Betting on the lottery

Californians could be forgiven for worrying that an important state asset -- the state lottery -- is in grave danger. In recent weeks, a rhetorical barrage, bordering on the hysterical, has been directed at Gov. Arnold Schwarzenegger’s proposal to borrow against future lottery receipts to help close a $15.2-billion budget gap.

The Contra Costa Times darkly suggested that the governor’s idea would mortgage the lottery’s future and “saddle future generations with irresponsible debt.” The top Democrat in the state Senate, Don Perata of Oakland, called it “the worst kind of market speculation.” Some Republicans have claimed that the proposal is a tax increase in disguise. And heavy-breathing commentators said that because lottery revenues go to education, the schools would be at risk. Voters, spooked by the talk about education, tell pollsters that they prefer a tax increase to changes in the lottery.

Memo to Californians: Take a deep breath.

The notion of the lottery as a great institution of the state is laughable. Although there are always risks to borrowing against future revenues of any kind, California has relatively little to lose from doing so -- precisely because the lottery produces so little already. The history of the lottery, in fact, illustrates much of what’s wrong with California politics. It’s the story of the orphan child of a dysfunctional state’s dysfunctional system of making laws.

The lottery was conceived in 1984, not by educators, legislators or policy mavens but by Fred Kimball, the owner of a signature-gathering firm -- Kimball Petition Management Inc. -- and a founder of the modern initiative industry in California.

Companies such as Kimball Petition Management are hired by the sponsors of ballot propositions to send out petition circulators to collect signatures. It’s a volume business: The more initiatives there are, the more money the company can make. Kimball and his sons were looking to dream up more initiatives. They aimed for ideas that would be popular and attract deep-pocketed backers who would pay the firm well to collect signatures to qualify them. “We were sitting around one day, bored, trying to think about what we were going to do next,” Kimball’s son, Kelly, once told the San Francisco Chronicle. He is no longer with the company.

Other states had lotteries, but in California, the horse-racing industry and Nevada gaming interests had fought off legislative proposals to establish one. The Kimballs ordered up polling that showed a state lottery would be popular if its profits went to education. So they filed the lottery initiative with the state attorney general and then went looking for a client to pay them to qualify it. Scientific Games, a Georgia company that provides the printed materials and technologies to put on lotteries, gave more than $2 million. And in November 1984, Californians voted themselves a lottery.

It was the perfect transaction. The Kimballs got business for their firm. Scientific Games got the most populous state in the Union as a customer. (To this day, the company is the lottery’s top printer.) Kimball died in 1996, but within the initiative industry, the lottery is still celebrated as a business innovation and a precedent. Signature gatherers, pollsters and political consultants no longer had to wait for interest groups to come to them with ideas. After the lottery’s success, they started to invent their own

“No. 1, of course, it was business,” Fred’s son, also named Fred Kimball, who still runs Kimball Petition Management in Westlake Village, told me last week with considerable pride. “But we also got the lottery on the ballot and helped education at the same time.”

By approving a lottery, California voters believed that they had found a way to provide a big pot of new money for education. They hadn’t. The lottery generates a little more than $1 billion annually for K-12 education -- or about 1.5% of annual education spending in California. No one knows how the money affects the classroom because school districts are not required to report how they spend it.

As a political matter, however, the lottery may hurt education. Some education leaders say that because voters mistakenly think the lottery is providing big money to education -- privately, political consultants tell me that Californians often guess in focus groups that the lottery provides 30% or more of education funding -- the public tends to oppose new, more productive ways of boosting education spending.

What’s clear is that without improvements to the lottery, the meager amount of money schools now get will decline.

Lottery sales are dwindling, falling to an estimated $3.1 billion in 2007-08 from $3.6 billion in 2005-06. Adjusted for inflation, lottery revenues are lower than when the lottery began a quarter of a century ago. And the language of the original lottery ballot initiative, augmented by state laws and a court decision, prohibit the lottery from boosting payouts, adding games or modernizing technology to boost sales. Schwarzenegger has backed legislation to modernize the lottery as part of his lottery-borrowing plan.

Joan Borucki, the lottery’s current and 20th director, says that unless the lottery is modernized, it may no longer be a viable business in 10 years. “It’s time that either we’re going to [modernize] the lottery [so it can] perform as it should, or we’re going to let it dwindle,” she said.

The case for modernizing the lottery is much stronger than the one for borrowing against its future revenues. But Schwarzenegger’s options are limited. Borrowing has proved to be the only politically palatable option in a state in which budget cuts and tax increases require a two-thirds vote in the Legislature. Democrats won’t accept the cuts, and Republicans have the power to block the taxes. Here’s the hard political truth: Without major changes in the state’s tax and budget systems, California could borrow against all kinds of anticipated revenues to balance its books in future years.

Ideally, any funds generated from borrowing against a revenue stream like the lottery would be used for public works or to make capital improvements that would benefit the state for decades. Borrowing against future revenues to cover budget deficits, as Schwarzenegger proposes, is far less responsible.

Nevertheless, the governor believes that his proposal is a way to make a minor virtue out of political and fiscal necessity. He would use some money from lottery borrowing to pay for a budget reform he’s long sought: a rainy-day fund. He would immediately use billions of dollars to cover part of the coming budget year’s deficit, while other money would be reserved for future years. The amount the governor wants to raise -- $15 billion over three years -- is probably too much. The nonpartisan Legislative Analyst’s Office has proposed an alternative plan using a modernized lottery to bring in $5.6 billion over two years.

For all the blustery opposition to Schwarzenegger’s proposal, the real questions should be how much money can safely be borrowed against the modernized lottery and, more important, how should it be spent.

The state Senate and Assembly have each proposed budgets, which are being reconciled in a conference committee. In a bit of grandstanding, the Senate’s spending plan rejects the lottery proposal altogether -- but doesn’t specify any method for raising revenues, thereby leaving an $11-billion hole. The Assembly’s budget adopts the governor’s lottery idea to pay for schools and debt service. Schwarzenegger and his aides maintain that they will fight to reserve all lottery funds for the rainy-day fund to stabilize the volatile revenue ups and downs that have produced multiple budget crises.

Such an outcome doesn’t sound like much, but it would be more valuable than what the lottery does now. Can the governor make it happen? There’s reason to doubt. In the name of budget peace, Schwarzenegger will be under heavy pressure to permit the Legislature to have its way with any money produced by lottery borrowing.

Even if Schwarzenegger gets his lottery and budget proposal through the Legislature, voters will have to sign on. The lottery, after all, is the creature we Californians made, at the suggestion of Kimball Petition Management and Scientific Games. So major changes require voter approval.

But if the lottery does provide a way to make California’s budget process a little more stable, the lemon finally would yield a little lemonade. And the California State Lottery might be -- for the first time in its history -- useful.