Fiscal Fragmentation: A Secret Formula for Revenue Mobilization and Fiscal Stability?
We have been conducting a series of studies examining how a fragmented budget system—characterized by the extensive use of earmarked taxes and the prominence of special funds—has enabled the Korean government to mobilize revenue and maintain fiscal stability. Given that government fragmentation is generally regarded as detrimental to fiscal discipline and overall fiscal health, the Korean experience presents a significant puzzle.
Budget Institutions and the Flypaper Effect of Reveue Earmarking
Abstract
The efficacy and efficiency of revenue earmarking depend critically on the extent to which taxation and expenditure decisions are linked through a clear benefit rationale. Using a panel dataset of 50 special fund accounts in the consolidated central government of Korea over the period 2001–2008, this paper estimates the extent to which increases in earmarked revenues remain within the targeted accounts—that is, the degree to which earmarked revenues “stick where they hit.”
Our results indicate that special accounts endowed with substantial fiscal autonomy and controlled by a single spending ministry tend to retain earmarked revenues within their boundaries. By contrast, in accounts where the Ministry of Finance exercises strong control, earmarked revenues are largely fungible and have little effect on expenditure levels. These findings suggest that budget institutions play a crucial role in determining whether revenue earmarking achieves its intended objectives.
Summary
Revenue earmarking – linking designated revenue sources to designated expenditures - could be an efficiency-enhancing budget tool. As Buchanan (1963, 1976) shows, a tight benefit link between taxation and expenditure decisions could prove to be an efficient way of providing puiblic services. With the taxpayers being the beneficiaries of a given public service, they provide financing for, their preferences are revealed in such a way (so) that economic efficiency is achieved.
A properly structured earmarking could also act as a constraint on the rent-seeking behavior of the Leviathan government (Wagener, Buchanan). A tight budgetary link between revenues and expenditure based on the benefit principle would constrain self-interested public agents from directing a larger share of public spending toward their preferred beneficiaries, including themselves. Using the proceeds from gasoline taxes to finance only road construction and maintanance is a classic example in this vein.
In the real world, however, tax money is fungible so that a tight budetary link (a strict match) between revenues and expenditures may not be established. If an increase in dedicated revenue for an expenditure item is offset by a simultaneous decrease in revenues from other sources, the actual effects of earmarking will deviate from the nominally proclaimed ones. Thus, any positive assessments about an earmarking case are critically conditioned on the fungiblity or stickiness of its revenue, which is an empirical quesiton.
Nonethess, the empirical research on the stickiness or “flypaper” effect of own-source revenue earmarking has been limited, focusing mostly on the U.S. state experiences with education and highways as major categories for investigation. The results for the US state cases are mixed in terms of the effectiveness of revenue earmarking in affecting the expenditures in targeted areas. Although earmarking practices are quite rampant at the central government level as well, evidence on the flypaper effect on this level is rare, probaby due to the lack of appropriate analytical framework and relevant data.
In this vein, the Korean experience provides an excellent case study in that this country has made heavy use of revenue earmarking at the central level with corrensponding special fund accounts. Furthermore, Korea’s speical accounts can be conveniently classified into separate groups with different characteristics of budget processes, allowing for investigating the channels through which budget institutions affect the efficacy and efficiency of reveunue earmarking.
The goal of this paper is to provide some systematic evidence as well as an analytical framework on whether and how budget institutions affect the stickiness of earmared revenues. Using a panal data set comprising 50 special fund accounts in the Korea’s cosolidated central governement for the period 2001-2008, we estimate the extent to which an incrase in earmarked revenues affect the expentiture level of a targeted account (stickiness). In the process, we also examine whether earmarking significantly influences the flow of funds out of this account– evidence of revenue flungiblity. As for possible theoretical explanations for our empirical results, we focus on various budgetary charectristics which could render “fiscal autonomy” with respect to the operations of a given account. These include flexibility of budget adjustments across time and items, the number of spending ministries involved in the oprations of an account, and the role of the finance minister as the central budget authority.
Our estimation results show that special fund accounts with relatively high autonomy(flexibility) in terms of inter-temporal and inter-item adjustments have a tendancy to keep earmared revenue within their boundaries. Prominent in this process is the balance of power between the finance minister (MOF) and spending ministers (SPM). Specifically, special accounts that are controlled by a single spending minister appear to have more fiscal autonomy, keeping earmared revenues within the account boundary. For those specal accounts in which earmarking revneues are shared among several ministries and the finance minister’s grip is strong, in constrast, earmarking appears to affect inter-account transfers rather than the expenditure level, implying the fungibility of dedicated revenues. Our results are robust to a wide range of model specifications. (2026, forthcoming)
Earmarking in Theory and Korean Practice
Richard M. Bird and Joosung Jun
University of Toronto and Ewha University
Working Paper 05-15. Georgia State University
Abstract
In the first part of this paper we present a non-technical analysis of earmarking. We then briefly review some international experience with earmarking and its apparent results. The main new contribution of the paper is the concluding description and evaluation of the nature, efficacy, and effects of earmarking in Korea.
