The Earmarked Money Illusion

William B. Irvine

Professor Irvine teaches philosophy at Wright State University in Dayton, Ohio.

Two stories that made recent headlines were President Bushes declaration of war on drugs, and securities firm Drexel Bum-ham Lambert’s payment of over $300 million in fines and penalties for having engaged in insider trading. One would naturally think that these two events were in no way connected, but according to the government they were: Acting U.S. Attorney Benito Romano announced that most of the money paid by Drexel could be used to fund the nation’s war on drugs.

This announcement no doubt created an agreeable image in the minds of many people. By fining Drexel, the government was not only taking steps to discourage insider trading, but was simultaneously generating funds with which to fight drug abuse.

It is not difficult to come up with other cases in which politicians and government officials have claimed that certain government revenues were “earmarked” for particular purposes. The federal government, for example, sometimes gives money to other nations with the stipulation that the money be used to buy food and medicine rather than arms. Similarly, in some states the law requires that the money raised in state lotteries be spent on education. And sometimes when a municipal government raises the sales tax, it stipulates that the additional tax revenues will be used only for some worthwhile purpose—say, to improve transit systems.

The image created by claims that revenues have been earmarked for worthwhile purposes is largely an illusion. It is rarely possible for a government to earmark revenue for a particular purpose.

Consider, for example, the claim that the Drexel fine could be used to fund the war on drags. Suppose, as is most likely the case, that the $300 million check from Drexel is deposited into an account which already contains funds from many other sources and from which a wide variety of programs are funded. What sense does it make to say, when money is drawn from this account to spend on the drag war, that it came only from the Drexel fine and not from any of the other sources of account funds? And what sense does it make to say that the Drexel fine was spent only on the war on drags and not on any of the other programs funded from the account? It makes no sense at all.

In general, once you commingle funds in an account, it is impossible ever to separate them again. This is because money is, as economists like to remind ns, a fungible commodity.

Suppose that the government, rather than com-mingling the Drexel fine with other revenues, is careful to start a new account in which the Drexel check is the only deposit. Suppose, too, that the only checks the government ever writes from this account are checks to fund the war on drugs. In this case, it might make some sense to say that the government has earmarked the Drexel fine to fund the war on drugs, but there is an element of illusion in even this claim.

Many would assume that because the government is earmarking the Drexel fine to fund the war on drugs, the war will receive $300 million more in funding than would otherwise be the case. This, of course, isn’t necessarily true. For if the government, after declaring that the $300 million in “the Drexel account” will be used only to fund the war on drugs, proceeds to cut by $300 million its general-revenues funding of the war on drugs, the war will be no better funded than it would have been without any earmarking of funds. In this case, all that earmarking the Drexel fine accomplishes is to allow the government to spend $300 million from general revenues accounts on things other than the war on drugs. It might, for example, buy part of a Stealth Bomber.

Along these same lines, consider a state lottery whose profits are earmarked for education. Suppose that before starting the lottery, a state spends $200 million out of general revenues on education. Suppose that the lottery brings in $50 million in new revenue, which must be spent on education. If, in the face of this windfall, the state kept its gen-eral-revenues funding of education at $200 million (so that education received a total of $250 million), it might make sense to say that the lottery profits had “gone for education.” Suppose, however, that in reaction to the $50 million in lottery profits, the state cuts its general-revenues funding of education to $150 million. In this case, the total amount of money that the state spends on education will remain at $200 million; and in this case, all the state accomplishes by earmarking lottery profits for education is to free up $50 million of general revenues to spend on something else. In short, although the lottery revenue is earmarked for education, education might be no better off because of it.

As another example of this phenomenon, consider what happens when our federal government gives another country money with instructions to spend it on food and not on guns. In such cases, who’s to say that the money was spent on food? Suppose, for example, that before getting a $5 million gift from the United States, the recipient country had planned (without telling us) to spend $5 million on food and $10 million on guns; and suppose that once it obtains our gift, it spends $5 million on food and $15 million on guns. It will look as if our $5 million gift was indeed spent on food. (The country did, after all, buy $5 million of food shortly after receiving our gift.) The real effect of our gift, however, is to enable the country to buy more guns than it otherwise could have afforded.

Of course, the earmarked-money illusion can take place outside the political realm. Parents might, for example, give their adult son a gift of money with the stipulation that he spend it on, say, neckties and not beer. If the son allowed the gift money to commingle with other funds, or if he would have bought neckties even if he hadn’t received the gift money, it makes little sense to say that the money he spent on neckties was “really” his parents’ gift.

The business world has also discovered the ear-marked-money illusion. When, for example, a hotel provides a “free” continental breakfast to people who pay $100 for a room, the breakfast isn’t really free. After all, the hotel wouldn’t let you have the breakfast if you didn’t rent a room. When a hotel charges $100 for a package of services, it makes little sense to say that the money “really” went for some of the services but not for others. Indeed, a hotel that says that $100 will get you a room and a free continental breakfast could just as well say that $100 will get you a continental breakfast and a free room; either way, the claim borders on nonsense.

Returning to claims that government revenues are being earmarked for certain purposes, we are faced with a new question: If such claims are generally illusory, then why do politicians and government officials persist in making them? In part because they don’t realize that they are talking nonsense and in part because it often serves theft purposes to talk nonsense.

When, for example, government officials wish to raise revenues by means of a new tax, they may, if they are clever, try to “sugarcoat” the tax by claiming that the money raised won’t be wasted on frivolous things, but will be earmarked for some worthwhile cause. Nine people out of ten not only will accept this claim, but will applaud those who make it.

Of course, we citizens should realize that you can’t judge a pill by its coating. And whenever a politician or government official tells us that the money the government is taking from us is being earmarked for a worthwhile cause, we should think twice before swallowing the pill. Chances are that beneath its sugar coating, it will turn out to be a bitter pill indeed.

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