Report 2019-112 Recommendation 4 Responses

Report 2019-112: California State Lottery: The Lottery Has Not Ensured That It Maximizes Funding for Education (Release Date: February 2020)

Recommendation #4 To: Lottery Commission, California State

To adhere to the Lottery Act's education funding requirements, beginning with fiscal year 2020-21, the Lottery Commission should require its staff to demonstrate that they have planned for education funding to be maximized and aligned with the proportionality requirement of the Lottery Act, and approve only those budgets that plan for such funding. It should then monitor actual education funding and ensure that it complies with the requirement.

Annual Follow-Up Agency Response From October 2023

The Lottery continues to prioritize its statutory mission of maximizing contributions to education, rather than attempting to meet the conflicting proportionality requirement.

California State Auditor's Assessment of Annual Follow-Up Status: Will Not Implement

As we noted in our report, state law requires the Lottery to increase its funding to education in proportion to its increases in net revenues. If the Lottery believes that meeting this requirement is unrealistic and unworkable, it should inform the Legislature that it cannot meet this requirement and seek to amend the law. We stand by our conclusions and recommendations about what the Lottery Act currently requires and how the Legislature should clarify it to ensure that the Lottery meets the intent of the 2010 amendments to the Act.

Annual Follow-Up Agency Response From October 2022

As noted in previous responses, implementing the CSA's recommendation would require the Lottery to intentionally halt sales of higher-priced Scratchers games, which would result in less funding to education. Unlike the Lottery Act's proportionality requirement, for which elements of the language are open to interpretation, providing less funding for education by purposely reducing sales clearly runs contrary to the mission of the Lottery as codified in the Lottery Act.

California State Auditor's Assessment of Annual Follow-Up Status: Will Not Implement

As we noted in our report, state law requires the Lottery to increase its funding to education in proportion to its increases in net revenues. If the Lottery believes that meeting this requirement is unrealistic and unworkable, it should inform the Legislature that it cannot meet this requirement and seek to amend the law. We stand by our conclusions and recommendations about what the Lottery Act currently requires and how the Legislature should clarify it to ensure that the Lottery meets the intent of the 2010 amendments to the Act.

Annual Follow-Up Agency Response From October 2021

As noted in our August 2020 response, in order to implement the CSA's recommendation, the Lottery would have to intentionally reduce sales by withdrawing higher-priced Scratchers games, which would result in less funding to education - and runs counter to the mission of the Lottery as codified in the Lottery Act.

California State Auditor's Assessment of Annual Follow-Up Status: Will Not Implement

As we noted in our report, state law requires the Lottery to increase its funding to education in proportion to its increases in net revenues. If the Lottery believes that meeting this requirement is unrealistic and unworkable, it should inform the Legislature that it cannot meet this requirement and seek to amend the law. We stand by our conclusions and recommendations about what the Lottery Act currently requires and how the Legislature should clarify it to ensure the Lottery meets the intent of the 2010 amendments to the Act.

1-Year Agency Response

The Lottery Act's proportionality requirement can run counter to its requirement to maximize funding for education. Encina Advisors, LLC, with whom the Lottery contracted for its most recent optimal prize payout rate study, succinctly confirmed this conflict in not being able to achieve proportionality while prize payouts are below optimal levels. Specifically, they noted in their analysis that growing funding for education in proportion to net revenues (which as defined by the State Auditor) "cannot happen by definition as well as by design: increasing prize payout rates from 50 percent to the optimum necessarily means that prizes consume an increasing proportion of total sales growth and contributions to education consume a decreasing proportion of total sales growth, all while contributions to education still grow in absolute terms. Thus, instituting a proportionality requirement would prevent the Lottery from maximizing contributions to education by preventing it from increasing prize payout rates to the 65 to 67 percent range." Encina Advisors' analysis goes on to state that "While it is understandable that the California State Auditor would have concerns over maximizing contributions to education and desire a simple rule with which to evaluate these contributions, we strongly disagree with the Auditor's conclusions and recommendations for a codified proportionality requirement. Setting such a standard would be unrealistic and would be unworkable for the Lottery to meet." The Lottery will therefore continue to strive for proportionality in growth between net revenues and funding for education while prioritizing the maximization of absolute dollars it provides to education.

California State Auditor's Assessment of 1-Year Status: Will Not Implement

As we noted in our report, state law requires the Lottery to increase its funding to education in proportion to its increases in net revenues. If the Lottery believes that meeting this requirement is unrealistic and unworkable, it should inform the Legislature that it cannot meet this requirement and seek to amend the law. We stand by our conclusions and recommendations about what the Lottery Act currently requires and how the Legislature should clarify it to ensure the Lottery meets the intent of the 2010 amendments to the Act.

6-Month Agency Response

Although the Lottery strived for strict proportionality in the growth of sales revenues and profits to education in developing its 2020-21 fiscal year budget, the approved budget doesn't fully achieve this goal. The department's mission, as set forth in the Lottery Act, is to maximize supplemental funding for education. If the Lottery were to prioritize strict proportionality over maximizing funds to education, the Lottery would have to intentionally reduce the sales of instant games in the current fiscal year, and public education would consequently receive less funding from the Lottery. For the four consecutive fiscal years leading up to the 2010 Lottery Act changes that allowed for increased prize payout flexibility, total Lottery sales and profits to public education were declining. In response, over the last decade, the Lottery used the prize flexibility afforded by the 2010 changes to spend more money on prizes to generate more sales and more profits for education. The Lottery's experience has shown that, as higher-priced Scratchers games have been introduced, more sales have been generated, and, more importantly, more funding for education has also been generated. While the Lottery experiences higher profit margins on lower-priced Scratchers games, higher-priced Scratchers games have proven to be very popular with consumers, and generate much of the Lottery's profits for education. Lottery profits for education have grown by nearly 80% in the last 10 years in large part because of increased sales resulting from higher prize Scratchers games. As a result of offering these higher prizes which have increased sales, total Lottery sales revenues have grown over the last decade to be disproportionate to profits for education. To achieve strict proportionality in the growth of sales revenues and profits to education, the Lottery would have to intentionally reduce sales by withdrawing higher-priced Scratchers games, which would result in less funding to education.

California State Auditor's Assessment of 6-Month Status: No Action Taken

We recommended that the Lottery Commission should require its staff to demonstrate that they have planned for education funding to be maximized and aligned with the proportionality requirement of the Lottery Act, and approve only those budgets that plan for such funding. However, the Lottery's response indicated that it has not done so. In fact, our review of the budget Lottery staff submitted to the Lottery Commission for 2020-21 shows that it planned for its sales to increase by almost 7 percent while its planned contribution to education increased by only 3 percent.

60-Day Agency Response

The Lottery is currently in the process of developing its Fiscal Year 2020-21 budget to maximize funds to education, which has always been the Lottery's primary objective, as required by the Lottery Act. The Lottery will also strive for proportionality between projected revenues and contributions to education in building its 2020-21 budget.

California State Auditor's Assessment of 60-Day Status: Pending

All Recommendations in 2019-112

Agency responses received are posted verbatim.