In 1984 California voters approved Proposition 37, also known as the California State Lottery Act of 1984 (Lottery Act), which established the California State Lottery (Lottery). According to the Lottery Act, the Lottery’s purpose is to provide additional money to benefit education without the imposition of additional or increased taxes. The Lottery Act specifies that the funding the Lottery provides to education will be used only to supplement the total amount of money allocated to public education in California. The Lottery Act prohibits the transfer, loan, or appropriation of state funds to the Lottery. Instead, the Lottery relies solely on the revenue generated from the sales of its games to fund its operations and make prize payouts.
The Lottery’s Mission and Organization
Consistent with its purpose as set forth in the Lottery Act, the Lottery states that its sole mission is to supplement funding for California’s public schools and colleges. State regulations authorize the Lottery to distribute and sell lottery tickets directly to the public. With the money it generates from ticket sales, it pays for its operational and administrative costs, makes prize payouts, and provides funding to education. The allocation of money the Lottery gives to education is governed by the Lottery Act. According to the Lottery, the State’s K–12 public schools have received the majority—about 80 percent—of the funding that it has provided to education. The remainder goes to the State’s community colleges, public universities, and specified educational programs. These funds, which supplement the State’s allocation, are a small portion of the State’s overall funding for education. In fiscal year 2017–18, the Lottery provided over $1.7 billion to education, which was about 1 percent of the State’s annual budget for public schools.
The Lottery Act also establishes the California State Lottery Commission (Lottery Commission), which consists of five members appointed by the Governor with the consent of the California Senate. The Lottery Commission is required to promote and ensure integrity, security, honesty, and fairness in the operation and administration of the Lottery. It is responsible for approving the Lottery’s budget and business plans. Moreover, the Lottery Act requires the Lottery Commission to promulgate regulations that specify the types of lottery games the Lottery can conduct and to establish a system for paying prizes. There have recently been changes in the Lottery’s leadership. Specifically, the Governor appointed the Lottery’s current executive director in June 2019, chief deputy director in July 2019, and chief legal counsel in August 2019.
Under the Lottery Act, the State Controller’s Office (SCO) is the primary entity responsible for oversight of the Lottery. The Lottery Act requires the SCO to conduct audits of the Lottery on all accounts and transactions and to perform any additional audits the SCO deems necessary. The Lottery Act generally exempts the Lottery’s operations from oversight by the Department of General Services (General Services) and Department of Finance (Finance). Further, provisions of the State’s Public Contract Code generally do not apply to the Lottery’s expenditures, and the Lottery is not subject to oversight by General Services for contracting services. Additionally, although the Lottery must provide informational reports on budget and revenue to Finance, the Lottery Commission, not Finance, approves the Lottery’s budget.
2010 Changes to the Lottery Act
In April 2010, the Legislature amended the Lottery Act and changed the requirements for how the Lottery must allocate its revenue. Those amendments took effect that same month. Before those amendments, the Lottery Act required the Lottery to provide at least 34 percent of its total annual revenue to education. However, over several years before the 2010 changes, the Lottery experienced declining revenues, along with declining funding for education. Specifically, between fiscal years 2005–06 and 2008–09, the Lottery’s revenues declined by $630 million and the Lottery’s funding for education decreased by $240 million. In changing the Lottery Act in 2010, the Legislature aimed to correct this trend and provide the maximum possible funding for education. The Legislature also declared that, according to the experience of other states, increases in the share of sales revenue allocated to prizes increased lottery ticket sales, which then increased the amount of funding available to the beneficiaries of those state lotteries. In summary, the changes moved the Lottery away from a strict required percentage of revenue to education. Instead, the changes allowed the Lottery to determine what percentage of its revenues should go to support education while meeting the requirement that the Lottery maximize funding for education. Figure 1 summarizes the changes the Legislature made to the Lottery Act’s funding allocation requirements. Also, in April 2010, the Legislature established that—beginning in fiscal year 2015–16—the Lottery was required to increase the amount it provides to education annually in proportion to the increases in its net revenues (proportionality requirement). For the purpose of the proportionality requirement, we have defined net revenue as the Lottery’s total sales revenue minus its administrative and operational expenses.
The SCO Was Required to Report on Whether
These Two Conditions Occurred:
- Total net revenue allocated to education was less than the amount the Lottery provided in fiscal year 2008–09.
- The annual average total net revenue allocated to education did not increase according to rates specified in the Lottery Act.
Source: The Lottery Act.
Further, the 2010 changes required the SCO to monitor and report on the Lottery’s performance for each of the first five fiscal years after the amendments took effect to determine whether two conditions were met, as the text box shows. The 2010 amendments to the Lottery Act established that if the SCO reported that the Lottery failed to meet both of these criteria, the Legislature’s 2010 amendments would automatically be repealed by operation of law. The SCO concluded in March 2016 that during the five‑year period the Lottery’s education funding did not grow according to the rates specified in the Lottery Act but that funding never declined below fiscal year 2008–09 levels. Therefore, the 2010 amendments became permanent when the SCO published its March 2016 report.
Lottery Spending Requirements Before and After Changes to State Law
Source: The Lottery Act.
* Lottery Act changed on April 8, 2010.
Since that time, questions have remained about whether the Lottery has done all it can to maximize the revenue it directs to education. Specifically, publicly available information shows a wide gap between the Lottery’s total revenue and the amount it annually provides to education. Members of the Legislature have questioned whether the Lottery has directed enough of its revenue to education in light of the fact that its total revenue and education funding have increasingly diverged since the 2010 amendments. The approaches the Lottery takes to maximizing education funding are the focus of this audit.