Lotteries: The Regressive, Oppressive Tax

August 20, 2012 § 9 Comments

One of the top stories in the US this week was the Mega Millions Lottery.  This state sponsored lottery is the largest of its kind in the US.  It spans a collection of states and its jackpot increases with each week that yields no winner.  So, this week the jackpot exceeded $300 Million and every major media outlet picked this up as a major news Imagestory, showing the frenzy of ticket buying while publicizing this jackpot as an exciting chance for some lucky future winner(s).  Just two months ago the media frenzy was even more frenetic as the jackpot exceeded ½ $Billion.

Heart Breaking News

This phenomenon of government sponsored gambling is troubling for the future prospects of general societal health and overall economic conditions.  While defenders of the lottery will argue that it’s a voluntary tax, the real wealth redistribution that occurs with lotteries is regressive.  What this means is that lower economic classes pay a higher proportion into the tax and yield a lesser benefit.  So, while the state may yield significant revenues from their lottery systems, the net impact on the general population is detrimental.  The working poor, lower middle class, middle class and senior citizens make up the vast majority of ticket buyers; some spending more on lottery tickets than on essentials.  The impact is not just on the individuals who buy the tickets, but on the families they support.  Children go without enough food while a parent continues to hinge future dreams on a lottery jackpot.  ImageWhat’s most egregious is that the lotteries are state government sponsored institutions and media outlets fuel demand through coverage.  Every major network morning show including ABC, NBC, CBS, FOX, and CNN recently aired this story with anchors saying they got their ticket and how exciting this all is.  Really?!  Is that what our news outlets have been reduced to?!  They are clearly acting as a platform for hawking worthless paper that effectively serves to bilk the lower economic classes of our society.  This practice is not unlike other legal practices such as predatory lenders (payday loans, auto title loans), pawn brokers, and not so legal enterprises such as loan sharking. 

 

Special Interests Trumping Public Good

I recently met with a public administration consultant who has worked nearly 40 years as town manager for several towns in New England, in municipal banking; consulting municipalities on business operations, financial management and negotiations.  His stories are incredible – anecdotes of collective bargaining agreements with labor unions, political arm wrestling with councilmen (board selectmen) and outright corruption on permitting and development contracts.  In an effort to protect the innocent, I won’t mention any names or exact places.  One such story of corruption he recently shared with me involved the development of a Massachusetts casino on non-native American land.  Powerful developer interests and local government tax interests push new laws that reject previous statues to keep gambling only on Native American lands. 

 ImageThe motivation for political leadership to support casinos is perhaps obvious as it can lead to new net jobs and increased tax revenues.  As the US becomes increasingly tolerant of gambling and casino activities, it is now tolerating exceptions to previously established boundaries that had kept gambling establishments on the periphery of large population centers.  To see how accepted gambling has become, one needs only to turn on any of a number of cable networks to see televised gambling such as World of Poker televised as a sport on ESPN, replete with “stars”; or visit casinos on Native American land in or near most every metropolitan area.  In Arizona, the pitchman for a local Indian Casio is the broadcast announcer for the Arizona Diamondbacks. 

 

A Public Gambling Addiction

The damage that gambling causes to the economically weak in American society is growing.  Local and state governments with large budget shortfalls become increasingly desperate to find alternative revenue sources.  Not only have state governments created policy that encourages gambling and sponsored lotteries, but also has managed to influence our news outlets.  The result is an entire generation of citizens sees gambling and lottery dreams as part of the American dream.  Shots in the dark, needles in haystacks, pies in the sky fantasies have replaced messages to young citizens that education, hard work, ingenuity, and family commitments are values to pursue.

 It appears that other states are likely to copy the acts of Massachusetts and allow greater integration of gambling activities in common public places.  With greater access, public promotion and celebrity endorsements, the great division of wealth that already plagues US society will only increase.  The most vulnerable are children who are dependent on parents or other caretakers who indulge in lotteries and gambling.  Their suffering is real.  One in five American’s are impoverished.  State sponsored lotteries and gambling is an epidemic in the US and leadership continues to take the easy political path rather than deal with the harsh realities that such policies are having on future generations.

Underground Markets: A Macro Risk Factor or a Better Supply Chain Model?

January 17, 2012 § Leave a comment

Recently, I read through the latest World Economic Forum “Global Risks 2011”  report which is an initiative of the Risk Response Network.  It’s an impressive assessment of global risks produced in cooperation with Marsh & McLennan, Swiss Re, Wharton Center for Risk Management, University of Pennsylvania and Zurich Financial.  What is compelling about the report is it is not simply a survey result or a list ranking, rather it details and illustrates the interrelationships between risk areas; identifying the causes in an effort to identify points of intervention.  The report highlights response strategies and even proposes long term approaches.

As with any risk report, it has a tendency to feel alarmist, but its value and content cannot be dismissed and its emphasis on response is encouraging.  The two most significant risks the report identifies are relative to economic disparity and global governance.  The main point being that while we are achieving greater degrees of globalization and inherent connectedness, the benefits are narrowly spread with a small minority benefitting disproportionately.  Global governance is a key challenge as each country has differing ideas on how to promote sustainable, inclusive growth.

