Earmark (finance)

The hypothecation of a tax (also known as the ring fencing or ear marking of a tax) is the dedication of the revenue from a specific tax for a particular expenditure purpose. This approach differs from the classical method according to which all government spending is done from a consolidated fund.

The history of hypothecated taxes goes way back. One of the first examples of earmarking was ‘Ship Money’ or in other words the tax paid by English seaports used to finance the Royal Navy. Later, in the 20th century, the hypothecated tax became to be discussed among the politicians in the United Kingdom. For example, the Vehicle Excise Duty from 1920 when earned revenues were used for the construction and maintenance of the roads, assigning 1p on the income tax directly to education in 1992 or giving £300 million per year from the revenues from taxes on the tobacco industry to help the fight against smoking-related diseases since 1999. Nowadays, earmarking of taxes is mainly connected to the health care system, education or the upkeep of the roads.

The hypothecated tax can be divided into three groups based on the main characteristics. The emphasis can be put on the final use of the revenues, on the vastness of the area financed from the money earned or on the type of the tax. Each group then has two subsections. In the first case, we distinguish between strong and weak hypothecation. Strong hypothecation means that the revenues from the tax go only to financing the particular service and the service is financed only through the revenues from this tax. Strong hypothecation is thought to be appropriate for pure public goods where voters must reveal their consumption preferences. If at least one of the two conditions is not met, we say that the hypothecation is weak. This distinction is the most common as many of the arguments for and against hypothecated tax are based on it.

Secondly, we differentiate between wide and narrow hypothecation. When the tax revenues finance the entire public service such as the health care, we talk about wide hypothecation. Narrow hypothecation means that only a specific area such as nursery education is funded.

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Wikipedia