Estimating the Effect of Unearned Income on Labor Earnings, Savings, and Consumption: Evidence from a Survey of Lottery Players

Written By: Guido W. Imbens, Donald B. Rubin, and Bruce I. Sacerdote

Presented By: Sara Walcott

The Current Study Original survey of lottery players in

Massachusetts in the mid-1980s Analyze the effects of lottery prizes on

earnings, consumption, and savings Critical Assumption: Among the people

who win the lottery, the amount that a person wins is randomly assigned

The Main Issue: Income Effects It is extremely important for welfare policy

makers to understand the effects of income on economic behavior, particularly upon labor supply.

Would the receipt of welfare payments (additional unearned income) to certain groups of individuals cause them to work less or, in some cases, stop working completely?

Income Effect Estimation Issues Estimating the effects of unearned income is

difficult because instances of randomly assigned and exogenous changes in meaningful amounts of income are quite rare and hard to identify.

Researchers often end up assuming either spousal income or property income is exogenous and try to use that to estimate the effects of unearned income - obviously a problematic assumption.

Literature on Income Effects Model A: Use data from large, representative

surveys i.e. the Panel Study of Income Dynamics (PSID), the

National Longitudinal Survey (NLS), or the Current Population Survey (CPS)

Run into problems with finding exogenous measurements of unearned income in data

Often must use capital income or spousal income as previously mentioned

See John Pencavel (1986), Richard Blundell and Thomas MaCurdy (2000) and Mark Killingsworth and James Heckman (1986)

Literature Continued… Model B: Analyze experimental data with clearly

exogenous sources of unearned income 1970s Negative Income Tax experiments - selected

population received randomly assigned tax schedules

Limitations due to the duration of the supplement (3-5 years), the modest size of the amounts of income assigned, and problems with attrition in the sample over time.

Literature Continued… Model C: “Natural experiments” where large amounts

of money are allocated without regard for preferences and other determinants of economic behavior

Examples: Mordechai Kreinin (1961) and Michael Landsberger (1963)

- One-time war reparations payments to Israeli citizens Ronald Bodkin (1959) - One-time payments from US

government to selected service men post-WWII Douglas Holtz-Eakin et al. (1993) - Inheritances and their

effect on employment

Most Similar Previous Study H. Roy Kaplan (1985) analyzed a survey

of lottery winners, much like the authors of this study Shortcomings of Kaplan (1985): The data

collected only reflected changes in economic behavior immediately prior to and immediately after the subjects won the lottery and there were only limited controls introduced.

How This Study Addresses the Issues in the Previous Studies The randomization of the lottery provides an

exogenous source of unearned income, which is missing in the Model A literature and weaker in much of the Model C literature

The authors have six years of accurate post-lottery earnings data from the Social Security Administration, and the winners are on average 10 years into their 20 years of payments. This addresses the time constraint issues of the Model B studies and the Kaplan (1985) lottery study.

The Data Two Samples - “Winners” and “Non-Winners”

Winners population: People playing the Mass. Megabucks lottery in 1984 through 1988 and winning a major prize that is paid out in yearly installments over 20 years

• Total prizes in this sample range from $22,000 to $9,696,000 with a sample mean of $1,104,000 and a sample median of $635,000.

Non-Winners population: Mass. Megabucks lottery season ticket holders between 1984 and 1988 who have won at least one small, one-time prize ranging from $100 to $5,000.

Data Continued… The survey questionnaire included three sets of

questions Outcomes at the time of the survey Economic behavior and background characteristics at the

time of winning Earnings - the release of Social Security earnings records

for at least six years preceeding and six years following the time of winning

Authors analyzed the data of individuals who gave complete answers to questions relating to certain pre-lottery conditions and who authorized their earnings to be released. The sample consists of 259 non-winners and 237 winners.

