California Lottery Debate

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SAN FRANCISCO — California can reap more by issuing bonds backed by lottery revenues than it can by leasing out the lottery, according to an analysis prepared by the office of state Treasurer Bill Lockyer. The treasurer’s office released the analysis last week, to fulfill a request from the lawmaker who chairs the committee that oversees the California lottery.The lottery’s future has been a subject of discussion since May, when Gov. Arnold Schwarzenegger announced that his administration would look into a plan to lease out the state lottery through a concession agreement, in which investors would provide the state with up-front cash in return for rights to operate the lottery.The Republican governor first floated the idea of a public-private lottery partnership as a standalone proposal. A few months later, he merged the lottery privatization proposal with an administration initiative to provide universal health insurance coverage for Californians, saying that money gained through a lottery concession could be used to seed a trust fund to help pay for the costs of his universal insurance plan.Lockyer, a Democrat, responded to the governor’s initial lottery proposal in May by suggesting that the state could get a better deal simply by keeping the lottery under its control and bonding against its revenues — following the path blazed by Florida, Oregon, and West Virginia, all of which have lottery revenue bond programs.Lockyer’s office followed up on that argument last week by releasing the results of an analysis comparing the governor’s lottery lease proposal for health care financing with the option of using lottery revenue bonds to finance the same program.“In summary, our analysis shows that selling lottery revenue bonds could provide more money for health care over a longer period of time than the proposed lease option,” deputy treasurer Paul Rosenstiel said in the letter to state Sen. Dean Florez, D-Shafter, chairman of the Senate Governmental Organizational Committee.

Florez has been publicly skeptical of the governor’s lottery lease proposals.Rosenstiel, in the letter, said the treasurer’s office asked three investment banks, Banc of America Securities LLC, JPMorgan, and Merrill Lynch & Co., to estimate the amount of money lottery bonds could make available for health care over 40 years.The governor’s health care plan projected that a private company would pay $37 billion up front for a 40-year lottery lease; $6.4 billion would be used to redeem the state’s outstanding economic recovery bonds, issued in 2004 to finance the state’s deficit, and the balance would fund a health care endowment, minus $600,000 for transaction costs.For purposes of comparison, Rosenstiel said, the analysis used many of the assumptions put forward in the governor’s health care proposal.They include voter approval of provisions to give the lottery greater management flexibility, increasing per-capita lottery revenues to the national average within 10 years; voter repeal of the present requirement that lottery profits go to schools, presumably in a trade for revenue from another source; that bonds are issued for 40 years, for comparison to the 40-year lease; that bonds would redeem all outstanding deficit bonds; and that other bond proceeds and lottery revenues be directed to an endowment, which would earn 8% annually.The scenario presumes that the state can issue tax-exempt debt to retire its deficit bonds, while taxable debt would be issued to fund the endowment.“Not surprisingly, all lottery bond scenarios provide more health care funding than the lease proposal,” Rosenstiel wrote. “This is primarily because the interest rate on the bonds is lower than the interest rate at which the private lessor will raise debt and equity capital to make the up-front lease payment to the state.”While the governor’s plan projects that a lottery lease would raise $30 billion for a health care fund, after paying off the state deficit bonds, Rosenstiel said three scenarios prepared by different investment banks project that the use of lottery revenue bonds would provide between $30.7 billion and $37.2 billion for health care — in present-value funds, and after paying off the deficit bonds.The governor’s proposal would finance 22 years of full funding for his health care plan and one year of partial funding, according to Rosenstiel’s letter. The three investment banks’ lottery scenarios would provide between 17 and 30 years of full funding, but all of them project at least partial funding for the full 40 years, because of ongoing lottery revenues that wouldn’t be used to back debt service.Most of the differences stem from interest rate assumptions on the taxable bonds, and the timing of bond issuances, the letter said.“We don’t have a specific reaction, because we haven’t seen all the details behind the different scenarios,” H.D. Palmer, a spokesman for the Schwarzenegger administration, said yesterday.“The fact that there is a continued dialogue about the benefits of leasing the lottery is a positive sign, and we hope to continue these discussions with the Legislature next year,” he said.At this juncture, the fate of Schwarzenegger’s health care plan is unclear. It has come under fire from both the left and the right, who say it doesn’t go far enough, or goes too far, respectively.Voter approval would be needed during 2008, even if the governor comes to terms with lawmakers on a plan, something that seems to be slipping farther away as 2007’s days dwindle.Health care reform or no health care reform, a plan to monetize the lottery may well be on the table during 2008, simply because it offers money at a time when the state is staring down a projected $10 billion shortfall heading into fiscal 2009.Political analyst David McCuan, a Sonoma State University political science professor, is all but certain that a lottery lease will be part of the governor’s fiscal 2009 budget proposal, due in about a month.“I assume that it’s practically a done deal,” he said. “They’re trying to figure out some way to make lemonade out of all this, and there aren’t many things in the state budget that allow you to do that.”Schwarzenegger has signaled that he intends to focus on public-private transportation partnerships next year, and the idea of a lottery concession would fit in with that.The irony, according to McCuan, is that a lottery lease may make it even harder for Schwarzenegger to pass a budget come the summer of 2008 because his fellow Republicans would view it as another one-time solution to the state’s persistent structural budget problems. The rule that a two-thirds vote is needed to pass a budget gave the minority Republicans leverage they used to obtain spending cuts after stalling the budget for weeks during the summer, and there is no reason not to expect a repeat next year, when the deficit is expected to be much bigger, McCuan said.“Leasing the lottery today, and having it pass relatively easily because there’s no political resistance, makes it more difficult to pass a budget in August,” he said. “[Senate Republicans] will see him as a spendthrift unable to make tough decisions.”

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