Budget Rigidity and Earmarked Revenue

When government revenues are constitutionally or legally earmarked—dedicated in advance to specific programs—the government loses flexibility to rebalance spending in response to crises or economic shifts. This rigidity can force painful across-the-board cuts or prevent targeted relief.

What earmarking means

An earmark is a legal requirement (usually constitutional or statutory) that specifies which revenue stream funds which program. For example:

• Fuel taxes are earmarked for road maintenance and highway construction.
• Payroll taxes are earmarked for social insurance (pensions, disability).
• Property tax on vehicles goes to public transit.
• Sales tax on meals funds restaurant workers’ retraining.

In a purely discretionary system, the government collects all taxes into a general fund and appropriates money each year through a political process. Earmarks bypass this: the link between revenue and spending is set in law, and a portion of the budget is “untouchable” during routine appropriations debates.

Earmarks often feel legitimate—voters accept fuel taxes because they see the money go to roads, not subsidies or bureaucracy. They create political credibility: “This tax is not a blank check; it has a dedicated purpose.” But this same feature creates rigidity.

How rigidity constrains fiscal adjustment

When the economy weakens or a crisis strikes, governments must adjust spending. Normally, they can:

1. Cut lower-priority programs to fund urgent needs.
2. Shift resources to countercyclical spending (safety nets, stimulus).
3. Trim discretionary outlays across the board.

Earmarks prevent #1 and #2. If gasoline tax is constitutionally earmarked for roads, the government cannot redirect that revenue to emergency healthcare or unemployment insurance, even during a pandemic or financial collapse. Roads still get funded even if traffic has plummeted and workers are in crisis.

The result: budget rigidity. The share of the budget that is truly discretionary shrinks, forcing either:

• Deeper cuts to the remaining discretionary slice (schools, hospitals, police, administration), or
• Increased deficits, because the government cannot reallocate and will not slash mandatory commitments.

Research on Brazil, which has among the world’s highest earmark ratios (upward of 90% of federal revenue is earmarked), has documented this pattern. During the 2015–2017 fiscal crisis, earmarks left the government unable to cut spending proportionally and forced it to accumulate debt or impose surprise austerity on non-earmarked programs.

Real-world examples of rigidity in action

Brazil’s fiscal straitjacket (2010s): Brazil constitutionally earmarks revenues to education (18% of tax revenue), healthcare (specific payroll tax allocations), and social security. When commodity prices collapsed and tax revenue fell, these earmarks were untouchable. The government could not rebalance spending; instead, it cut discretionary spending sharply and incurred mounting primary deficits. By 2017, the primary deficit exceeded 10% of revenue—unsustainable. Only a constitutional amendment (PEC 95) that introduced a spending cap bypassed the earmark problem and enabled adjustment.

U.S. gasoline tax lock-in: The U.S. federal gasoline tax (18.4 cents per gallon) is statutorily earmarked for the Highway Trust Fund. When vehicle miles fell during the 2008–2009 recession, fuel tax revenue collapsed, yet the government could not reallocate those funds to other infrastructure or stimulus without changing law. Congress had to appropriate general revenue to keep highways funded—essentially double-taxing to maintain the earmark.

Australia’s dedicated health funds: Some Australian states have earmarked property taxes or levies for health. When population health crises surge (epidemics, aged care failures), the governments cannot easily shift discretionary money back to health; instead, they either accept underfunding elsewhere or run deficits.

Sweden’s education earmark: Sweden maintains high earmarks for education and childcare to protect spending. During the 2008 financial crisis, this rigidity meant these sectors remained insulated while other programs contracted—a politically defensible outcome but one that reduced the government’s flexibility to target relief where need was greatest.

Why governments embrace earmarks despite rigidity costs

Earmarks persist despite their inflexibility because they offer politicians and publics real benefits:

Commitment and credibility: By constitutionally enshrining a funding link, a government signals to voters and interest groups that it will not divert money. Teachers, road users, and pensioners gain assurance. This credibility can justify a higher tax rate—voters accept a higher fuel tax if they trust it funds roads, not pork.

Insulation from politics: Earmarks remove annual decisions from political bargaining. Roads get funded without competing against defense or welfare each budget cycle. This stability helps long-term planning (multi-year road projects, pension accrual).

Protection of politically weak beneficiaries: Earmarks protect programs that lack electoral clout. Pensioners, rural road users, and health patients gain automatic funding. Without earmarks, annual politics might starve these programs.

Regional equity: Earmarks can ensure that revenues raised in one region (e.g., fuel tax on truckers in a remote area) fund that region’s priorities (rural roads). Without earmarks, centralized discretionary budgets might shortchange regional needs.

These benefits feel especially valuable in normal times, creating strong political resistance to removing earmarks even when economists warn of rigidity.

Measuring and assessing fiscal rigidity

Economists quantify rigidity as the share of total government revenue that is earmarked or, conversely, the share that is truly discretionary. A government with 10% earmarks has more flexibility than one with 75%.

Rigidity index: Some researchers compute an index of rigidity by assigning weights to earmarks by their modifiability. A constitutional earmark for social security is “stickier” than a 5-year statutory earmark for a subsidy. High rigidity indices correlate with difficulty in achieving rapid fiscal consolidation and larger deficits during downturns.

Countries with high rigidity (above 50% of spending earmarked) show:

• Slower adjustment to revenue shortfalls
• Higher procyclical spending (spending falls when revenue falls, amplifying economic weakness)
• Larger structural deficits
• More political gridlock during crises (because unearmarked programs bear all cuts)

Reforming earmarks: trade-offs and alternatives

Governments can reduce rigidity by:

1. Removing constitutional earmarks and allowing annual re-appropriation (costly politically; requires consensus to change constitutions).
2. Time-limiting earmarks to 5–10 years, requiring periodic renewal (preserves credibility while enabling renegotiation).
3. Creating escape clauses for emergencies (e.g., “earmark can be suspended during declared national crisis”; weakens credibility but enables flexibility).
4. Replacing earmarks with transfer rules (e.g., “all education spending must be no less than X% of discretionary budget”; less rigid than a dollar earmark).
5. Ring-fencing funds operationally but not legally (e.g., separate bank accounts for road revenue; conveys credibility but allows legal reallocation).

Each reform trades off credibility against flexibility. Brazil’s PEC 95 spending cap chose flexibility; it angered protected groups but enabled fiscal adjustment. Sweden’s slower erosion of earmarks preserves political trust but leaves the system rigid.

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