New Research on Dedicated Taxes

Earlier this week, George Crowley and Adam Hoffer published new Mercatus research on dedicated tax revenues in the states. The practice of dedicating tax revenues to a specific purpose is popular among both politicians and voters. Dedicating new taxes to a specific program gives the illusion of fiscal discipline by making it appear as if the new revenue is not contributing to the overall growth of government.

As an example, policymakers may implement a cigarette tax dedicated to funding public health programs. On the surface, such a program appears to achieve many laudable goals. It could curb smoking rates and improve health without a big increase in the size of government or increasing the tax burden for nonsmokers.

As Crowley and Hoffer demonstrate, though, dedicated tax revenues don’t actually go to the programs they are said to support. Say that a policymaker implements a 1% tax on cars to fund bike lanes and that this tax generates $1 million in revenue. Without the tax, the state would have spent $5 million on bike lanes. Without violating any budget laws, the state could spend, say, $5.1 million on bike lanes under the new tax and then spend the rest of the “dedicated” revenue on whatever programs they like.

The practice is perhaps easier to see at the household level. Governments can give low-income food stamps, as a subsidy “dedicated” to food. If a household gets $100 in food stamps per week, it’s easy to sell the program as providing $100 of additional food per week. This is an inaccurate way to look at it though. Without the subsidy, the household will spend some money on food, say $80 on food per week. With the subsidy, they now spend an extra $20 on food and have $80 left over for other goods. At the state level and the household level, this effect takes place because money is fungible. Specific dollars cannot be dedicated to specific uses.

Crowley and Hoffer’s research is important because the revenue from dedicated taxes is difficult to follow. Policymakers can take advantage of this characteristic to mask the growth of state government. Crowley and Hoffer suggest that voters should seek to ban the practice of earmarking tax revenues for specific programs to make the growth of state governments more transparent.