Most state lotteries are clean, but some corruption is seeping in

Corruption. If there's anything that could squelch the states' booming lottery business, that's it. Lottery operators all over the United States still recall the ignoble events of April 24, 1980 -- a day of shame in the lottery game.

The Pennsylvania lottery was holding its regular draw of the daily 3-digit number that evening. Thousands of people were watching on TV as numbered Ping-Pong balls were chosen, supposedly at random, by air-blowing machines. Riding on the outcome was about $1 million, a typical day's bet in 1980.

Security at the TV studio in Pittsburgh was lax. A lottery official was there to make sure no one tampered with the machines. There was also a retired person in the studio -- a symbolic gesture, since profits from the Pennsylvania lottery go to the elderly. But the atmosphere at the station was casual, and the machines were left unattended for periods of as long as 15 minutes.

Several people, including a TV host, knew of the loose security. On that evening, these people planned to take advantage of it, and win big.

Before the drawing, a part-time stagehand at the station used a hypodermic syringe to inject a substitute set of balls with white latex paint. (He first tried baby powder, but that didn't work.) Every ball except those numbered 4 and 6 was filled with the paint. When the studio was empty, another stagehand quickly entered, removed the good balls, and put the doctored balls into the lottery machines.

Meanwhile, two other members of the conspiracy, motoring around Pittsburgh in a white Cadillac, had gone from store to store buying up $10,000 in lottery tickets, all with various combinations of the numbers 4 and 6.

At 7 p.m., the cameras were turned on and the drawing began. Viewers saw first a 6 pop to the top; then another 6; then another 6.

The day's number, 666. The conspirators had won $1.18 million.

Ironically, it was other criminals who blew the whistle on the conspirators. In addition to their bets on the state lottery, the conspirators had also put some bets on 666 with illegal bookmakers. The bookies in Pittsburgh use the state lottery number in their own illegal numbers racket. Sensing something was wrong with the state drawing, the bookies refused to pay off on 666 and triggered an official investigation. Eventually, two of the conspirators were sentenced to prison, and four turned state's evidence.

The Pittsburgh TV caper was an exception. Most state lotteries have so far maintained a clean record since New Hampshire began the first modern-day state lottery in the mid-1960s. Drawings are honest. Monies are carefully accounted for. Payoffs are made promptly to winners. Profits are turned over to the states. Expenses are kept within bounds.

There are, however, some areas that have concerned investigators. These include:

Questionable use by lotteries of the United States mails.

Tax dodging by lottery winners.

Use of state lotteries by the illegal numbers racket and other criminals.

Each of those bears watching, experts say.

Last month, for example, US postal officials ordered six state lotteries to stop violating federal mailing laws. The Postal Service charged that the states were illegally using the mails to take bets across state lines -- an action that was outlawed in the 19th century when Congress became incensed over the corrupt Louisiana Lottery.

The states that received warnings were Maryland, New Hampshire, Michigan, New York, Rhode Island, and Massachusetts.

Maryland lottery director Martin M. Puncke, who is also president of the North American Association of State Lotteries, concedes there is cross-border use of the mails. Maryland, for example, has many customers who bet by mail from Florida, which has no lottery. Maryland sells about $180,000 tickets a week this way.

Says Mr. Puncke: ``If you want to get real technical and get explicit as to what we can and cannot do, we should not be doing it.''

But he argues that precedent is on his side. This practice of using the mails has been going on for years. He continues:

``I want the business. It's partially illegal, but it's not illegal. So you're sitting right on the line.''

After being warned, New York State appears to have stopped using the mails for cross-border betting. Postal lawyers have told the others that legal action will be taken if they don't also abide by the rules quickly.

Another area of concern involves tax cheating by lottery winners.

All lottery winnings are taxable. But cheating is easy, especially for small winnings. Here's why.

Uncle Sam groups lottery winnings into three categories:

Over $5,000. Large winnings are automatically reported to the federal government, which immediately takes a 20 percent deduction.

$600 to $5,000. Winnings of this size trigger an automatic Form 1099G to the Internal Revenue Service (IRS). This makes it hard to escape your taxes.

Under $600. No report goes to the IRS on these winnings, even though most winnings in the lotteries fall into this category. While these individual winnings might seem small, they add up to more than $1 billion a year.

In Maryland, Puncke says, almost no one pays federal taxes on winnings under $600. ``It's just a normal reaction,'' he says.

Further, bettors know how to avoid taxes. If someone wants to bet $5 on Number 287, for example, the payoff would be $2,500 -- and that would require a report to the IRS. But gamblers know that five separate $1 bets on the same number would not result in a report to the IRS because it would pay off five separate $500 prizes, none of which would meet the reporting threshold.

If a bettor tries to put $5 on a single bet, says Puncke, Maryland Lottery clerks would probably warn them of the IRS reporting requirements and show them how to avoid it. In his words:

``Any clerk who is selling you tickets will ask you, `Do you really want to play $5 on Pick 3? Because if you win, you are in IRS. If you play five $1 tickets, you are not in IRS.' ''

Another Maryland lottery official says: ``It's a smart move. . . . They [the bettors] are well educated on how to avoid getting themselves involved with the IRS.''

If Uncle Sam wanted to collect on all these winnings, the answer is simple: just require a 1099G on all winnings.

Finally, there is the very sensitive question of whether criminal elements are making use of state lotteries.

Federal investigators say this is happening in several ways.

Numbers rackets are using the official state numbers drawn on TV as their own. In other words, illegal bookies will take bets on today's state number. If a person bets 6-7-8 with a bookie, for example, and that number is picked in the official state drawing, the bookie will pay off, usually at 600 to 1.

Since the state payoff is only 500 to 1, there is an incentive to go with the bookie. The availability of an official state number, however, actually increases confidence in the illegal rackets because it reduces the possibility of cheating.

Law enforcement officers also note that state lotteries act unwittingly as the ``bank'' for the illegal rackets. For example, sometimes bookies get too many bets on a single number, such as 1-2-3, or 7-7-7, or 9-9-9 -- numbers which readily come to mind when people bet.

Bookies realize there is a danger in this. Since a large number of people bet these numbers, a bookie could go broke if a popular number ``hits.''

To reduce the risk, bookies take money from these popular numbers and ``lay it off'' with the state lotteries. In other words, they take a certain amount of money that has been bet on 1-2-3, for example, and bet that money with the state. Thus, if a popular number hits, it is the state lotteries, not the bookies, who get hurt. The state lotteries therefore act as a kind of ``insurance company'' for the illegal numbers rackets, law enforcement officials say.

Bookies are not the only ones apparently using state lotteries for nefarious purposes. A few weeks ago, federal agents swooped down on a money-laundering scheme in Puerto Rico. They discovered that drug smugglers were using lottery tickets to hide large amounts of drug profits. Smugglers were buying up winning tickets in the Puerto Rican lottery. When questioned about where they were getting large sums of money, they planned to say: ``We won it in the lottery.''

There are no easy answers to such illegal uses of the lotteries. These are what experts call the unavoidable byproducts of putting state governments into the gambling business.

Sixth of eight articles. Next: Would a national lottery reduce the federal deficit?