ECONOMIC ANALYSIS: Earmarking taxes in vogue, but is it good state policy?

February 12, 2007

I was taught economics, and in particular, the subject of public finance, by a faculty dominated by old Kennedy Democrats. A lot of that teaching has rubbed off or has simply been forgotten. Much of it also could be dismissed as idealism, a sort of ivory-tower thinking not relevant to the real world. Yet as I scan and digest the various tax proposals now in front of the Indiana General Assembly, several of those old lessons keep coming to my mind.

One is the amazingly simple-and sensible, to my thinking at least-principle that discussions about taxes and spending should be separated. We should spend public money on things we think are the most important, I was taught, and raise money through taxes to pay for those things in the least painful way.

When specific taxes are linked to specific programs, that doesn't usually happen. Important programs can be starved at the same time as less critical initiatives are awash with funds, due simply to the relative performance of their earmarked revenue base.

Roads and highways stand out as a critically important example of this situation. Last year, I wrote-in error-that Indiana motor fuel taxes devoted to highway spending rose along with the price of gasoline. In fact, they rise only when the gallons of gasoline we pump go up, and I thank those of you who pointed out my mistake.

But that just makes the inadequacy of the tax instrument we depend on to help preserve and expand our transportation infrastructure even more apparent. The whole discussion of Major Moves and privately funded toll roads-as well as the recent efforts by the Indiana Fiscal Policy Institute-call attention to the breakdown of the mechanical way we finance highways and other transportation needs.

Yet with each passing session, the linkages between spending and taxes grow stronger. The governor's call for an increased cigarette tax in past years never got off the ground. But now that those plans are linked to a spending initiative to provide health care coverage to children, they are on the way to becoming law. Privatization of the state lottery is joined at the hip with higher education support for both students and universities.

Likewise, the call by mayors and other local government officials for the freedom to raise local income and sales taxes wasn't setting the world on fire-but the recent proposal to specifically earmark 60 cents of every dollar raised toward property tax relief has given it new life. It's a plan with a lot of other details, but it does something legislators and those who vote for them apparently like, namely, a carrot to go with the stick.

Would my old teachers be appalled? Perhaps. But the evidence of elections in the wake of tax legislation is hard to ignore. It's more than voters simply not liking taxes. As IBJ columnist Abdul-Hakim Shabazz recently wrote, they don't like the taxers. Or more specifically, they don't trust their governments to spend their tax dollars according to their wishes. The earmarking of tax proceeds for specific purposes gives voters a sense of control that helps them swallow the discomfort of digging into their wallets and pocketbooks.

But is that control actually realized? As long as there is flexibility elsewhere in the budget, the purpose of earmarked revenue easily can be defeated. Taxes intended to provide added support to such popular causes as health care, education or transportation can be, and sometimes are, used to fill the holes left when funds once used for those purposes are diverted elsewhere. The result is that new revenue is effectively used for whatever the Legislature wishes to use it on.

So is this business of earmarking tax proceeds a sham or a real problem? In truth, it is a little of both. As long as voters continue to believe they can control spending priorities by supporting, or at least tolerating, tax increases, we will have more of these mechanical rules for spending revenue, and budgeting and public accounting will become more complex. And that in itself is a problem.

Barkey is an economist and director of economic and policy study at the College of Business, Ball State University. His column appears weekly. He can be reached by e-mail at pbarkey@ibj.com.
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