Someone in a small Florida town has the winning ticket for the largest Powerball jackpot in history—nearly $600 million. The prize has reignited the debate over lotteries, which produce much-needed revenue for state governments by encouraging, as critics argue, a form of gambling. At ThinkProgress, Bryce Covert argues that lotteries amount to a regressive tax, as poor people are more likely to purchase tickets than wealthier citizens:

[Poor people] spend a larger percentage of their income on the lottery, and many studies of state lotteries have found that low-income Americans account for most of the sales and that sales are highest in the poorest areas. One study found that a reason for this is that “lotteries set off a vicious cycle that not only exploits low-income individuals’ desires to escape poverty but also directly prevents them from improving upon their financial situations.” The loss in income of buying tickets that provide no reward is harder to bear on a slim budget.

Covert offers the standard explanation for lottery ticket purchases among the poor -- the cost of the ticket seems to be a small price to pay for the possible chance to "escape poverty." In a chapter for our book, Insufficient Funds, however, economists Sendhil Mullainathan and Eldar Shafir suggest that the reality may be more complicated:

Calls for increasing financial literacy have grown louder recently, as the soaring costs of health care and education, high unemployment, and the effects of the Great Recession all converge to strain the budgets of governments, businesses, and individuals. Many agree that financial education benefit those who participate, but the results have been underwhelming. According to a recent column in The Economist, not only is financial literacy a major stumbling block for most people, but interest in—and success in teaching—financial education is incredibly low, regardless of age or life circumstances. Last September, the SEC released its own report on financial literacy among Americans, and its results of which were fairly discouraging. Some argue that the main problem is the ability to engage students in the material, but as we’ve written before, the problem may be more fundamental than that.

In their paper “Misunderstanding Savings Growth,” published in the RSF-funded Journal of Marketing Research, Craig McKenzie and Michael Liersch argue that the failure to begin saving early for retirement—or to reach retirement savings goals—comes down not just to a lack of financial knowledge, but also to gross misunderstandings of how savings grow over time. Conventional economic wisdom holds that people are able to “[calculate] future values and [make] trade-offs with present values.” However, through a series of experiments, McKenzie and Liersch notice that not only do people systematically underestimate how much retirement savings grow exponentially, but that understanding how compound interest works doesn’t always help to motivate them to save earlier.

In fact, what helps the most in motivating people to save is demonstrating the effects of exponential growth. Offered a graphical representation of how compound returns accumulate over time (see below), participants were markedly better able to determine whether early saving would prove beneficial over the course of a career. Not only that, but they were better able to think their way out of the fallacy that saving twice as much later might yield the same returns at the point of retirement. This finding was successful without any interventions that told participants explicitly what compound interest was or how it could be calculated. Interestingly, this approach increased motivation in participants at different stages of their careers. McKenzie and Liersch did experiments with undergraduate students as well as employees at a Fortune 100 company, and found that workers’ reactions to exponential savings growth were similar to those of the undergraduate sample. As the authors point out, this finding indicates that it isn’t an understanding of compound interest that motivates people, but demonstrations of its effects over time.