantially. The growth was driven by restructuring prizes and the introduction of new, more popular games.

Lottery receipts have grown at a much faster pace than the General Fund portion of school aid. During the 12 year period from 1970 to 1981, the lottery increased 285 percent compared to an 84 percent increase in General Fund school aid. The pace accelerated in the next 12 year period, when lottery increased by 482 percent and General Fund school aid increased by only 90 percent.

Despite the difficulty in comparing shares of spending from the early 1960s to the present, it is clear that the lottery has not acted as a supplement to school aid. General Fund support to public schools has not nearly kept pace with lottery's contribution and the share of school aid to total spending has declined significantly.

Note: Administrative spending is not available for all years; 1992's increase in school aid was the result of changes in the timing of payments. Source: New York State Comprehensive Annual Financial Report, various years.

Sources of School District Revenues

The second set of data examined was a historical series on school district revenues.⁽¹⁷⁾ The major categories of data are school property taxes, other taxes, state school aid (excluding lottery), school aid paid from the lottery,⁽¹⁸⁾ federal aid and all other sources. Table 2 provides the raw data and Table 3 calculates the share that the various sources contributed to school district revenues. The column "Local Sources" is the share contributed by property taxes, other taxes, and all other sources combined. These data are presented on a school year basis.

The trends in the shares contributed by state aid, the lottery and property taxes for the period from 1965 (three years before the lottery's operation) through 1978 are a decreasing share contributed by state aid (which declined from 41 percent to 36 percent, and no change in the share from local sources (58 percent in 1965 and 57 percent in 1978). The lottery had not yet begun to contribute a significant share of revenues during this period. Although the state share had declined, the share paid by the federal government increased as the Federal Elementary and Secondary Education Act of 1965 was implemented. This suggests that the budget makers adjusted state budget allocation to schools to account for the larger share of aid paid by the federal government.

Federal aid peaked in 1981 at 9.1 percent of revenues; at the same time, state aid was at the low end of its range at 40 percent and the local share was also close to a low at 51 percent.

As the policy of reduced federal aid was implemented, the federal share declined to 6 percent in 1996. The state share without lottery declined from 1981's 39 percent to 34 percent in 1995. However, growth in lottery during this period maintained the total share from state aid at about 39 percent.

Examining the historical data in broader perspective reveals the same trend. For the seven years prior to the introduction of the lottery, state aid was 43 percent of school districts' total revenue. For every seven year period after the lottery, General Fund state aid (excluding lottery receipts) has always been less than the average share prior to the lottery.

While there are variations in some years, there does appear to be a general trend of the state first reacting to increased federal aid by reducing its own contributions. Federal aid began to decline at about the same time that the lottery experienced strong growth, and allowed the state to reduce the General Fund share of its contribution to school aid.

Note: These figures are on a school year basis and will not match the data presented on a state fiscal year basis in Table 1.

 

 

 

Note: These figures are on a school year basis and will not match the data presented on a state fiscal year basis in Table 1.

Lottery Games

The New York lottery consists of eight distinct games that are authorized in statute. Proceeds of ticket sales going to prizes varies from 55 percent for the scratch-off games to 40 percent for Lotto. The share used for education ranges from 45 percent for Lotto to 30 percent for the scratch-off-games. The combined share for education and prizes equals 85 percent for all eight games; the remaining 15 percent is the maximum allowed for administrative expense.

Any funds allocated to administrative expenses but not needed for that purpose are added to the funds available for the state budget. In 1996-97, the administrative surplus totaled $168.6 million; in other words, if the lottery had used the full fifteen percent allowed for administrative expenses, receipts for government use would have been $168.6 million lower.

In 1996-97 (the most recently completed fiscal year) ticket sales totaled $4.0 billion; $2.0 billion of this amount went to prizes, $240 million went to lottery agent commissions, $96 million was paid in fees to the lottery's on-line vendors, and $11 million was used to print scratch-off lottery tickets. The overall distribution of ticket sales -- 51 percent to prizes, 41 percent to government use and 9 percent for administration -- is more favorable than the shares received by most other states. Domestic customers of the state's lottery vendor generally split ticket sales 50 percent to prizes, 15 percent for administration and 35 percent of government purposes.

