Study Questions Fiscal Earmarking

IT sounds like a good idea. A state needs more cash for schools, human services, or aid to local governments. But legislators and voters are reluctant to raise taxes.

So someone proposes earmarking specific revenues - part of the state income tax, sales tax, gasoline tax, or lottery earnings - to support the desired program. Proponents say that if voters can see exactly how their tax money is spent, they will be more likely to support a tax increase. They also say earmarking guarantees a stable income to popular programs.

But it often doesn't work that way, according to a study on state tax-earmarking for the National Council of State Legislatures.

``The arguments in favor of earmarking tend to be of limited application to the real world of state taxes and budgets, or to be limited in scope,'' says the report, which surveyed 45 states. ``The arguments against earmarking are more powerful.''

Practice on the upswing

Earmarking is nothing new. In fact, it was once a far more popular practice among state governments than it is now, says the study, ``Earmarking State Taxes.'' In 1954, 51 percent of state tax collections were earmarked, compared with only 23 percent in 1988.

But the practice is still widespread, and the study concludes its popularity may be increasing.

Almost every state earmarks its gasoline tax for highways and transportation programs. Twenty-two states dedicate part of their alcoholic beverage tax for aid to local governments, while 13 set aside part of the state sales tax for this purpose. Education is another popular recipient of dedicated taxes.

Earmarking is most popular in Alabama, which dedicates 89 percent of tax collections, and Montana, which dedicates 72 percent of tax revenues. On the bottom of the scale, Rhode Island earmarks only 5 percent of its tax income.

Proponents of earmarking say:

It reinforces the principle that those who receive a favor from the state should pay for it.

It ensures a minimum level of support and stable funding for specific programs.

It stabilizes state finances.

It can mobilize support for new taxes or tax hikes.

The study finds, however, that few earmarked state taxes actually do link the beneficiary and the payment. Some that do are fees such as highway tolls or state university tuitions. In special cases, such as in Maryland and Oklahoma, which earmark revenues to pay off bond issues, dedicating taxes does provide steady funding. But ``earmarking funds for operating expenses is another matter,'' the report says.

The study also argues that instead of offering stability to state finances, earmarking instead adds rigidity, and ``can distort policy on the basis of decisions made in previous years.''

And instead of increasing funding for programs such as schools, cash-strapped lawmakers often take non-earmarked revenue away from a program at the same time the program gains the new dedicated funds. The program then ends up with the same level of funding, or sometimes even less than before.

``A key issue is the amount of revenue earmarked compared with the existing level of funding for the designated program,'' the report says.

A ``classic example'' of this, the study says, took place in Illinois, where a state lottery was created to increase education funding. The lottery brought in $524 million in fiscal 1988. But instead of state support for education increasing, funding from sources other than the lottery fell off.

Utah, New Jersey, and Michigan all set aside income tax or sales tax revenues for education, the report notes. ``In all three cases, however, a substantial amount of additional revenue from other taxes must be added to fund the school-aid program, so the earmarking does not necessarily increase the size of the program at all.''

In Colorado, voters approved a lottery in 1982 on condition that 50 percent of the net proceeds be used for developing parks and open spaces. Faced with severe fiscal problems, however, the legislature deducted an amount equal to the lottery revenues from its traditional appropriations to these programs, thus eliminating any funding increase.

Earmarking can also allow lawmakers to feel they adequately supported programs, even if actual funding has decreased. ``Such a perverse result is especially likely if the earmarked tax source grows at a relatively slow rate,'' the report says. ``It is far better for the designated program to receive revenue from a tax that grows at least as fast as inflation....''

Threat to budgeting

In a nutshell, the report says, ``earmarking prevents comprehensive budgeting'':

It ``hampers legislatures' budgetary control'' and ``infringes on the policymaking powers of the executive branch and the legislature'' by removing programs from the appropriations review process. This prevents lawmakers from weighing the relative merits or needs of the many programs competing for state funds. Earmarked programs get less legislative scrutiny than others, and ``past decisions to earmark revenue for a program may remain after the need for the program has changed.''

It ``distorts the distribution of funds among programs, since there is no necessary relationship between the amount a source produces and what it is used for.'' There is also usually no relationship between the amount of funds earmarked for a program and the amount the program actually needs.

It reduces state government's flexibility in managing revenue, making it harder to adapt to the changing economy. Earmarking also ``complicates revenue structures by requiring more elaborate accounting and cash-management procedures than otherwise would be necessary.''

Recent state ballot proposals, the report notes, indicate that earmarking may be on the upswing. But, it warns, ``earmarking is more likely to hamper than assist state budgetary design and management....''