A Tax on Stupidity?

Lotto Max with Encore

Topic: Human Interest

John C.A. Stevenson CFA

May 22, 2019

Image used with permission: iStock/RobMattingley


Print & Share

Print

A Tax on Stupidity?

The French philosopher, Voltaire, is reputed to have said that “lotteries are a tax on stupidity.” While it’s hard to find evidence that Voltaire actually said this, I’ve always loved the quote nonetheless.

Like going to the casino, if one analyzes the probability of success on the purchase of a lottery ticket the expected outcome is negative. Or so a self-styled rational being like me thinks. This simple view of the world was upset recently by a fascinating article in the Huffington Post that was brought to our attention by our friends at Northwood Family Office. It’s the story of Jerry and Marge Selbee.

It may surprise some, but lotteries have been around for centuries (as the sarcastic comment from Voltaire suggests). In Colonial America churches, universities and even government bodies sold lottery tickets as a means of generating revenue to pay for roads, schools, or the military. Despite the fact that most players understand that buying a lottery ticket is a “sucker’s bet”, the thrill of the game spurs them on, just as the slot machine does in a casino. As early as 1762, however, lawmakers in Pennsylvania noticed that poor people bought lottery tickets more frequently than the rich. It was apparent, even then, that in many ways the lottery was a tax on the poor.

Today, 44 U.S. states conduct lotteries that generate a staggering $80 billion in ticket sales. By comparison, the U.S. movie industry sells about $11 billion in movie tickets. Eleven states generate more revenue from lottery ticket sales than they do from corporate income tax. And the ugly truth of the lottery remains: it is a regressive form of taxation. Lower income households are disproportionately active lottery players. Yet it is easy for governments to generate revenue through lotteries, and the revenue is impossible to resist.

The story of Jerry and Marge Selbee, however, is that buying a lottery ticket is not necessarily a tax on stupidity. It turns out that in certain circumstances it can be financially rewarding.

Jerry Selbee was a Kellogg’s factory worker and, later, a convenience store owner who had a knack and passion for puzzles and math problems. In 2003, a new lottery in Michigan called “Winfall” caught his eye. It was a game where a player picked six numbers. If you got all six correct you won the jackpot, which was guaranteed at least to be $2 million. You got a lesser prize if you picked five, four, three or two of the numbers. If no one won the jackpot for a few draws then money available for the jackpot swelled. When it crossed the $5 million mark there was a “roll down” where, if no one picked the six correct numbers at the next draw, the payouts increased to those with five, four, three, or two of the correct numbers. What Jerry noticed was that in a roll down, the odds of winning changed dramatically. So long as no one hit the jackpot with six correct numbers in the roll down, playing the lottery in this special circumstance was not a “suckers bet”. It was an investment with a positive expected return! (See the article for more details.)

It took more than Jerry’s mathematical insight to push this story along. In order to benefit from the odds that were in their favour, Jerry and Marge needed to buy lottery tickets in large volume. A single ticket produced a random event. In fact, several statisticians had observed anomalies in various lottery formats in the past. But most were not interested in the grunt work that would be required to exploit it. In order to turn Jerry’s mathematical insight into profit, the effort Jerry and Marge put into their scheme was extraordinary.

At the end of their run, Jerry and Marge were going to separate convenience stores and spending 12 straight hours per day printing out $2 lottery tickets. They spent as much as $720,000 buying 360,000 individual tickets. After each lottery draw it took a full 10 days of 10 hours a day to sort through their tickets and figure out their winnings. But Jerry’s insight proved to be correct. The only time they didn’t profit was when another player claimed the jackpot with six correct numbers. When they stopped playing in 2012 they had grossed nearly $27 million over nine years, and netted $7.5 million before taxes.

The full Huffington Post article is long, but we think it is worth the read. The larger question to ponder is whether there was anything ethically wrong with what Jerry and Marge did? There is little evidence they harmed anyone. And as Jerry said, “if you figured it out and you could do it, would you do it?”

Jerry and Marge were brilliant rather than stupid, but their brilliance could only be rewarded through extraordinary effort. For most of us, lotteries and casinos must remain in the category of entertainment, with a cost attached to it. For reward, most will be better served by entrusting their excess funds with Nexus!

