Associated Press

So You Want to be a Billionaire?

by victor matheson

victor matheson is a professor of economics at the College of the Holy Cross in Massachusetts.

Published August 25, 2023


If you have the impression that America is becoming a reality show, there’s a reason. Every week — well, not quite, but often enough — someone wins a billion dollars in Powerball or Mega Millions, the nation’s two major multistate lotteries.

Yes, this is a pretty new phenomenon. Six of the eight lotto jackpots in U.S. history with an advertised value in excess of $1 billion, including a $2.04 billion payout won in November 2022, have been recorded in the past three years. But no, it isn’t some wondrous accident. While choosing the winning numbers is purely luck, a lottery that so frequently generates nine-figure nominal payouts is anything but. The marketing gurus who run the lotteries have spent the few decades engineering Powerball and Mega Millions to offer super-sized jackpots.

Long a Nation of Gamblers

Lotteries have been around since the earliest days of European settlements in the Americas. In fact, the original Jamestown Colony, the oldest permanent English settlement in the Americas, was financed in part by a lottery back in England. Famed Faneuil Hall in Boston, as well as both Harvard and Princeton universities, used lotteries to fund construction. And lotteries remained a popular form of public financing into the 19th century, until concerns about fraud, as well as a growing societal disapproval of gambling, led to their decline. The last of the big ones, the Louisiana Lottery, finally closed its doors in 1894 under a cloud of corruption.

But killing lotteries is like whacking moles. In 1964, New Hampshire became the first state to revive its lottery. Its reasoning was purely economic. As one of the only states without a sales or income tax, New Hampshire was hard-pressed for revenue — and what could be better for the Live Free or Die state than an entirely voluntary tax on people who are bad at math?

Other states followed quickly in New Hampshire’s path, with border states often pressured to adopt lotteries since the alternative was giving away money to their neighbors. Indeed, Hawaii and Alaska, the two states with the least worry about cross-border lottery sales, are two of only five states today that do not offer a government-sanctioned chance for overnight riches.

The Era of Powerball and Mega Millions

While state lotteries offer a variety of games including daily numbers games and instant scratch-off tickets, the product that generates the most interest, if not the most sales, is the “lotto” game. Here, players purchase a ticket and pick a series of numbers, as with any other lottery game. A portion of the ticket price is allocated to the prize pool. And if all of the numbers match those picked in a regular drawing, the player wins the jackpot. Players matching some but not all of the numbers can win a variety of lower tier prizes.

But now comes the distinction with a difference. If no tickets match all of the numbers drawn, the money in the jackpot pool is rolled over to the next drawing and proceeds from new ticket sales are added. If, by chance, no one wins the jackpot in long series of drawings, the grand prize can become quite large.

Now, it turns out that folks really like the chance to gamble on really big potential jackpots. But you need a very large pool of potential ticket buyers to assure that the jackpot pool gets big enough to be exciting while also guaranteeing that the game is won often enough that the players decide winning at least seems possible.Research by Philip Cook and Charles Clotfelter of Duke showed that in order to offer a successful game with 1 in 10 million odds, roughly enough to generate occasional $50 million jackpots, requires a population of about 10 million people. So while big states like California and Florida could offer up lotto games with rich pots on their own, smaller states were out of luck.

Hence the birth of two multistate lotteries that offer the game to enough potential bettors to yield head-turning jackpots. Powerball (originally known as Lotto America) was created in 1988 and Mega Millions (formerly known as The Big Game) followed in 1996. Eventually, most states joined one of the two multistate consortiums.

It is a sad commentary on financial literacy that ticket buyers, not to mention the media, have bought into the lottery associations’ framing instead of focusing on the present (cash) value of the jackpot.
The Rise of Billion Dollar Jackpots

While initially states could only belong to one of the multistate lotteries, in 2009 the two signed a truce allowing any state to offer both games — the first step toward billion-dollar jackpots. Soon every state with a lottery was offering both, giving each a population pool approaching 250 million. Now the games could be engineered to spew out truly humungous jackpots on a fairly regular basis. Powerball eventually moved to a 1-in-292-million chance of hitting the jackpot, while Mega Millions settled in at 1-in-302-million odds.

The next step toward billion-dollar jackpots was an increase in the price of the tickets from $1 to $2. At $2, money obviously flowed into the jackpot pool at twice the rate. In addition, both games decided to shift prize money out of the lower-tier prizes and into the jackpot pool, increasing the percentage of the price of the ticket going into the jackpot pool from roughly 30 percent to 34 percent for Powerball and to 38 percent for Mega Millions, further augmenting the rate of jackpot accumulation.

The final push toward nine-figure jackpots came, surprisingly, from Federal Reserve Chair Jerome Powell. Historically, states have awarded lotto jackpots in form of annuities paid out over decades. The states would take whatever amount was in the jackpot pool and invest it in fixed-return securities that would pay out an initial sum and then distribute the rest over the next 29 years.

The point of this long tail, of course, was to give the lotteries a way to be able to deliver a huge payout at far less cost in present-value terms. The lottery associations report the jackpot as the sum of these 30 annuity payments, so that a $300 million jackpot is really “just” $10 million annual payments over 30 years.

So where does Jerome Powell fit in? Well, at the rock-bottom interest rates that prevailed in 2020 during the Covid-19 recession, it would have taken $833 million to purchase the bonds necessary to deliver a total of $1 billion in annuity payments over 30 years. By the summer of 2023, however, thanks to aggressive interest rate hikes by the Fed designed to cool inflation, it took only $489 million in the jackpot pool to purchase the bonds needed to back $1 billion in total payments. So, in effect, the same lotteries were able to announce billion-dollar prizes with roughly half of the cash on hand as before.

Of course, it is a sad commentary on financial literacy that ticket buyers, not to mention the media, have bought into the lottery associations’ framing instead of focusing on the present (cash) value of the jackpot. But, then, lottery players are not exactly hyper-rational when it comes to purchasing a product with the worst expected return of any legal gambling product and a chance of winning roughly equal to the chance of getting a hole-in-one in golf … twice in a row.

A Silver Lining (Sort Of)

It may walk and talk like fraud, but there is some redeeming social value to these over-the-top lotteries. For every billion dollars of jackpots awarded, states collect about $500 million in voluntary revenue — which presumably means $500 million less that they need to otherwise extract involuntarily in the form of taxes.

Here’s another advantage worthy of at least faint praise. Many lottery products, particularly instant-win, scratch-off tickets, constitute a wildly regressive levy because buyers are disproportionately poor. But economist Emily Oster of Brown found that when jackpots get really large, Powerball and Mega Millions draw in ticket buyers from across the income spectrum, leading to a much more equitably distributed financial burden.

So the next time you see a billion-dollar jackpot advertised, go ahead and buy a ticket with a clear conscience. You’re not going to win. But $2 is a small price to pay to be able to fantasize about what you would do with a billion dollars — and the 70 cents that goes to public schools may just pay for a new chalkboard eraser.

main topic: Culture