Privatize State Lottery - Gov. And Lawmakers Taking Another Look

Gov. Arnold Schwarzenegger and some lawmakers are again looking at the possibility to privatize the state lottery for addressing the state's financial troubles.

The Governor first considered this plan almost a year ago but that was when the recently amended compacts were being battled over in the state legislature and the outcome of that battle would have an impact on the privatization idea.

Now that the citizens of California have basically voted for the expansion of gambling in our state, the idea has renewed interest because in order to make the lottery enticing to private investors, voters would have to agree to authorize bigger jackpots and allow games that are currently banned.

An analysis prepared by Lehman Bros. for the Schwarzenegger administration revealed private investors would want to target middle-class Californians by installing more terminals and vending machines where they frequently shop, such as Target or Costco. It would boost revenues by running aggressive marketing campaigns and selling ads on lottery tickets.

Schwarzenegger's finance director, Michael Genest, said leasing the lottery to an investor like Lehman Bros. would likely require a statewide vote.

"The more bang for your buck, the more likely it would necessitate a vote of the people," Genest said.

"I think it would be a mistake not to have everything on the table when we're in such a dire situation," said Assembly Republican leader Mike Villines.

The question that arises though is that California’s gaming tribes have exclusive rights on electronic gambling devices, and a lottery expansion might conflict with newly minted state compacts.

"If their zones of exclusivity are breached, their payments to the state automatically stop," said Democratic political consultant Garry South, who has worked for governors and Indian tribes. "That's a factor Schwarzenegger and the Legislature have to take into account, because there's now several hundred millions going in every year under those contracts."

Launched by voters in 1984, the state lottery was billed as a windfall for public schools. While it provides $1.2 billion annually, the Legislature's fiscal analyst says the amount actually makes up just 1.5 percent of total K-12 funding.

"Californians generally seem to believe the lottery provides a lot more for education than it really does," said Jason Dickerson of the Legislative Analyst's Office.

In fact, when adjusted for inflation, lottery revenues have remained stagnant for a decade. Last year, the lottery generated $3.3 billion in sales.

Hoping to improve on the returns, the Schwarzenegger administration last year suggested the state could generate as much as $37 billion in one-time money in exchange for letting a private investor run the business for 40 years. The governor suggested some of the cash could be used to close persisting deficits while the rest could be saved for a "rainy day" account.

Since then, the Legislature's fiscal watchdog has lowered the value of a lease to between $10 billion and $20 billion, citing historically lower lottery sales in California compared to other states.

Dickerson said private investors would likely want to loosen the rules so they could offer bigger jackpots and create new games. Currently, the lottery is hamstrung by the constitution from using new technologies, such as video lottery terminals that look like slot machines and feature instant payouts.

It is also banned from using casino themes such as roulette or blackjack.

The technology and the gizmos that really drive successful state lotteries have changed significantly, but that has not happened in California because of the limitations passed by voters in 1984," South said. "Buying paper lottery tickets at the corner liquor store, that's not an attractive proposition."

California is currently among a number of states – Texas, Indiana, Massachusetts and New Jersey – considering at least some privatization of their lotteries.

Villines, who has met with Wall Street representatives in recent months, said he believes elected officials can craft a viable lease option because it makes sense to get government out of running an inefficient lottery system.

While Republicans want to use any lump sum from a lottery lease toward paying down debt, Villines said he would also want to guarantee money for education.

"It's important to acknowledge that part of the lottery was to fund education, so I think it's important to do that," Villines said. "We'd like to work with the education community on that."

Democrats are keeping an open mind, as well.

Sen. Dean Florez, D-Shafter, wants to improve the existing lottery business so the state can command a premium from potential lessees. Florez, who is the chair of the Senate Governmental Organization Committee, has a bill – Senate Bill 1679 – that would allow the Lottery Commission to modernize ticket terminals and give it more flexibility in handing out prizes.

Florez believes his bill requires only a two-thirds legislative vote and the governor's approval since it does not propose an outright lease. Still, he acknowledged his legislation, if passed, may be challenged as requiring a statewide vote.

An alternative to a lease could involve borrowing cash against future lottery earnings.

State Treasurer Bill Lockyer suggested selling lottery revenue bonds as a way to generate cash without giving up control of a state asset. Currently Florida, Oregon and West Virginia issue bonds backed by future lottery sales to build schools and university buildings.

Lockyer wrote late last year that securitizing bonds with future lottery sales would generate more up-front cash than the 40-year lease proposed by Schwarzenegger. The treasurer argued the state could get a better interest rate than a private equity firm, and could use a cash windfall to fund retirement liabilities.

David Crane, Schwarzenegger's advisor on public-private partnerships, said all options are on the table.

Gambling foes said any thought about expanding gambling in a state with 1 million problem gamblers should give lawmakers pause. According to a 2006 report by the California Research Bureau, gambling is a $13 billion industry in California, nearly half from Indian casinos.

Fred Jones, an attorney with the California Coalition Against Gambling Expansion, said there's an incessant desire to expand gambling, whether it's for bingo, card rooms, horse racing tracks or Indian casinos. Already, he said, lottery administrators have to engineer new games just to keep players interested.

"When is it enough?" Jones said. "At what point do lawmakers step out of their advocacy role for gambling?"

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