New York State contracts with GTECH Holdings to provide a variety of services related to the operation of the lottery. GTECH is the vendor used by 22 other states plus the District of Columbia.

The lottery vendor plays an important part in developing new games and recommending changes in the prize pay-outs for existing games. The vendor has a financial interest in increasing the amount wagered in lottery games because compensation is based on a percentage of lottery sales. Keno (which is marketed as QuickDraw in New York) is described by GTECH in its most recent financial statements as a game that provides a new market for lottery sales without having much impact on the sales of existing games. By the end of its 1997 fiscal year, GTECH was able to introduce Keno to 15 different governments ranging from New York to Lithuania, Kansas and South Australia. GTECH notes that its success will lead to the adoption of the game in other jurisdictions in the next few years.

Prize payouts for games in New York have been adjusted over time to maximize revenues to the state. State law specifies the maximum percentage of ticket sales that may be paid out in prizes; this percentage has been changed over time for many of New York's games. Because an increased prize payout will increase sales, the optimal prize level must find the point where higher prizes generates enough sales to compensate for expenses. In 1991-92, for example, an increase in the prize level for scratch-off games to 55 percent was enacted as a means to balance that year's budget. The increase in prizes was more than offset by an increase in ticket sales, resulting in increased revenue to the state.

Ticket Sales and Uses by Lottery Game
State Fiscal Year 1996-97
(in $ millions)

Share of Uses of Ticket Sales by Lottery Game
State Fiscal Year 1996-97
(in $ millions)

Source: New York State Lottery: Financial Statements, Year Ended March 31, 1997 and 1996.

This report was prepared by the State Comptroller's
Office of Fiscal Research and Policy Analysis
Sandra M. Shapard, Deputy Comptroller.

Major Contributors to this report were:

Nick Smirensky
William Murphy
John Clarkson

1. "The Game of Mystery Bucks", Governing, January 1998, pages 20-21.

2. Donald E. Miller and Patrick A. Pierce, "Lotteries for Education: Windfall or Hoax?", State and Local Government Review, Winter 1997.

3. 1964-65 Executive Budget, page 639.

4. 1997 New York State Statistical Yearbook, 22^nd Edition, p. 320.

5. 1965-66 Executive Budget, pages M22-M24.

6. "A State Lottery?" New York Times, June 16, 1965; "Legalizing the Lottery," New York Times, January 27, 1966.

7. "Regents opposed to Lottery Plan," New York Times, August 27, 1996.

8. For a description of the aid system, the manner in which it has become so complex, and problems inherent such a system, the reader is referred to An Agenda for Equitable and Cost-Effective School Finance Reform, Office of the State Comptroller, October 1996.

9. The lottery formula is actually quite simple in calculation and provides an unambiguous distribution aimed at equalizing local differences in property wealth. It may be of interest to note that if this formula were truly applied, it would allocate 39 percent of aid funds to New York City, more than the 35 percent share the City receives.

10. However, the amounts calculated in this manner do have a small impact on the timing of aid payments, because the September payment to school districts is based on this calculation, but subsequent aid payments are based on the remainder of aid due under the formulas (after deducting the September payment).

11. Office of the State Comptroller, Fiscal Review of the 1996-97 Executive Budget, January 8, 1996, p. 29.

12. 1996-97 Executive Budget, Appendix II, p. 182.

13. 1991-92 Executive Budget, Annual Message, p. A98-A99.

14. 1991-92 Executive Budget, p. 327.

15. 1967-68 Executive Budget, p. M17-M18.

16. "No Tax Rise Seen for State till '69," New York Times, December 15, 1966.

17. Collected from publications from the Comptroller's Division of Municipal Affairs.

18. As published by the Division of the Lottery.