Saturday, March 04, 2006

Touch Play Lotto: Risks of Fickle Government

Iowa is currently wrestling with the issue of so-called Touch Play Lotto machines, which have been installed in numerous bars, convenience stores, and restaurants throughout the state. Small business owners invested a little more than $7,000 for each machine, which gives them the privilege of selling a lottery-type product via a machine with bells and whistles. These machines resemble slot machines, but they are slightly different.
First, they dispense tickets, not cash. Second, their protocols for winnings are controlled by the lottery commission, rather than internal algorithms within the machine itself.

According to a story by Elizabeth Ahlin in today’s Omaha World-Herald (front page on the Iowa edition), there are currently more than 6000 of these machines operating in Iowa. Doing the math, that translates into private investment of more than $42 million. (The World-Herald reports total private investment of $130 million, based on the spokesman for the TouchPlay Coalition. The difference, which is significant, should be explored. The group, which is advocating the protection of this investment, would surely have an incentive to overstate it.)

The reason why business owners invest in these machines is quite clear: lottery officials predict that over the next fiscal year, consumers will drop more than $380 million into these machines. Of that amount, about $255 million will be returned as prizes (of course, income taxes can be expected to take away a significant percentage of that amount). Of the remaining $125 million, the state gets 24 percent or $30 million, leaving about $95 million for the industry to pocket. Even without my trusty calculator, I think that sounds like a pretty fast payback for the owners.

Doing some quick math, that means that the expected value of every dollar you put in to these machines is about 67 cents before tax effects. Assuming you report taxes on your winnings (as you should, good citizens), and further assuming that the average tax rate for state and federal taxes is a modest 25 percent, that expected value goes down further. Ultimately, you are only getting about 50 cents on the dollar. Would a rational citizen bet if they knew the odds were stacked against you two to one? Would a benevolent government choose to take money from its citizens in this way? Go figure.

The legislature is now coming to the realization that this may not be the best thing to have in every convenience store and restaurant in the state. For one thing, for those of you with kids who play video games, there is just something about electronic games that make us want to keep playing. That is bad enough if it is Super Mario Brothers and your kids are wasting their study time, but it is potentially disastrous if the mom and dad are wasting their grocery and rent money. Another dimension of this problem involves the matter of minors gambling – we proscribe them from entering casinos where slot machines are housed, but we can’t keep the under-21 crowd out of all the 7-11 stores, can we?

The big controversy brewing now is whether the state can take the right to use these away. My own prediction: they can, and without legal liability to the owners. I am not privy to all the facts, but unless there is a contractual right to operate for a period of time, the mere act of purchasing a good in reliance upon the stability of existing laws is generally not sufficient to protect you from legal change.

The message to small business owners who bought these machines: caveat emptor. You use them at the pleasure of the state. The law may be an ass for not giving you compensation, but that’s the risk one takes for dealing with a fickle government. At the least, I think the legislature should post warnings on all such machines: Using these machines is bad for your fiscal health.


Anonymous said...

What a load of hooey! Ed I know you don't really believe that movie stars actually pay the same or higher marginal income tax rate than you do. After all, do you have the ability to write of the expense of an a personal aircraft or breast implants (even if you wanted them Ed). Also I trust that the IRS commissioner understands that interest expenses on a $12 million home is not subject to the AMT.

Ed Morse said...

Anonymous, you must think I really do ok in the world. I'm a poor college professor, remember?

You are right that those who operate in the star realm (whether in movies or top executives), they do get some benefits that others don't. Most of these come in the form of perks that are paid for by others. But some might involve tax deductions for traveling by jet, as you mention, instead of on commercial flights. (I'm not sure on the breast implants being deductible under 162 - those seem like capital expenditures to me, and for the record I'm not investing. I haven't researched that issue, though. Do you know of any cases on this point?)

On the home mortgage, you know there is a $1 million overall limitation. If they have a second mortgage, they are subject to AMT like the rest of us. They might structure ownership through a corporation and then get use of the home, though that use might well be taxable. That may be what you are getting at.

But the main point of my post was not to make a comment on the substance, but to congratulate the Commissioner on his ability to work three movie titles into his comments. I think we can all do with a little more humor in our lives, no?

Best regards.

Anonymous said...

The state can always do what they want.....Fickle or not. I think its a shame that the State Legislators are all running and hiding now. point your fingers to
every one of yourselves. the business owners and operatoers are the ones who are being screwed by "Our Fickle State Government".
I went back and read the mins from the lottery meetings with the legislators, Guess What? The all knew what was going on.

Anonymous said...

Now that the machines have been removed, what do you suggest that the small business owner do now that they are left holding the bag? The state should have done its homework before inviting personal investing. As far as our children witnessing gambling, there are much worse things they can witness, things that won't help make their state better in the long run. Revenue from these machines were astronomical, which could have been used for better schools, roads, health care, etc. As a parent I feel it's my job to teach morals and ethics in my home...and not be so nieve to think my child won't be confronted with a multitude of elements that I may or may not agree with. I don't believe these machines should be on every corner, but what harm do you see with them being in bars, no children there! I think the state was careless and hope the people now left to pay hundred of thousands of dollars are left in the dark.

Anonymous said...

The state new damn well what they were getting into. Not only did they go into this operation, the state was the ones that aproached the private investors. After they aproached them, they went to their customers and told them of the available program. They also gave them a list of people offering the service if their current provider wouldn't. Now they think they cantake all the money and leave their business partners nothing. Doesn't a partnership mean the people share both profits AND losses?