BASED ON YOUR INTERPRETATION OF THE TEXT THAT FOLLOWS, DETERMINE IF THE DECLARATION IS RIGHT OR WRONG.
SECOND TEXT
Paying for Public Spending: Is There a Role for Earmarked Taxes?
(Abridged version of Margaret Wilkinson’s “Paying for Public Spending: Is There a Role for Earmarked Taxes?” Fiscal Studies (1994) vol. 15, nº 4, pp. 119-35, adapted for the Exam).
Tax earmarking, or hypothecation, refers to the assigning of receipts either from a single tax base, or as a proportion from a wider pool of revenue, to a specific end use; it contrasts with general fund financing of expenditure from consolidated receipts. The idea has been seized on both by those who want to defend the public sector who think it would make taxation popular and by those who want to cut public spending who expect the opposite effect. Earmarking may be applied in a strong or substantive sense, or in a weak or nominal sense. In the strong case, revenue determines expenditure, or at least revenue must match expenditure, and there may be associated referendums on the amount of spending and the tax rate. In the weak case, earmarking is purely formal — undertaken to make the system more transparent and to inform the taxpayer of the cost of a service. Earmarking may also be wide, covering a whole spending program, or narrow, for a specific project within a program. The principal example of earmarking (nominal) in the UK today is National Insurance Contributions which go to the National Insurance Fund out of which contributory benefits are paid.
The idea of earmarking has made considerable progress among politicians. Supporters of earmarking who are on the Left or in the Center see it as a means of encouraging people to pay for better services (such as health and education). Those on the libertarian Right see it as demonstrating to voters the cost of state services and advancing opting out and privatization. A third view is that, whatever its outcome, earmarking would make for informed choices and more democracy. Finally, there are the skeptical who think that there should not be any greater role for earmarking than there is at present.
Attitudes to Public Spending and Taxation
A 1991 research on British Social Attitudes show that, in most areas of expenditure, people want more public spending. Even though the rubric warns ‘Remember if you say “much more”, it might require a tax increase to pay for it’, 90 per cent for health and around 80 per cent for education and pensions want ‘more’ or ‘much more’ spending. ‘The environment’ and police/law enforcement are also viewed favorably. Respondents are neutral on unemployment benefits, and only defense spending and the arts are seen as areas to be cut.
However, they do not expect to pay higher taxes. How the conflict is reconciled? The research also shows what people think about levels of taxation on different incomes, and in which income group they place themselves. Fifty per cent of respondents thought that those in the high income group paid too little in taxes and, by implication, could pay more and fund desirable social expenditure. However, they found tax levels on those with middle and low incomes were about right or too high, and 96 per cent of respondents placed themselves in these income groups. Thus people think that those with ‘high incomes’ should pay more tax — but hardly anyone thinks that he or she has a high income. Given this situation, some politicians think that earmarking could make taxes less unpopular.
Traditional Public Finance
The traditional approach describes the allocative and distributive failures of the market, and the normative role of government in correcting those failures. Tax revenues from several sources are put into a single pot, a general fund, from which public services are provided. Equity
in raising taxes is judged by ability to pay rather than by the benefit criterion on which earmarking is based. In the orthodox account, the government is shown to act as an omniscient and benevolent institution, which improves on the market outcome and achieves an efficient
allocation of resources. Traditional theory employs the device of a ‘social welfare function’ which guides an independent decision-taking budgetary authority. Critics of this account argue that in this approach, ‘the government’ is a black box into which voter preferences are fed and from which outcomes, which are claimed to be welfare-maximizing, emerge.