More Like This...

See another CRM2 blog post that may be of interest to you.

No posts found.

More Like This...

See another Foundations & Endowments blog post that may be of interest to you.

That Giving Feeling

Topic:
Foundations & Endowments, Tax Planning
Excerpt:
Summer is now a distant memory. In fact, a radio announcer declared only 77 days until Christmas. Ugh. It is usually in the last quarter of the year

More Like This...

See another Human Interest blog post that may be of interest to you.

What a World!

Topic:
Human Interest
Excerpt:
You don’t need to read a blog from your most trusted investment advisor to realize that 2020 might go down as one of the most notable and difficult

More Like This...

See another Inside Nexus blog post that may be of interest to you.

Swimming Naked

Topic:
Inside Nexus
Excerpt:
Warren Buffett has a wonderful line. “Only when the tide goes out do you discover who's been swimming naked.”

More Like This...

See another Investments blog post that may be of interest to you.

It’s a Topsy-Turvy Year: Investing During COVID

Topic:
Investments
Excerpt:
This year has been plenty weird. For starters, it feels like January was about five years ago… if you can remember it at all. Putting aside the health

More Like This...

See another Pearls of Wisdom blog post that may be of interest to you.

“Work, Work, Work, Work, Work, Work”

Topic:
Pearls of Wisdom
Excerpt:
This has been a busy year. I’ve had lots happening on the home front (a wedding!) and lots going on at the office (too long to list!) Managing work

More Like This...

See another Tax Planning blog post that may be of interest to you.

The (U.S.) Taxman Cometh

Topic:
Tax Planning
Excerpt:
Like the medical patient who expects to endure a fair bit of poking, probing and prodding from the doctor, clients of financial providers have had to

More Like This...

See another Wealth Planning blog post that may be of interest to you.

Estate Planning: Questions from our Virtual Chat

Topic:
Wealth Planning
Excerpt:
Helping clients with their estate planning is something we do here at Nexus. However, we are often involved in identifying the best tools for the

On a Side Note…

See another CRM2 Nexus Notes Quarterly article that may be of interest to you.

No posts found.

On a Side Note…

See another Foundations & Endowments Nexus Notes Quarterly article that may be of interest to you.

No posts found.

On a Side Note…

See another Human Interest Nexus Notes Quarterly article that may be of interest to you.

It’s About Time

Topic:
Human Interest
Excerpt:
Over the last 25 years, we have written frequently about time. In fact, in 2010, our annual client presentation carried the same title as this article

On a Side Note…

See another Inside Nexus Nexus Notes Quarterly article that may be of interest to you.

A Virtual Nexus Welcome

Topic:
Inside Nexus
Excerpt:
We are excited to welcome Preethi Khatri Chetri to Nexus.

On a Side Note…

See another Investments Nexus Notes Quarterly article that may be of interest to you.

Uncertainty… Who Needs It? Apparently, We Do.

Topic:
Investments
Excerpt:
It is not exactly a revelation to say that uncertainty contributes to stress. In “normal” times – take 2019, for example – three common sources of

On a Side Note…

See another Pearls of Wisdom Nexus Notes Quarterly article that may be of interest to you.

China’s Larger Role in the World; Immortality in a Test Tube

Topic:
Pearls of Wisdom
Excerpt:
Reading is one of the principal occupations in our profession. As we digest a wide range of material, interesting ideas and surprising facts – some

On a Side Note…

See another Tax Planning Nexus Notes Quarterly article that may be of interest to you.

The (U.S.) Taxman Cometh

Topic:
Tax Planning
Excerpt:
Like the medical patient who expects to endure a fair bit of poking, probing and prodding from the doctor, clients of financial providers have had to

On a Side Note…

See another Wealth Planning Nexus Notes Quarterly article that may be of interest to you.

From the Editor: Happy New *Planning* Year

Topic:
Wealth Planning
Excerpt:
As the weather cools and the leaves begin to change colour, it seems to me that fall is the more natural start of a new year compared to the start of