Old idea enjoys a new lease of life: Robert Chote examines the arguments put forward by both advocates and opponents of earmarked taxes

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EARMARKING the revenue of particular taxes to particular areas of public spending is an old idea enjoying a new lease of life. The opposition parties hope it can help to defuse the public's instinctive hostility to paying taxes.

Plenty of earmarked taxes have been tried in Britain, but few have lasted for long. An earmarked 'whisky tax' was used briefly in the late 19th century as the first source of state funding for secondary schools; Harold Wilson imposed the 'Eady levy' on cinema seats in the 1940s to help finance the film industry; road building was paid for by petrol tax and vehicle excise duty between 1911 and 1937, and the BBC is funded from the television licence fee.

Advocates of earmarking (or 'hypothecation') believe that it makes people happier to pay taxes because they have a better idea what the money is being spent on. The Liberal Democrat leadership cites the popularity in opinion polls of its proposal to fund higher education spending by adding a penny to the basic rate of income tax as evidence of this. But critics within the party point out that people were not prepared to back the idea when they cast their votes in the general election.

Just as hypothecation can increase public willingness to pay for popular areas of spending, so it might fuel resistance to unpopular ones. Pacifists may object to paying a defence tax, while a football fan may object to subsidising the Royal Opera House. If the tax system is made more transparent, people may demand that they be allowed to opt out of taxes to which they object.

A more decentralised version of hypothecation might allow people to vote in local referendums on paying extra taxes for particular projects. Some councils already use referendums to decide between different combinations of local spending and council tax levels. However, this system could be exploited by pressure groups to push through spending on particular areas of interest. The Liberal Democrats accept hypothecation would be unsuitable for many areas of taxation and public spending. It is difficult to apply to tax revenues or public spending which is sensitive to the state of the economy, for example.

But the Treasury's main objection to hypothecation is that it reduces the overall flexibility of the tax and public spending system. The Government has deliberately tried to move to a system in which the size of the total public spending bill is set first, after which Cabinet ministers fight for as large a slice as they can for their own departments.

The Labour Party is also considering hypothecation as a policy option, which means that the pressure for the public to be given more information on what their taxes are spent on may become unstoppable. But whether this makes people more or less happy about paying tax remains to be seen.