The Rise of the Informal Economy

The report goes on to highlight a number of risks including the “illegal economy”.  The illegal economy risk includes a cluster of risks: political stability of states, illicit trade, organized crime and corruption.  Specifically, the issue lies with the failure of global governance to manage the growing level of illegal trade activities.  In a recent book by Robert Neuwirth entitled, “Stealth of Nations: The Global Rise of the Informal Economy”, the author estimates that off-the-books business amounts to trillions of dollars of commerce and employs half of all the world’s workers.  If the underground markets were a single political entity, it’s roughly $10 trillion economy would trail only the US in total size.   Further, it’s thought to represent in the range of 7-10% of the global economy and it’s growing.  To be clear, underground markets are not only dealing in illegal substances, crime, prostitution or drugs.  It’s mostly dealing in legal products.  Some of the examples Mr. Neuwirth provide include:

  • Thousands of Africans head to China each year to buy cell phones, auto parts, and other products that they will import to their home countries through a clandestine global back channel.
  • Hundreds of Paraguayan merchants smuggle computers, electronics, and clothing across the border to Brazil.  
  • Scores of laid-off San Franciscans, working without any licenses, use Twitter to sell home-cooked foods.  
  • Dozens of major multinationals sell products through unregistered kiosks and street vendors around the world.

A Global Risk?

Are the underground markets really a global macro-economic risk?  Mr. Neuwirth makes solid arguments that these markets provide jobs and goods that are essential to these populations and that it is the corrupt authorities in most developing countries that are being worked around.  In some ways, it can be argued that these unlicensed vendors and importers are the purest of capitalists; innovatively providing goods by avoiding intervention.  In a recent interview in WIRED magazine, Mr. Neuwirth points out that Procter & Gamble, Unilever, Colgate-Palmolive and other consumer products companies are selling through small unregistered, unlicensed stores in parts of the developing world.   He goes on to point out that P&G’s sales in these unlicensed market’s make up the greatest percentage of the company’s sales worldwide.  I found this tidbit shocking.  Really, a company that brings in over $80 Billion in revenue a year is actually pulling in most of its revenue through unlicensed channels?  Now, that doesn’t mean P&G is directly selling through those channels, but they sell through distributors that may use others that do sell through to unlicensed vendors who don’t pay taxes.

The WEF concludes that illicit trade has a major effect on fragile country states given that the high value of commerce and resulting high loss of tax revenues impinge on national salaries and government budgets.  An example that’s included in the report is that of Kyrgyzstan.  “Members of the Forum’s Global Agenda Councils argue that the undermining of state leadership and economic growth by corrupt officials and organized crime contributed significantly to social tensions which erupted in violent conflict in June 2010, causing widespread destruction, hundreds of civilian deaths and the displacement of 400,000 ethnic Uzbeks.” 

The Threat to Quality and Public Safety

So, if you were guess what type of goods top the list of sales that take place in these underground markets, what would you guess? Cocaine? Opium? Software Piracy? Cigarettes smuggling? Small arms?  Topping the list with a rough estimate of $200 billion in value is counterfeit pharmaceutical drugs.  Just behind at $190 billion is prostitution.   Which leads me to the next serious risk issue if global efforts don’t improve to govern these markets: quality.  I’m not qualified to address the quality of prostitution, but let’s consider the quality of counterfeit pharmaceuticals and the general issue of public safety.  If these markets go unregulated and unmonitored, we are likely to see terrible abuse by profiteers whose only concern is to bring high value products to market quickly.  No regulation also means an inability to create safe work environments and to protect rights of laborers all along the supply chain.

On the other hand, the vast majority of workers and consumers in developing countries thrive because of these markets.  A strong effort to disrupt or disband these markets would cause a high degree of distress in communities that rely on these markets for access to essential goods.  But in return, without tax revenue that can only be gathered from legitimate, licensed businesses can governments function and provide oversight services that would benefit quality and public safety concerns.  It’s an endless loop as we say in the software world; a true catch-22.   Even relatively well functioning supply chain operations at pharmaceutical companies in developed countries are consistently challenged to maintain a high degree of quality (note recent impact of product recalls at Novartis).  Considering how much effort and money is spent on quality assurance, inspections, and FDA audits on legitimate pharmaceuticals, it’s beyond scary to consider the quality of counterfeit pharmaceuticals that are circulating in illicit markets.

Within the US, in the state of California, we’ve seen recent evidence of solutions such as bringing the trade of marijuana within the framework of the law.  Potential results include ensuring quality and safety for the public, raising tax revenue and reducing the profits of organized crime.  Still, the issue of economic disparity is a much tougher nut to crack.  Widening gaps in income within all economies provide incentive for lower income individuals to work outside of established trade structures.  This incentive leads to greater illicit trade which in turn hinders a government’s ability to effectively tax businesses and provide services such as regulatory oversight. 

Can We Govern Illicit Markets?  And If So, Should We?

These are obviously very difficult challenges, but ones that the WEF is analyzing in an effort to form solutions.  The relationships between economic disparity, illicit commercial trade, public safety and government corruption becomes glaringly clear.  How can the global community govern these illicit markets?  They exist everywhere to some degree, even in the US where informal markets are estimated to account for 10-20% of GDP.  One solution that WEF recommends is to strengthen financial systems.  The implication is that weakened systems are the result of the heightened volatility and risk deriving from the recent capital markets crisis.  With diminished confidence comes incentive to work outside the system.  Some suggestions include:

  • Better surveillance of the financial sector, including all systemically relevant players
  • Tighter capital and liquidity ratios for all banking institutions (including non-banks), with higher ratios for systemically relevant institutions
  • Risk retention for securitization (so-called “skin in the game”)
  • Improved transparency and counterparty risk management in “over-the-counter” derivative markets

Perhaps the most interesting part of this global risk challenge is how interrelated these issues are.  The influence that government corruption has on illicit markets is direct, but not the only factor.  Further, the ability of governments to regulate, control and tax this commerce is not straight-forward and overly severe policies can prove detrimental to workers and consumers.  And how much do other factors such as financial stability contribute to activity moving outside conventional channels?  There is no certain view on these underground markets as we must consider why they exist, for whom they exist and how valuable they are for the good of all.

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