RogerBW's Blog

Why Not Hypothecation? 28 September 2018

A perenially tempting idea in financial policy is hypothecation (or "earmarking"): dedicate the money raised from tax A to pay specifically for thing B, as distinct from putting all the revenue into a single account and using ongoing political processes to decide where it's spent. In the naïve household accounts model of national finances, this makes sense: the money I save from giving up smoking goes into the holiday fund. Why, in general, doesn't it get done at the national scale?

Note that these are the genuine non-cynical arguments. I'm sure you can work out the cynical ones for yourself.

  • You don't know how much money you'll get. If something has sales of £1m a year and you put a 10% tax on those sales, you won't get £100,000: people will modify their behaviour, reducing their consumption of the thing. (Indeed, that's one of the points of having a tax policy in the first place.) You have an estimate, which if it's within 10% will be a pretty good one.

  • You don't have the money yet. Tax revenue will dribble in over time, more around March as things get settled up, but there are still fines and late fees and all sorts of other complications that can delay the availability of actual money (as well as producing more uncertainty as to how much there'll be).

  • Taxation isn't free. There will be costs associated with collecting the tax; if "all the money" from a tax is meant to go to something else, should these costs be paid for out of that tax too? What limit do you consider acceptable?

  • You probably won't get the right amount of money. Maybe it will be too little, in which case the linking of tax to spending is a token gesture because the expenditure needs to be topped up from the central fund anyway; maybe it will be too much, and the money will be used less efficiently than it might be as the recipients line their pockets. And both supply and demand will change over time. (If you try to change the tax rate to fit the spending requirement, you're working with numbers that have somewhere between a 3 and 12 month lag from what's actually happening now, and you don't necessarily know what that lag is.)

  • When policy priorities change, you can't readily alter the amount of spending on thing B. And if thing B has come to rely specifically on tax A, you can't easily reduce the tax even if you have plenty of money available from other sources.

Tags: economics

  1. Posted by Dr Bob at 11:00am on 28 September 2018

    I know virtually nothing about tax, so does the 'dribble in over time' mean that the government gets more dosh from self-employed people and companies waiting until March to do their annual tax returns than it does from all the folks who get paid a regular monthly/weekly wage? Or the companies which do their tax several times a year.

  2. Posted by Chris at 12:59pm on 28 September 2018

    I go on having a small quiet thought which goes: "why not wait until you actually have money before you spend it?" I know that this is amazingly old-fashioned and we have all been taught for years that being in debt is a thoroughly good idea rather then a source of shame; but any "naïve" housewife before the last forty or fifty years who ran her household in a welter of unpaid bills would have found she could no longer get credit from her grocer after a month or so. Banks used not to offer credit cards, and a single unpaid bill would cut off your supply from that source, quite possibly not just for a week or a month but forever: a "bad debtor". You (gasp) had to save up for a new carpet or clothes, not just put them on your card or hire-purchase and then hope for the best unless you were what used to be called "feckless".

    An awful lot of misery during the past forty or so years has been caused by debt: individuals being encouraged to borrow more money than they can pay back and finding suddenly that there is no money to pay for food and heat; companies borrowing in order to increase in size and then finding that they are not making enough to stay out of receivership, so that their employees through no fault of their own are out of work; banks borrowing more than they lend, buying "against the expectation" and collapsing, with the resulting financial chaos; countries "running a deficit" (which to me means "borrowing in order to spend more than they actually have or even expect to have"), selling off every asset that they can in order to pay the immediate expenses until they have nothing left (and their citizens are paying over the odds to private profiteering companies for their heating and their lighting and their healthcare and their transport and the water they drink) and then finding that the IMF will no longer lend them money except with crippling conditions attached, in attempting to meet which the people (but not on the whole the ones who created the mess) die of cold and hunger or kill themselves in despair.

    When the entire economy is based on hypothetical future-tense money then the problems you outline with hypothecation arise; if it were not, they would not, because there would be none of this "we don't know" about it; we would know, because we would have the money when we spent it -- rather than going through our lives thinking maybe we will have this or that in the future but we can by god grab the other thing now and hope in a vague way that something will happen which means we won't have to pay for it at all, or only in dribs and drabs over a few years so that the fact it is costing us twice as much really doesn't bite so hard.

    There is nothing now to be done about this, because the habits of debt have become ingrained at every level from the individual upwards.

  3. Posted by RogerBW at 09:37am on 29 September 2018

    Dr Bob: usually not, since there's no interest if you pay on time. But they might get £600 all in March rather than £150 every three months and therefore not be able to rely on it.

    Chris: I think that's something of a side issue, though I take your point. You could I suppose take in all the money from say vehicle excise duty for a year, count it, and then decide whether to spend it all on the roads; but taking it in and leaving it to sit for a while is wasteful, because a government can't effectively earn interest - and even if it did, a few per cent. of interest would be less effective in terms of economic gain than spending it a well-chosen project that would be of benefit to lots of people.

    Of course governments often choose projects poorly, as well as being subject to the perverse incentives of accounting rules (which is why PFI persists despite being terrible value and every government promising to stop using it).

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