Summary Statistics

Summary Stats Continued…

Specifications of Analysis Given a population of individuals with

Stone-Geary preferences who are maximizing utility over consumption and leisure, subject to an intertemporal budget constraint… Can write an expression for labor earnings as

a linear function of the yearly lottery prize

Specifications Continued… The above equation REQUIRES that within the

sample, the amount of money won is independent of all the other inputs to the economic decision-making process (i.e. wages, other unearned income, life span, and lifetime discounted discretionary income without the lottery winnings.

If this is true, then the error term is uncorrelated with the independent variable, and a least-squares estimator of the coefficient will be unbiased.

Specifications Continued… The authors also estimate regression

functions with additional covariates such as… As long as the added covariates are

independent of the given lottery prize, they can be included without introducing a bias into the equation, and their inclusion may correct some of the non-response bias.

Results: Coefficient Estimates

Notes on the Previous TableFor Average Post-Lottery Earnings… In specifications I-IV, the estimates do not change

very much, although they do become more precise. In specification V, it is shown that the skewed

distribution of prizes means that the few very large observations disproportionately affect the linear regression estimates.

Note that the winners only specification VI results are similar to those in I-IV and results from the specifications that exclude the big winners (VII and VIII) are closer to those in V.

Interactions With MPE Results

Notes on the Previous Table Estimate of MPE of .085 for those with zero earnings

in the year prior to winning the lottery is not significantly different from zero, but at least suggests no evidence of negative effects of the lottery payments on the labor supply of low earners.

Surprising to find no significant differences between MPE of men and women, even though in this sample men and women have substantially different labor market experiences.

Being close to retirement age (but not above) seems to have an effect on the MPE

Effects on Consumption & Savings

Notes on the Previous Table For car values, total or net, there is a small but

highly significant effect of lottery prize After winning the lottery, people appear to be

buying more expensive houses, especially the big winners, but they also finance them through correspondingly larger mortgages.

The authors’ preferred estimate of the marginal propensity to save out of unearned income is based on the sample without non-winners and big winners and is equal to 15.8% (5.6%).

Interactions with Savings Results

Notes on the Previous Table Men appear to be saving more out of their winnings

than women do. Surprising that there is no evidence to support the

idea that older people save less out of unearned income.

The closer someone is to the end of their lottery payments, the larger the marginal propensity to save. This pattern seems to be consistent with consumptions

smoothing - people make large expenditures when they first start receiving lottery payments and then save more as they get towards the end

The Authors’ Conclusions Find that for annual unearned income between

zero and $100,000, the MPE out of unearned income is around -11%. Robust against a variety of specifications and does

not differ much between men and women; however, the effect is stronger for those close to retirement age

Savings rate for unearned income is estimated at 16% and increases as a greater proportion of the prize has been received.

Critical Comments Greatest Issue: Although the authors present the

research as being fundamental to answering policy questions related to the effect of unearned income on labor supply, they never return to the discussion after presenting their data and results. Make no efforts to relate their results to policy issues

whatsoever after their introduction The only part of the paper that at all ties back to the

policy issue is one sentence that states that they found no evidence of negative effects of the lottery payments on the labor supply of low earners.

Critical Comments Continued… The sample is significantly different from

the CPS and may not be representative of the population policy makers are concerned with.

Critical Comments Continued… The authors do not actually measure hours of

labor and measurement earnings may not necessarily accurately reflect labor market participation. No way to know whether changes in earnings are

due to changes in number of hours worked or changes in wage or some combination of the two.

Earnings may not be able to really address the question of how unearned income affects labor market participation as it would relate to welfare policy issues and whether welfare payments discourage workforce participation.

Final Comments Although there is no direct evidence concerning the

difference in responses to lottery winnings versus other sources of unearned income (such as welfare), lottery winnings do provide the exogenous source of unearned income that researchers need in order to estimate the effects of unearned income on labor.

However, future studies need to be able to measure labor force participation directly and need to be focused on relating their studies more closely to welfare policy issues.