EARMARKED REVENUE. Revenues from a particular public revenue source, a tax or a user charge, which have been legally dedicated on a continuing basis in whole or in part to the finance of a specified public purpose. The dedication, known as hypothecation in the United Kingdom, may be constitutional or statutory, but the commitment extends beyond the life of a single annual appropriation process and normally is permanent.
Many governments specifically dedicate the proceeds of a particular revenue stream to a particular public purpose. For instance, 46 states earmark the proceeds from their motor fuel tax to the finance of their highways ( Gold et al. 1987, p. 11). By that earmarking of a benefitbased tax, the states are trying to divide the cost of providing those highways in rough proportion to use of those facilities, inasmuch as to use those highways normally involves the purchase of taxed motor fuel. In some sense, applying the tax to a complementary private good amounts to a synthetic price that must be paid for use of the public facility, but without the need to erect the special barriers that would allow direct charging for those public facilities. Other earmarking may involve prices directly charged for use, for example, park admission revenue dedicated to operation and maintenance of the recreation facility. The earmarked link between payment and use, where such a connection is feasible, would appear to be a logical extension of market principles to government action.
Much of the U.S. social insurance system, including Social Security, Medicare, and unemployment compensation, is financed by dedicated taxes, mostly on payrolls. This longstanding dedication is entrenched in the fiscal system and emerges from decisions to employ insurancelike logic to defend the early development of the system. Dedications outside social insurance-in other words, earmarks in the general budget system-involve much less money but, in practical terms, are more consistent with ideas of using earmarks as a tool in applying user pay principles to government finance.
Across the nation, states earmark less than one-quarter of their revenue, with motor fuel tax dedication to highway finance constituting a major portion of the total, but at least one state earmarks each of the major state taxes ( Gold et al. 1987). At the federal level, around 20 percent of revenue outside Social Security and Medicare is earmarked (U.S. General Accounting Office 1990). Some earmarks reflect an effort to accommodate the quasi-price logic, like that of the motor fuel tax linked to highway finance. Other earmarks reflect the exercise of political power in which an interest uses its clout to assure a revenue flow to a particular purpose for many fiscal cycles, as with a California referendum which guaranteed a particular portion of state spending for education. And other dedications may result from a desire to make a politically difficult activity more acceptable. For instance, there is no clear link between state lottery profits and the earmarked programs they often support-primary and secondary education or economic development; because the revenues are used in an attractive way, ethical dilemmas about state support for gambling are overcome.
There is considerable dispute about the political and economic advisability of earmarking. Proponents make three major points in support of earmarking. First, earmarking can make part of government operate more like a business in regard to responding to public demands for service. A benefit-related tax or charge levied on users of a service with those revenues dedicated to provision of that service makes agencies react to market forces. When the agency provides what the public wants, it will have the resources for its operations. If the agency gets out of touch with its clients, its revenue base will decline. The agency thus has a real interest in serving the public, regardless of what the independent ideas of the bureaucracy might be. Rather than convince agency heads and legislatures of what the citizenry ought to want, a standard bureaucratic practice, the operation has to respond to what the citizenry actually wants and, more importantly, will pay for through the dedicated revenue base. Revenue flows show the nature of public preferences and the government need not speculate about or try to interpret what the public really wants; the quasi-market data from earmarked revenue provide the signals for supply of government services. In order for this system to provide meaningful signals, however, there must be close complementarity between what is being taxed and the public service being provided. Otherwise, dedicated revenue flows provide no information about demand for service. In other words, dedicating motor fuel taxes for highways may give demand information; dedicating a portion of individual income tax revenue to a similar use would not.
Second, earmarking may thaw political resistance to higher taxes by showing the citizenry exactly how the proposed new revenue will be used. If the voters are skeptical about government in general, possibly believing that services are provided inefficiently or that government is simply too big, they will not be sympathetic to additional taxes. If, however, the new revenue source is tied to a particular service to be delivered to the public and the service will be delivered only if the new revenue source is approved, the new revenue may be approved. This linkage is consistent with ideas about the contractual nature of democratic government ( Wagner 1991).