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Is Earmarking the Best Way to Fund Projects?

It's not black and white, but understanding the pros and cons increases your chances of coming to the right answer for a particular project.

There are many issues in government management where things aren’t black and white, where gray is the color of the day. One particularly important field in which answers often live in the gray zone is in the funding of projects. Should they be financed with direct, designated flows of cash or is it better to have as many projects as possible use monies from the general fund?

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The former route—in which a project’s funds are dedicated, often from a special revenue stream—has the advantage of guaranteeing consistent funding. This so-called earmarked fund protects or buffers a program from the powerful wind of a changing political climate.

But before we go on, we need to address a semantic issue associated with the word “earmark.” At the federal level, earmarks are frequently associated with targeted dollars for specific programs that may benefit a political representative or his district or constituency. Generally, the funds are distributed outside of the regular competitive award or formulas that usually govern how money is distributed among the states. That’s why earmarks at the federal level have come to be identified with pork. “The practice is a form of ‘quid pro quo’ where one legislator obtains an extra helping of pork with the expectation of a return favor,” wrote Wiley Brooks, the Alaska director of Americans for Fair Taxation, in the Anchorage Daily News several years ago.

At the state and local level, we’re not talking about pork when we refer to earmarking funds for services that potentially benefit the population as a whole. It’s a financing tool rather than a political one, and it’s transparent.

There is nowhere that the state version of earmarking has been taken to as dramatic an extreme as Alabama, where the general fund makes up only about 16 percent of total state generated dollars. The majority of tax revenues flow into different earmarked pots, the largest one being for education, which automatically gets the state’s income and sales taxes. “If money isn’t protected, you’re very much exposed to getting it taken away from you,” says Jim Williams, executive director of the Public Affairs Research Council of Alabama.

There’s another potential benefit to providing dedicated funds to specific programs: It can sometimes be easier to get the citizenry to go along with funding an operation that it particularly cares about—rather than just sending a few more million bucks to city hall to use as the council wishes. This can even help to gather funding for some generally unsexy areas, like road maintenance, which are easily cut in bad times but which offer immediate benefits to taxpayers in the form of disappearing potholes and fewer accidents.

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On the other hand, the one-fund-fits-all approach gives managers and lawmakers far more financial flexibility. Both legislators and managers benefit from systems where funds can be moved to correspond with changing needs. “I can see the pluses [to dedicated funds],” says Maria Doulis, director of city studies at the Citizens Budget Commission in New York, “but it’s generally better to have flexibility in your budget. You don’t want to have all these separate pots of money. It doesn’t allow you to adjust to changing circumstances.”

In extremis, when an emergency funding shortage occurs, legislators may be forced to change a law if they can or subvert it by figuring out convoluted ways of diverting money. This is well recognized everywhere, including in Alabama. “If you want to fix something,” Williams says, “you can’t fix it honestly and objectively.” Instead, you’re forced to deal with problems as they arise in a piecemeal way.

One good example of the unintended side effects of dedicated funding comes from Louisiana, where a $1 billion trust fund was set up a decade ago that can only be used for nursing homes. Interest from the trust fund protects nursing homes from cuts in annual state funding. Good? Yes, to a point. But it also delayed the rebalancing of long-term care service—the shift from institutional care to home and community care—that has taken place more rapidly in other states.

Also in the gray zone, there are instances in which the lack of flexibility in dedicated revenue streams can accomplish the opposite of making sure there are enough dollars to run a program for years to come. The most recognized issue here falls in the realm of gas taxes. The idea that gas taxes should go directly to transportation needs may seem like a wonderfully justified way to make sure there’s always money in the bank.

But over the course of time, as vehicle miles driven decline and fuel efficiency improves, overreliance on gas taxes can be extremely painful to departments of transportation. As a December 2011 article from the Institute on Taxation and Economic Policy reads, “Thirty-six states levy only a fixed-rate tax that collects the same number of cents in tax, year after year, on every gallon of fuel purchased. But ... inflation has been eating away at these fixed-rate taxes as the price of asphalt, concrete and other transportation construction inputs continues to grow almost every year.”

Unfortunately, there’s no overridingly best practice here—no black or white. But understanding the pros and cons of both routes to funding holds out the hope of coming to the right answer for a particular project.

Caroline Cournoyer is GOVERNING's senior web editor.
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