State’s Lottery Expenses Exceed Legal Limit : Revenue: A continuing ticket sale plunge is forcing officials running the games of chance to gamble. They are betting on more players to justify a costly advertising campaign to revive interest.

A precipitous drop in ticket sales during the past year has caused the California Lottery to overspend its administrative budget by millions of dollars in violation of state law.

To cope with the unprecedented crisis, state lottery officials are planning to gamble: Despite California’s slumping economy, they will project a hefty increase in sales for next year in order to justify an expensive advertising campaign aimed at bringing players back to the ticket counters.

“You cannot turn around a lottery that has fallen this quickly in a short period of time,” said Sharon Sharp, who took over as the lottery director last October and is scheduled to appear today before the Senate Rules Committee, which is considering whether to confirm her appointment. “You need advertising and promotion to be able to change the image--to get people back in the fun of it again.”

Sharp confirmed that ticket sales have dropped 33% since July, 1991, requiring a corresponding reduction in administrative expenditures. She said the lottery reduced its budget by $75 million, or 30%, but still was not able to keep from exceeding the limits set by law for administrative expenses. She said lottery lawyers have advised her that there are no criminal penalties for the violation, but she said “we are still taking it very, very seriously.”

Sharp is expected to be questioned about the excessive administrative costs at her confirmation hearing today.

Although the law requires that no more than 16% of gross sales be used for administrative expenses--including promotion, advertising, retailer commissions and computer costs--Sharp said the lottery will in fact spend about 17.5% of its revenues by June 30, exceeding the legal limit by more than $21 million. Besides the 16% for operating costs, the lottery is required to allocate 34% for schools, leaving 50% to pay prize winners.

The excessive expenditures underscore the depth of the financial problems facing a lottery that four years ago was registering the highest profits in the nation. At the height of its popularity in fiscal 1988-89, the California Lottery posted sales of $2.6 billion. But by 1990-91 revenue had dropped to $2.1 billion and this year is expected to fall to about $1.35 billion.

“We are in a whole heap of problems,” Sharp recently told the state Lottery Commission, whose five members are appointed by the governor.

For the state’s schools, the figures are particularly grim. Last year, the schools received $128.64 for each student from the lottery. This year the schools will get about $500 million, or $77 per student.

“The schools are getting a triple whammy this year,” lamented state Supt. of Public Instruction Bill Honig. “The lottery money is down, the state money is down and the federal money is down, and we’ve got this huge influx of kids.”

Adding to the lottery’s woes, the Los Angeles riots closed down about 100 ticket outlets, resulting in a four-day sales loss of about $1 million. Although most of those ticket outlets are still closed, Los Angeles-area sales have returned to normal.

Despite the lottery’s overspending on administration, Sharp vowed that neither schools nor the lottery’s prize pool would be shortchanged. She said the lottery will make up for the higher administrative costs with unallocated prize funds and interest income that in the past has been given to education.

Acknowledging that she underestimated the severity of the state’s economic recession when she became lottery director eight months ago, Sharp said she now hopes to revive sales with a major advertising campaign. In a strategy some critics consider risky, Sharp said lottery officials will project sales for next year at $1.9 billion--a move that will free millions of dollars for advertising.

Sharp said she considered the projections a “pretty realistic figure,” but she conceded that if sales do not rebound, the lottery will again have to cut spending. Without a major advertising campaign, she predicted “sales would continue to fall and not go back up.”

However, state Controller Gray Davis, whose office audits lottery operations, said the new projections seem high. He said he is concerned that “the lottery’s going to compound this year’s mistake by overestimating revenues in the next fiscal year.”

“Ultimately it’s the lottery commission members that are accountable,” he said. “They must satisfy themselves that the revenue projections are realistic. Otherwise, schools and lottery employees will suffer down the road.”

State Sen. Tim Leslie (R-Auburn), a frequent lottery critic, put it even more strongly. “Deliberately overstating revenues so they can have a large budget for advertising is very, very questionable, to say the very least,” he said.

Nor did Leslie accept the lottery’s contention that overspending could not have been avoided in a year when the state was in a deep recession. He said he would like the Legislature to conduct hearings on the lottery’s operations.

“When the lottery was sold to the people of California it was sold on the basis that there would be a specific set of (spending limits) and it’s not living up to that,” he said.

Sharp, however, said that any deeper cuts in lottery operations would have forced her to virtually “shut everything down,” causing an even greater drop in sales.

As it was, Sharp said, the laws governing the lottery required her to take action which “no prudent business would ever take.” She said the lottery stopped all television advertising in February, just as its new Fantasy Five game was making its debut. Advertising was still off the air in April, she said, when a daily numbers game was introduced.

“How would anybody even know about our games?” she asked. “It’s been me on a street corner.”

Lack of advertising was only one of many factors that contributed to the lottery’s financial problems, Sharp said. For months, she said, the lottery’s most popular game--Lotto--has been plagued with the bad luck of having a winner for nearly all of its top jackpots. If there had not been a winner, she said, the jackpots could have rolled over to the next game, allowing them to build up and attract more players.

But even worse than the lack of big jackpots, she said, was the economic recession which took away discretionary spending for millions of people who might have bought lottery tickets.

She said that last summer, by miscalculating the depth of the recession, officials projected lottery sales for the 1991-92 fiscal year now ending at $2 billion. She said the lottery’s administrative spending was based on those projections and it was not adjusted until she became director and discovered sales were actually tracking at about $1.4 billion. By then, she said it was too late to make all the cuts that were needed.

Other lottery directors say it is not unusual for the games of chance to go through a long period of decline, although they acknowledge that they have not seen a drop in sales as severe as that in California.

Steve Caputo, deputy director of the Oregon lottery, said his operation exceeded its 16% spending limit two years in a row and did not rebound until it was able to introduce new games and advertise them.

Caputo said Oregon officials finally adopted a strategy similar to California’s: They projected high sales in the coming year so they could spend more for advertising.

“We had to try to jump-start it. I think if you don’t do that you’re throwing in the towel,” he said. “Once you go down, it takes a lot to get yourself back up. I think they (California officials) have their work cut out for them.”