Dedicated taxes distort the market

Dear A.M. Costa Rica:

Hypothecation is bad for everyone.

Before everyone reaches for the dictionary to read about a new illness, let me disappoint you by saying that this refers to taxation in Costa Rica. A hypothecated tax is one dedicated to a particular item of government expenditure. Such taxes appear in U.S. states where citizens get a vote on particular taxes, because the electorate does not trust the government to fund something or with general funds. A.M. Costa Rica has covered the many such taxes in its reports.

The whole $100-billion special districts scandal in the U.S. is an example. Costa Rica is rife with special purposes taxes, probably in the belief that a tax for worthy causes is likely to get support from the people. One effect may be that some organizations build new facilities when there are vacant premises elsewhere.

So why are such taxes bad for everyone? There are several reasons:

They make budgeting income and planning difficult. One problem with any tax is that the amount collected is uncertain. For example, a tax on beer will yield more or less according to consumption. If funding for the Bomberos or the Policia is from a single tax, they do not know how much they will receive. It will vary from year to year. This means that they may have too much. They might spend a surplus on parties. If the tax yield is too little, the government has to bail them out because the service is essential.

Hypothecation makes auditing and control difficult. Letting some government and supported organizations run their affairs in isolation makes overall economic management virtually impossible. If some but not all of a ministry’s budget is from a dedicated tax, it might well spend that money on vital services and still fund parties from the central budget. Dedicated taxes may tempt recipients to give the finger to any audits and attempts at control. In a country of dubious public ethics, this can be a real problem.

Special taxes distort the free markets. The result is certain goods or services are taxed and priced more than others. This may be in the public good, but is as likely to simply bend the economy in fairly random ways. The lobbies for particular industries love such opportunities.

So what is better? If there has to be taxation, it should go into a central pool. This does require open disclosure, honest supervision, auditing and planning. Then there can be no hidden backwaters where the public funds semi-autonomous organizations from single taxes. In addition, a central budget can aggregate the swings and roundabouts of greater or less than expected single taxes to smooth out distortions.

Let us hope that legislators see the opportunity for reform rather than the opportunity to seek their own ends from special purpose taxes.

Chris Clarke
Retired economist and businessman,
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