Governor says billions could flow into system

Friday, May 11, 2007 posted 10:18 AM EDT

SACRAMENTO – Gov. Arnold Schwarzenegger's plan to turn the state lottery over to a private firm could yield about $15 billion, but a powerful teachers union, Indian gaming tribes and some legislators are skeptical.

The governor's aides said two investment banking firms, Goldman Sachs and Lehman Brothers, have submitted proposals to run the underperforming lottery. Several other firms and financial institutions also are interested.

The lottery is lagging because sales per capita are half that of the national average, and the number of lottery ticket outlets is below average, said Fred Klass of the state Department of Finance.

The private firms believe they could dramatically increase ticket sales for the lottery, created by a ballot initiative in 1984, and make a profit while generating more revenue for the state.

“Lotteries are not necessarily the core competency of government,” Kathleen Brown, a former state treasurer who now works for Goldman Sachs, said during a news conference yesterday.

Under Schwarzenegger's plan, the state would lease the lottery, not sell it outright. He emphasized that no decision has been made and he wants to move slowly and discuss the plan with legislative leaders and all of the groups that have a stake in the lottery.

“I think our lottery is not run in the most efficient way,” Schwarzenegger said. “I think we can do much better. I think we owe this to the taxpayers because it will mean more revenue for us.”

The governor, who has been struggling to close a chronic budget deficit, is scheduled to issue a revised state budget proposal Monday for the fiscal year beginning July 1.

H.D. Palmer, the governor's budget spokesman, said the new budget proposal will not assume that the state would get any additional revenue from leasing the lottery next fiscal year.

“Should it go through, we believe this transaction will have significant long-term impact to the state,” Palmer said.

The governor's aides declined to give a possible range of revenue from leasing the lottery, saying the amount would be determined by the structure of a proposal and market conditions.

A legislative aide said one of the concepts proposed is for a 40-year lease providing $21 billion to $22 billion to maintain the annual lottery payments to schools, leaving $14 billion to $15 billion for other purposes.

An initiative in 1984 that created the lottery was placed on the ballot by a firm, Scientific Games, that later won a contract to sell lottery-ticket equipment.

A selling point in the initiative has long annoyed educators.

Part of the revenue from the lottery goes to schools, and an early advertising slogan declared: “The schools win, too.” Educators say many Californians now mistakenly believe that the schools are well-funded with the help of the lottery.

In fact, the lottery is expected to provide about $1.1 billion for schools this year – a small part of a $60 billion total from state, local and federal sources. Per-student funding in California is below the national average.

The annual lottery report for fiscal year 2005-06 shows total ticket sales of $3.6 billion, prizes paid out at $1.9 billion, administrative expenses costing $413 million with schools receiving $1.3 billion.

“We have some serious concerns,” said Barbara Kerr, president of the California Teachers Association, starting with the fate of the 400 government employees who work for the lottery.

“Then the question is, will schools lose money over time?” Kerr said. “We don't want people to think that by doing this it's a fix for school funding. It is a minuscule part of school funding. And I doubt that the proposal is constitutional.”

A state senator who is chairman of a legislative committee overseeing the lottery, Dean Florez, D-Shafter, said a Legislative Counsel opinion he requested in February said that privatizing the lottery requires voter approval.

Klass of the state Finance Department disagreed, contending that the lottery initiative can be amended by a two-thirds vote of the Legislature.

He said one of the arguments for leasing the lottery is that annual payments to schools, which vary with ticket sales, could be stabilized under a long-term financial agreement.

Legislative leaders, who had not seen detailed proposals, reacted cautiously. A spokesman said Assembly Speaker Fabian Núñez, D-Los Angeles, thinks a lottery lease is “worth looking at.”

Senate President Pro Tempore Don Perata, D-Oakland, who opposed the lottery initiative because of the “risky” school funding provision, said of switching to a private operator: “I am agnostic on whether they do it or we do it.”

Senate Minority Leader Dick Ackerman, R-Tustin, who shares concerns about creating more misleading school-funding expectations, said private investment is a way to help solve some government problems.

“We encourage these public-private partnerships and would like to see it expanded to other programs,” Ackerman said.

Assemblyman Roger Niello of Fair Oaks, the top Republican on the budget committee, said spending one-time money requires care. A half dozen years ago, the state spent temporary tax revenue from a high-tech boom on ongoing programs and tax cuts, creating a chronic deficit when revenue returned to normal.

“That is really the crucial question: What would we use those funds for?” Niello said.

California has recently approved huge bond measures to improve infrastructure, particularly transportation, and Schwarzenegger is pushing for even more public-works bonds in coming elections. Critics have questioned whether the state can afford it all.

The lottery proposal appeared to catch the state's politically powerful gambling tribes off guard. The California Nations Indian Gaming Association, the state's dominant tribal lobby, reserved judgment until more is known. But tribal representatives were immediately wary.

All of California's gambling agreements, or compacts, attempt to guarantee the tribes a monopoly on Nevada-style games – conventional slot machines and house-banked card games such as blackjack.

If the state permits some commercial operation to offer the same games, tribes' exclusivity would be breached. In most cases, gaming tribes could then simply opt out of their compacts.

More recent compacts – those Schwarzenegger has negotiated since 2004 with many of the state's richest tribes – would cancel millions of dollars in annual payments to the state if commercial competition is permitted within broad areas outlined as a tribe's exclusive market.

“One of the reasons the lottery may be worth so much money to a private entity is that they would push the envelope on the games,” said Howard Dickstein, a leading tribal attorney.

He said the move almost certainly would require a public vote to amend the 1984 ballot measure that authorized only a state lottery, not one operated by a private entity.

“I think it could be seen as a Trojan horse to expand gaming and get a deep pocket private entity in there to start expanding and really transforming the state lottery into private, commercial gaming,” Dickstein warned.

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