Opinion & Commentary
They’re Taxing Goodwill
Although Australian governments still rely overwhelmingly on general taxation, specific purpose levies (‘earmarked’ or ‘hypothecated’ taxes) have multiplied in recent years at federal, state and local levels. There is a place for earmarked taxes in public finance, but the way they have been used in Australia smacks more of political opportunism than principled fiscal policy.
As well as the Medicare levy, which was introduced in 1984, we have the aircraft noise levy, the passenger movement charge, the wool tax, the milk levy, the sugar levy, fire services and emergency services levies, parking space levies, infrastructure levies, various environment levies, a health benefit levy, health insurance levies, and so on. We have had the gun buy-back levy and the Ansett levy, and almost had a Timor levy.
It would not be surprising to see governments resort further to this technique, particularly when budgets tighten.
In principle, by making the link between taxing and spending more transparent, earmarking can better inform taxpayers of the cost of government programs, lead to more rational fiscal choices and allow a more efficient allocation of resources. There is even a view among public finance theorists that if all or most government spending were to be financed through earmarking, not only would the composition of public spending be more in line with voters’ preferences, but overall tax and spending would be more disciplined.
However the conditions for earmarking to have these benefits are demanding and rarely found in practice. The earmarked tax (which may be a separate tax or a fixed portion of a broad tax) needs to be quarantined from other revenue, be applied exclusively to the expenditure program for which it is earmarked, and fully fund (but nor over-fund) that program.
Governments usually don’t like earmarking in this strong form because it restricts their flexibility. When used, it tends to be applied narrowly as user-pays or beneficiary-pays taxation, such as various agricultural levies, the passenger movement charge and fire services levies, among others. By replicating the price mechanism, earmarked taxes of this kind can promote efficient resource allocation. Even then, however, the concept is sometimes misused either because those paying the tax are not the beneficiaries, or the tax over- or under-funds the expenditure.
But governments’ aversion to strong earmarking hasn’t stopped them from using weak forms of it such as levies on broad-based taxes for specific purposes. It is this type of earmarking that offends most strongly against sound public finance principles. Because the revenue covers only part of its stated purpose, it conveys no useful program cost information to taxpayers. Taxpayers are in fact deluded because the fungibility of money makes weak earmarking meaningless; governments determine their expenditure on each program by allocating resources from consolidated revenue, not from a portion of one tax. Governments tend to cherry-pick the more popular targets for earmarking, such as health, the environment and infrastructure. And earmarking facilitates incremental budgeting by taking pressure off governments to find savings in existing budgets to fund new initiatives.
The Medicare levy is a good example of the misuse of earmarking and its reform should be included in any future personal income tax reform. The levy is accepted because of the popularity of the program, but the levy is independent of how much is actually spent on Medicare; in fact the levy covers only a small fraction of the cost of Medicare.
Every time you hear governments say that they are increasing a general tax for a specific purpose, chances are the earmarking concept is being misused. Just this year, we’ve seen the Queensland government increase motor vehicle stamp duty by $200 million a year ostensibly to fund mental health services and the Victorian government increase the tax on gaming machines by $39 million a year supposedly for the benefit of the state’s hospital system. The targets are popular, but the tax increases do not determine how much is spent on them.
It is often said that the art of taxing is to pluck the goose with a minimum of hissing. If so, governments have tended to use earmarking as a way of minimising the hissing. But taxpayers should be deeply skeptical and on their guard against the misuse of earmarking; it often amounts to the same thing as a general tax increase. If, say, an “education levy” or a “Save the Murray-Darling levy” is ever proposed, don’t be conned into thinking that it is anything other than an increase in general taxation.
Robert Carling is a Senior Fellow at The Centre for Independent Studies. This article is based on his new paper Tax Earmarking: Is It Good Practice?
