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The hypothecation of a tax (also known as the ring-fencing or earmarking of a tax) is the dedication of the revenue from a specific tax for a particular expenditure purpose. [1] This approach differs from the classical method according to which all government spending is done from a consolidated fund.
Hypothecated taxes have a long history. One of the first examples of earmarking was ship money, the tax paid by English seaports used to finance the Royal Navy. [1] Later, in the 20th century, the hypothecated tax began to be discussed by politicians in the United Kingdom. For example, the Vehicle Excise Duty from 1920 when earned revenues were used for the construction and maintenance of the roads, [1] assigning 1p on the income tax directly to education in 1992, [2] or giving £300 million per year from the revenues from taxes on the tobacco industry to help the fight against smoking-related diseases since 1999. [3]
The hypothecated tax can be divided into three groups based on the main characteristics. The emphasis can be put on the final use of the revenues, on the vastness of the area financed from the money earned or on the type of the tax. Each group then has two subsections. In the first case, we distinguish between strong and weak hypothecation. Strong hypothecation means that the revenues from the tax go only to financing the particular service and the service is financed only through the revenues from this tax. Strong hypothecation is thought to be appropriate for pure public goods where voters must reveal their consumption preferences. If at least one of the two conditions is not met, we say that the hypothecation is weak. [2] This distinction is the most common as many of the arguments for and against hypothecated tax are based on it. [4]
Secondly, differentiation is made between wide and narrow hypothecation. When the tax revenues finance the entire public service such as the health care, it is described as wide hypothecation. Narrow hypothecation means that only a specific area such as nursery education is funded.
The third level of splitting is based on the type of, and the reason for imposing, the tax that is hypothecated.
The most supported type is a combination of strong and narrow hypothecation. In this case, the hypothecation can serve as a beneficial link between demand and supply. An example can be financing the roads in the U.S. by the gasoline tax.
There are three main ideas of which benefits hypothecation can bring: believing that people will be willing to pay more for better services; demonstrating the real cost of services to people; and supporting democracy. [2] These can be broken down into four main hypothecation-supporting points.
The arguments against earmarking come mostly from the traditional way of viewing the taxes where they were confined to compulsory, unrequited payments to the general government as defined by the OECD in 1988. Firstly, public spending should be determined by policies and not by the amount of the revenue raised. With earmarking, inappropriate funding levels may occur as the strong hypothecated tax implies the dependence of spending on the tax revenues and thus on the macroeconomic performance of the country. Secondly, the flexibility of fiscal policy and thus the ability to influence the economic situation is reduced when hypothecation is used. [2]
In 2012, the Mercatus Center pointed out [5] the negative effects that dedicating tax revenues to specific expenditures can have on the policymakers. In their report they stated that hypothecation can be used to mask the increases in total government spending.
The problem of ambiguity of hypothecation occurs in many countries all over the world. As mentioned before, revenues of hypothecated taxes are often used to finance health care or education because in these sectors the aggregate preference can be easily revealed.
One of the most known cases of hypothecation in Europe is the National Insurance contribution in the United Kingdom. Money that is raised goes directly to the National Insurance Fund from which the benefits are paid. This is also an example of the combination of wide and weak earmarking. [2] (In practice, National Insurance today funds general government expenditures, for after accounting for health spending there is a large surplus which is loaned to the Consolidated Fund.)