Traditional theorists take a pragmatic view of earmarking (Musgrave and Musgrave, 1989, and Rivlin, 1989), or ignore it entirely (Kay and King, 1990), or are skeptical (Dilnot, 1993). Musgrave and Musgrave admit that earmarking introduces rigidities into the budgetary procedure, but support strong earmarking where particular taxes are like charges on the consumer; they cite US gasoline taxes. In the most recent edition of their classic text, they allow that formal, information-giving earmarking may also have a part to play in the fiscal system. Rivlin finds earmarking reduces resistance to paying taxes; she points to the fact that there was no backlash to the 1983 US federal gasoline tax increase which ‘paid to fix roads’, nor to the repeated increases in US payroll taxes which fund social security. In Britain, Hills, of London School of Economics, supports earmarking as a measure to promote greater democracy (Hills, 1993). However, most traditional thinking on taxation rejects a large role for earmarked taxes.
The OECD definition of a tax appears to rule it out: ‘the term taxes is confined to compulsory, unrequited payments to general government’ (OECD, 1988). Orthodox public finance theorists argue that public spending should be determined by policy decisions, not by the amount of revenue raised by an earmarked tax. They point out that earmarking reduces the flexibility of the fiscal system: the yield of a tax and the revenue necessary for a service may at the start coincide, but over time, excess revenues may accumulate under some heads while there are deficiencies elsewhere. Dilnot (1993) shows Britain’s principal earmarked tax does not determine the amount of spending on the programs they pay for. He points out that in the early 1980s, when high unemployment cut that tax revenue, the tax rate was raised; in the boom of the late 1980s, as receipts rose, the subsidy to the National Insurance Fund from general taxation was cut; and in the recession of the 1990s, the subsidy was increased. In his view, ‘any further hypothecated taxes would principally be an exercise in deceiving voters that their tax payments controlled government spending in a way, which they simply will not’. However, he comments that more hypothecation might make it possible to raise more revenue, but remark that this would be on the basis of deluding taxpayers rather than increasing their choices over tax and spending decisions.
The Public Choice School
The theoretical base that libertarians refer to is the public choice school, which grew up in the 1950s and 1960s. The social welfare function has no place in the public choice model where the state is not ‘an independent choosing agent’, but ‘exists only as a means through which individuals combine to accomplish collective or jointly desired objectives’ (Buchanan, 1963). The public choice school contends that market failure is not corrected at zero cost. As well as market failure, there is government failure, which arises through the self-interested behavior of politicians and bureaucrats. The growth of the public sector is not a response to the demands of citizens, but a burden imposed by a powerful government bureaucracy. To restrain public spending, mechanisms to give more power to the citizen are necessary. Earmarked taxation is one of these mechanisms. Buchanan’s seminal paper on earmarked taxation (Buchanan, 1963) argued that financing public services from a general fund allowed the citizen to vote only on the aggregate level of public services, whereas earmarking allowed the voter/taxpayer/beneficiary ‘to participate separately, either directly or through his representative, in the several public expenditure decisions which may arise’. Thus voters could make ‘private’ choices on each public service by comparing their costs with their benefits. At the bottom line, earmarking represents a return to the benefit approach to equity in taxation.
An Unorthodox Approach
In a pamphlet, Reconnecting Taxation (1993), Mulgan and Murray contend that fundamental shifts in the nature of the economy and of society, which is now a ‘sophisticated, consumerist culture’, have made the old system unsustainable: the payment of taxes into a central pool out of which the state determines spending is too centralized, opaque and unresponsive. They base their arguments on ‘a tradition which works from the ground up’, which is suspicious of the state, and which ‘can be found in Jeffersonian liberalism, Catholic social thinking and in more recent years in feminist and green approaches to government’. They propose an alternative agenda, an important part of which is ‘to reconnect taxes and services, and to share sovereignty between elected representatives and citizens’. This reconnection will happen by hypothecating funds wherever possible. They propose ‘citizen choice’, rather than ‘top-down decision-making’. To make it work, they propose a ballot on a series of options which would give information on the annual cost of each option to the average taxpayer.
According to the text, in the traditional approach to public finance
Item 1 - equity in raising taxes is judged by the ability to pay as well as the benefit criterion.
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