General Budget vs Earmarking
Should carbon tax revenue go into the general government pot, or should it be dedicated to specific purposes? This fundamental choice shapes both the economics and politics of carbon pricing.
The General Budget Approach
Under the general budget approach, carbon tax revenue is treated like any other government revenue. It flows into consolidated accounts and can be spent on any government priority.
How it works:
- Revenue is not committed to specific programs
- Annual budget processes determine spending
- Government has full flexibility
Arguments for general budget use:
Economic efficiency
Earmarking can lead to inefficient spending. If $1 billion is earmarked for solar panels, government must spend $1 billion on solar panels even if other uses would deliver more benefit. General budget allows spending where it is most needed.
Budgetary integrity
Finance ministries generally oppose earmarking because it ties their hands. They argue that all revenue should be evaluated against all spending needs through the normal budget process.
Flexibility
Priorities change. What seems important today may not be important tomorrow. General budget use allows adaptation.
Think of household budgeting. You could earmark your salary: "The first $1,000 goes to rent, the next $500 to food, the next $300 to transportation..." But most people prefer flexibility: all income goes into one account, and spending adjusts based on needs. Government works similarly.
The Earmarking Approach
Under earmarking, carbon tax revenue is dedicated by law to specific purposes.
Types of earmarking:
Hard earmarking: Revenue flows directly to a separate fund that can only be spent on specified purposes. Often managed by a different agency than the one collecting the tax.
Soft earmarking: Revenue goes to general accounts, but there is a commitment to spend an equivalent amount on specified purposes. More flexible but potentially less credible.
Partial earmarking: Some revenue is earmarked, rest goes to general budget. Many jurisdictions use this approach.
Arguments for earmarking:
Political sustainability
People accept taxes more readily when they see where the money goes. A carbon tax that visibly funds clean energy or household rebates is easier to defend than one that disappears into government coffers.
Accountability
Earmarking creates clear accountability. Agencies must report on how funds are used and results achieved. This transparency can build trust.
Appropriate connection
There is a logic to using pollution revenue to address pollution. It creates a "polluter pays, society benefits" narrative.
Research consistently shows that earmarking increases public support for carbon pricing. Studies find 10-20 percentage point increases in support when revenue is visibly dedicated to climate or household benefits.
What Gets Earmarked?
Common earmarking targets include:
Climate-related purposes:
- Renewable energy development
- Energy efficiency programs
- Electric vehicle infrastructure
- Public transit
- Climate adaptation
- Research and development
Household protection:
- Direct rebates or dividends
- Low-income energy assistance
- Utility bill credits
Economic purposes:
- Reducing other taxes
- Business competitiveness measures
- Green job creation
- Regional development
Environmental purposes:
- Natural resource conservation
- Biodiversity protection
- Clean air and water programs
Case Studies: Different Approaches
Switzerland: Direct return to households
Switzerland earmarks about two-thirds of its carbon tax revenue for direct return to citizens through health insurance premium reductions. The remaining third funds building efficiency programs.
This creates a highly visible benefit. Every Swiss resident sees their health insurance bill reduced. The connection between the carbon tax and the benefit is clear.
Result: The carbon tax is popular and has survived multiple referendum challenges.
California: Climate program funding
California earmarks cap-and-trade auction revenue for the Greenhouse Gas Reduction Fund, which funds:
- High-speed rail (25%)
- Affordable housing near transit (20%)
- Sustainable communities (10%)
- Various clean energy and transportation programs
At least 35% of investments must benefit disadvantaged communities.
This creates tangible projects: rail construction, solar installations, transit improvements. However, some argue that funding priorities reflect politics more than efficiency.
Australia (2012-2014): Mixed approach
Australia's short-lived carbon tax split revenue among:
- Household assistance (50%)
- Business assistance (40%)
- Climate programs (10%)
Despite the compensation, the policy was repealed after a change in government. Critics argued the messaging was poor: people noticed higher energy bills but did not connect the tax cuts and rebates to the carbon tax.
Lesson: Earmarking must be visible and well-communicated to build support.
The Trade-offs
| Factor | General budget | Earmarking |
|---|---|---|
| Economic efficiency | Higher (spending goes where most needed) | Lower (may fund less efficient uses) |
| Political sustainability | Lower (invisible benefits) | Higher (visible benefits) |
| Flexibility | Higher | Lower |
| Accountability | Lower (mixed with other spending) | Higher (separate reporting) |
| Administrative complexity | Lower | Higher |
When Earmarking Makes Sense
Earmarking tends to work better when:
1. Political support is uncertain
If the carbon tax faces significant opposition, visible earmarking can build a coalition of supporters who benefit from the funded programs.
2. Trust in government is low
Where people distrust government spending, direct return to households or transparent program funding builds credibility.
3. Complementary spending is needed
If infrastructure or technology investments are genuinely needed to enable emissions reductions, earmarking for these purposes makes sense.
4. Revenue is large relative to existing programs
A small carbon tax might disappear into general budget without notice. A large one generates enough revenue that visible uses make a difference.
Public finance economists often oppose earmarking for several reasons:
Mismatch between revenue and needs
Revenue from a carbon tax depends on emissions, which may rise or fall for many reasons. But spending needs do not follow the same pattern. A recession might reduce carbon tax revenue just when climate programs need more funding, or vice versa.
Inefficient allocation
Earmarking can force spending on less valuable activities. If $500 million is earmarked for solar panels, that $500 million will be spent on solar panels even if the last $100 million could have been better spent elsewhere.
Rent-seeking
Earmarking creates interest groups that lobby to protect "their" revenue. This can make reform difficult and spending inefficient.
Budget fragmentation
Too many earmarks can fragment the budget, making it hard to manage overall fiscal policy.
The counter-argument: These efficiency costs may be worth paying if earmarking makes carbon pricing politically viable. A "second-best" policy that survives is better than a "first-best" policy that gets repealed.
Hybrid Approaches
Many jurisdictions use hybrid approaches that capture benefits of both:
Partial earmarking
Earmark a portion (say, 50%) for visible purposes while leaving the rest for general budget flexibility.
Sunset provisions
Earmark for a defined period (say, 10 years) to build initial support, then transition to general budget use.
Floor commitments
Commit to spending at least a certain amount on climate purposes, without requiring that exact amount to come from carbon tax revenue.
Broad earmarking categories
Earmark for broad purposes ("climate and clean energy") rather than specific programs, giving flexibility within the category.
Design Principles
If you earmark carbon tax revenue, follow these principles:
Make it visible
Whatever you earmark for, make sure people know about it. Rebate checks, utility bill credits, and tangible infrastructure projects are more visible than programs buried in agency budgets.
Track and report
Create separate accounting for earmarked funds and report regularly on how they are used and what results are achieved.
Build in flexibility
Avoid overly specific earmarks. "Clean transportation" is better than "electric buses made in-state." Allow priorities to evolve.
Plan for revenue changes
If emissions fall (which is the goal), carbon tax revenue will fall too. Build mechanisms to handle fluctuating revenue.
Looking Ahead
The next lesson explores a specific form of revenue use: revenue-neutral carbon taxes that return all revenue through tax cuts. This approach has been influential in shaping how jurisdictions think about carbon pricing.