The health care system is also often supported by taxes on tobacco, as smoking is considered a serious threat. For example, in Egypt, the revenue earned from these taxes is used to help to cover health insurance and provide prevention and rehabilitation for students. Besides the United Kingdom and Egypt, hypothecation helps to finance health care in many countries including Finland, the Republic of Korea, Portugal, Thailand and Belgium. [6] (Hypothecation of tax revenue for health Ole Doetinchem, World Health Report (2010) Background Paper, 51)
An example from a different sector is television licences. People who use television sets to receive broadcast transmissions can be obliged to pay an annual fee (depending on local laws) and the revenues can be used to fund public broadcasting. In the United Kingdom, the funds raised are dedicated to the BBC, but this type of hypothecation is also applied in many European countries. [4]
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer by a governmental organization in order to collectively fund government spending, public expenditures, or as a way to regulate and reduce negative externalities. Tax compliance refers to policy actions and individual behaviour aimed at ensuring that taxpayers are paying the right amount of tax at the right time and securing the correct tax allowances and tax relief. The first known taxation took place in Ancient Egypt around 3000–2800 BC. Taxes consist of direct or indirect taxes and may be paid in money or as its labor equivalent.
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Publicly funded healthcare is a form of health care financing designed to meet the cost of all or most healthcare needs from a publicly managed fund. Usually this is under some form of democratic accountability, the right of access to which are set down in rules applying to the whole population contributing to the fund or receiving benefits from it.
In many states with political systems derived from the Westminster system, a consolidated fund or consolidated revenue fund is the main bank account of the government. General taxation is taxation paid into the consolidated fund, and general spending is paid out of the consolidated fund.
Universal health care is a health care system in which all residents of a particular country or region are assured access to health care. It is generally organized around providing either all residents or only those who cannot afford on their own, with either health services or the means to acquire them, with the end goal of improving health outcomes.
Two-tier healthcare is a situation in which a basic government-provided healthcare system provides basic care, and a secondary tier of care exists for those who can pay for additional, better quality or faster access. Most countries have both publicly and privately funded healthcare, but the degree to which it creates a quality differential depends on the way the two systems are managed, funded, and regulated.
Government spending or expenditure includes all government consumption, investment, and transfer payments. In national income accounting, the acquisition by governments of goods and services for current use, to directly satisfy the individual or collective needs of the community, is classed as government final consumption expenditure. Government acquisition of goods and services intended to create future benefits, such as infrastructure investment or research spending, is classed as government investment. These two types of government spending, on final consumption and on gross capital formation, together constitute one of the major components of gross domestic product.
The United States budget comprises the spending and revenues of the U.S. federal government. The budget is the financial representation of the priorities of the government, reflecting historical debates and competing economic philosophies. The government primarily spends on healthcare, retirement, and defense programs. The non-partisan Congressional Budget Office provides extensive analysis of the budget and its economic effects. CBO estimated in February 2024 that Federal debt held by the public is projected to rise from 99 percent of GDP in 2024 to 116 percent in 2034 and would continue to grow if current laws generally remained unchanged. Over that period, the growth of interest costs and mandatory spending outpaces the growth of revenues and the economy, driving up debt. Those factors persist beyond 2034, pushing federal debt higher still, to 172 percent of GDP in 2054.
A government budget or a budget is a projection of the government's revenues and expenditure for a particular period of time often referred to as a financial or fiscal year, which may or may not correspond with the calendar year. Government revenues mostly include taxes while expenditures consist of government spending. A government budget is prepared by the Central government or other political entity. In most parliamentary systems, the budget is presented to the legislature and often requires approval of the legislature. Through this budget, the government implements economic policy and realizes its program priorities. Once the budget is approved, the use of funds from individual chapters is in the hands of government ministries and other institutions. Revenues of the state budget consist mainly of taxes, customs duties, fees and other revenues. State budget expenditures cover the activities of the state, which are either given by law or the constitution. The budget in itself does not appropriate funds for government programs, hence need for additional legislative measures. The word budget comes from the Old French bougette.
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The Road Fund was a British Government fund designated to pay for the building and maintenance of the United Kingdom road network. Its income came originally from Vehicle Excise Duty, until that ceased to be hypothecated for roads use in 1936, and then from government grants. It was created by the Roads Act 1920 and Finance Act 1920, and was wound up in the Miscellaneous Financial Provisions Act 1955.
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Examples of health care systems of the world, sorted by continent, are as follows.
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