There’s been an interesting idea floating around for a while that seems to finally be coming to fruition here in the United States: savings account lotteries. You may also hear them called “prize-linked savings accounts”.
I first heard mention of the idea from Freakonomics a few years back. Apparently this idea has been around and in practice for over 50 years now in various other countries and has had a profound impact on increasing the number of people who save. The idea is pretty simple: instead of buying lottery tickets and hoping for a big win, people deposit money into savings accounts or CDs and occasional lottery winners are drawn from the depositors. It offers a sort of no-lose proposition.
In a traditional lottery people pay for a chance at a big prize (or prizes), but the overwhelming majority of people lose their initial investment. In a prize-linked, or lottery, savings account – if you don’t win the jackpot you still have guaranteed savings in a bank. It operates on the principle of distributing interest payments in a very lopsided manner, whereas a typical bank account would guarantee some small interest rate to all depositors – the lottery version would instead give large returns back to a small set of depositors. The brilliant idea here is that the “losers” don’t actually lose their deposit, they effectively just forfeit some of their interest gains to the lottery pool. The easiest way to organize this is to require a set deposit into a shorter term CD, say $25 in a 12-month CD. Each $25 gives the depositor a single “ticket” or entry. Winners are drawn based on those entries. People wishing to cash in the CD early are hit with early withdrawal fees (like any CD), possibly at a higher rate to more effectively discourage simply entering for the contest and then withdrawing.
It’s a great win-win idea for increasing the savings participation rate across the country, but up until recently it’s been illegal in the United States. That’s right, the no-lose lottery idea was (and in the majority of the country still is) illegal. So why is this illegal if it increases the savings rate of citizens and still satisfies the desire for a “big prize” lottery?
The desire and demand for lotteries like this have existed throughout history. In fact, the demand is so strong that it currently draw tens of billions of dollars in revenues every single year in the United States alone. In 2009, eleven states collected more revenue from lotteries than they did from their corporate income taxes!
That’s a giant cash cow. And as a result, the states are reticent to give up their monopoly on operating such a lottery. Thankfully, some states like Michigan are starting to loosen their grip on that monopoly to allow these forms of savings accounts. There are now six states that allow such a program, with plans to introduce bills to legalize this in New York. The interesting part is now to see how this impacts savings rates for residents, as well as the state-run lottery participation – and see if this idea spreads to more states quickly. It’s a much better system for lottery players since they retain their principal, but for non-lottery players this may actually result in higher taxes to offset the lost state lottery revenues.