Pursuit of Truthiness

my gut tells me I know economics

Lotto Tickets- A Potentially Good Investment

with 2 comments

Neither normal people nor economists can make much sense of those who buy lottery tickets hoping to make money.  To rescue the lottery from being an “idiot tax” they think of other reasons to play, such as the lottery being “entertainment” or a convenient way to donate to education.  However, in some reasonably common circumstances, the lottery makes perfect sense as an investment.

To see why, you have to calculate the implicit marginal tax rate people face.  The explicit marginal tax rate is what you see when you pay taxes, and for low-income people in the United States it is small.  The implicit tax rate is what you get by considering both taxes paid and subsidies received.  Many government subsidies in the US target the poor, which is nice, but it means that as people work more they receive fewer subsidies- reducing their incentive to work more.  Sometimes, earning more income from work will actually reduce what you are able to consume by making you ineligible for benefits- this means you face an implicit marginal tax of 100% or more.

Why does this matter for the lottery?  By one calculation (shown in the chart below, which I haven’t checked myself, but is close enough to being true for my argument), a significant number of people in the US see nearly no benefit from increasing their income from $15,000 to $40,000.  Say you have a job that pays $20,000.  Getting a second job or investing “responsibly” will not increase your income above $40000 and so will not make you better off.  A winning lottery ticket, however, could shoot you out of the “dead zone” and make you money you actually get to keep.  If you are stuck with a near-100% implicit tax rate until you can drastically increase your income, the lottery makes sense for you.  You just make sure the potential payoff is big enough to get you clear of the poverty trap, so go big or go home.

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Written by James Bailey

April 5, 2011 at 10:53 pm

2 Responses

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