Dedicating Tax Revenue: Constraining Government or Masking Its Growth?
Evidence shows that tax revenues dedicated to politically popular expenditures like education or highways are used to increase general fund revenues and overall government size rather than for the intended purpose. Dedicated, or “earmarked” tax revenues, are generally ineffective in increasing expenditures for the program they are tied to, and they successfully increase total government spending.
Earmarking tax revenue is a budgetary practice that involves dedicating a percentage of the tax revenue from a specific source to a specific expenditure. Empirical studies have found evidence that while some portion on dedicated tax revenue does stick to its intended target, the majority goes elsewhere.
The fundamental issue with earmarking tax revenue is its fungibility. This means that additional earmarked revenue dedicated to a specific expenditure can be used as a substitute for previous funding that had been coming from the general fund. The money’s fungibility provides policy makers with a way to increase government size without highly unpopular increases in rates on general fund taxation sources. Should the tax increase they propose be approved, the earmarked revenues may be used in place of previously used general fund revenues, allowing these funds to be spent elsewhere. The result is no net effect on the target expenditure and an increase in total government size.
After examining data from 49 states, the results indicate that the majority of dedicated revenues fail to increase spending in their target expenditure category. These same earmarks, however, are quite effective at increasing spending on other expenditure categories.
To illustrate, let’s say a state government spends $100 from the general fund on education. The legislature passes a special sales tax on the basis of its revenue being set aside for education spending. Further, suppose this new tax brings in $50 in revenue. Although you may assume education spending will increase to $150, policy makers actually have the option to decrease spending on education out of the general fund. Even if the $50 earmarked for education spending is actually spent on education, total education expenditures may remain unchanged if the legislature decides to decrease general fund spending on education from $100 to $50. This allows them to spend $50 of revenue previously for education on another project, education spending remains the same as before, and the earmark is functionally equivalent to a $50 increase in unspecified general fund revenue.
To that end, the study investigates whether earmarked revenues are used for their intended purposes and whether overall spending and spending on categories other than the intended destination increase as the amount of earmarked revenues grows.
The table above shows that in general, earmarking is not an effective method of increasing expenditures on specific programs, and typically some (or all) of the increase in revenue dedicated to a program is compensated for by associated decreases in spending from the general fund. Of the 15 earmarks explored, only tobacco tax revenue and personal income tax revenue earmarked to education and sales tax revenue and vehicle registration revenue earmarked to local governments unambiguously led to increases in expenditures on the targeted category. In some cases, the earmarks had a negative effect on spending in the targeted category. In nearly every case where an earmark failed to stick to its targeted expenditure, nontargeted spending increased.