The Cash Advance of Prop 1C

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Perhaps no operation of state government has been sized up for reform more in recent years than the California Lottery.

Lease it... sell it... remove the existing restrictions... all have been discussed in hopes of getting higher profits out of a lottery that's more than two decades old and, in the eyes of many, not making as much money as it should.

In two weeks, voters will be asked to approve a relatively mild tweak to the California Lottery, but one worth major bucks to the state budget. This morning on The California Report, we examined the proposal at the heart of Proposition 1C.

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Prop 1C, if approved by voters, would make a simple but landmark shift in the state-operated lottery created by voters in 1984: the removal of public schools as the sole benefactor.

There's hardly a person involved in government who hasn't been asked countless times why the lottery doesn't provide more help for schools. After all, that's the way it's been promoted all of these years. But as we reported in a series of stories last summer, the California Lottery is different from every other lottery in the nation, because the original 1984 ballot initiative enshrined a rigid formula that mandates the percentage of profits going to schools. That formula may have sounded good 25 years ago; but it limits how much money is left over for jackpots. And smaller jackpots don't usually draw as many players... or profits.

Prop 1C severs the lottery's relationship with K-12 and community colleges. And here's why: the lottery's profits need to be fully available to the Wall Street investors who the state will ask for an advance on future profits.

David Crane, the governor's top economic adviser, is adamant that such a process not be called borrowing... even though it's $5 billion the state would receive now, and would pay back over time. So why isn't it borrowing?

"If those revenues don't arise, there's no obligation by the state to repay," says Crane. He's right, though it would be hard to imagine that state lawmakers would want to anger Wall Street investors if the lottery couldn't cover its bet.

The $5 billion cash advance is technically a "securitization," not unlike California's decision to accelerate its long-term payment from a nationwide tobacco lawsuit to help balance budgets earlier this decade. These days, the securitization market isn't what it was before the current Wall Street chaos; and the securitization of subprime mortgages has been widely crtiticized for its part in the resulting collapse.

Crane says securitizations have been unfairly maligned as the "bogeyman" of the economic meltdown. "As a principle," he says, "it's what created a massive credit market for the sorts of things that people use daily."

Both Crane and the nonpartisan Legislative Analyst's Office think there is enough current lottery revenue to cover a $5 billion securitization, plus have some possibly left over for other state budget needs (depending on the length of the payback). But it's important to note that nowhere in Prop 1C is the 'cash advance' limited to $5 billion; that's just the number contained in the February budget agreement. The ballot measure also gives the Legislature and state officials the OK to securitize future revenues more than just once -- thus opening the door for future budget solutions in addition to a $5 billion effort next fiscal year.

So what happens to schools? Here's where Prop 1C could end up being another of those 'good now, bad later' budget gimmicks that have become so commonplace in California. To keep K-12 education and community colleges happy, Prop 1C adds an amount equal to the lottery's existing education contribution -- about $1 billion -- into the complicated Proposition 98 school funding system.

And that $1 billion will grow larger -- and do so faster -- under Prop 98's complicated formula than it would have as lottery revenue. In other words: the state may very well be required to spend more on education in the future than it would if the lottery stays the same.

LAO analyst Jason Dickerson says that extra cost could run in the hundreds of millions of dollars. "That several hundred million dollar difference," he says, "would be dollars that future legislators would have to find in the budget."

Finally, it's worth noting that the passage of Prop 1C would probably create a profound change in the way that those inside the state Capitol view -- and keep tabs on -- the inner workings of the California Lottery. With its revenues historically small and earmarked for public schools, lawmakers haven't always paid close attention to lottery leadership or operations. But should those revenues become central to state budget negotiations, you can bet that will change.

After all, it wouldn't then just be the public wanting to know why lottery revenues weren't doing more, it would also be legislators and future governors... not to mention anxious investors on Wall Street.

[Note: Click on the icon below to hear part one of my original series on the California Lottery, heard on The California Report on July 28, 2008.]

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About John Myers

John Myers is senior editor of KQED's new multimedia California Politics & Government Desk.  He has covered California politics for most of the past two decades -- serving previously as Sacramento bureau chief for KQED News and, most recently, as political editor for KXTV News10 (ABC) in Sacramento. He moderated the only gubernatorial debate of 2014, and was named one of the nation's top statehouse reporters by The Washington Post. Follow him on Twitter @johnmyers.

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