Earmarking – assigning revenues from designated sources to finance designated expenditures – is an old and popular practice in many countries around the world. In Section 1, we set out a taxonomy of earmarking to set the stage for discussion in Section 2 of the reasons why countries might decide to earmark particular revenues. In Section 3 we review briefly some international experience with earmarking and its apparent results. Against this general background, in Section 4, the main new contribution of the paper, we describe the perhaps surprising amount of earmarking in Korea and present a preliminary evaluation of its efficacy and effects. A brief Section 5 concludes.
Keywords: earmarking; benefit taxation; Korea
Fragmented Budget Systems and Fiscal Performance: Evidence from South Korea
This paper empirically examines how a fragmented budget system affects fiscal deficits, focusing on the role of fiscal autonomy in terms of own-source revenue, expenditure flexibility, and intertemporal budget adjustment. Greater revenue autonomy implies that the fungibility of earmarked revenues is not the primary determinant of fiscal performance. Using a panel dataset of Korea's consolidated central government special accounts, we test the hypothesis that fiscal autonomy enhances fiscal stability.
The results show that, in accounts with "sticky" earmarked revenues, predetermined revenue sources contribute to maintaining budget balance by supporting both revenue generation and expenditure growth. In contrast, in accounts with "fungible" earmarked revenues, the principal effect of earmarking is to reduce political resistance to taxation, thereby strengthening revenue-raising capacity. We further find that fiscal autonomy is most effective in promoting fiscal discipline when budgetary authority is shared between the finance minister and the spending minister under an institutional framework of effective checks and balances. (2026, forthcoming)
Fiscal Fragmentation: A Secret Formula for Revenue Mobilization and Fiscal Stability?
We have been conducting a series of studies examining how a fragmented budget system—characterized by the extensive use of earmarked taxes and the prominence of special funds—has enabled the Korean government to mobilize revenue and maintain fiscal stability. Given that government fragmentation is generally regarded as detrimental to fiscal discipline and overall fiscal health, the Korean experience presents a significant puzzle.
Budget Institutions and the Flypaper Effect of Reveue Earmarking
Abstract
The efficacy and efficiency of revenue earmarking depend critically on the extent to which taxation and expenditure decisions are linked through a clear benefit rationale. Using a panel dataset of 50 special fund accounts in the consolidated central government of Korea over the period 2001–2008, this paper estimates the extent to which increases in earmarked revenues remain within the targeted accounts—that is, the degree to which earmarked revenues “stick where they hit.”
Our results indicate that special accounts endowed with substantial fiscal autonomy and controlled by a single spending ministry tend to retain earmarked revenues within their boundaries. By contrast, in accounts where the Ministry of Finance exercises strong control, earmarked revenues are largely fungible and have little effect on expenditure levels. These findings suggest that budget institutions play a crucial role in determining whether revenue earmarking achieves its intended objectives.
Summary
Revenue earmarking – linking designated revenue sources to designated expenditures - could be an efficiency-enhancing budget tool. As Buchanan (1963, 1976) shows, a tight benefit link between taxation and expenditure decisions could prove to be an efficient way of providing puiblic services. With the taxpayers being the beneficiaries of a given public service, they provide financing for, their preferences are revealed in such a way (so) that economic efficiency is achieved.
A properly structured earmarking could also act as a constraint on the rent-seeking behavior of the Leviathan government (Wagener, Buchanan). A tight budgetary link between revenues and expenditure based on the benefit principle would constrain self-interested public agents from directing a larger share of public spending toward their preferred beneficiaries, including themselves. Using the proceeds from gasoline taxes to finance only road construction and maintanance is a classic example in this vein.
In the real world, however, tax money is fungible so that a tight budetary link (a strict match) between revenues and expenditures may not be established. If an increase in dedicated revenue for an expenditure item is offset by a simultaneous decrease in revenues from other sources, the actual effects of earmarking will deviate from the nominally proclaimed ones. Thus, any positive assessments about an earmarking case are critically conditioned on the fungiblity or stickiness of its revenue, which is an empirical quesiton.
Nonethess, the empirical research on the stickiness or “flypaper” effect of own-source revenue earmarking has been limited, focusing mostly on the U.S. state experiences with education and highways as major categories for investigation. The results for the US state cases are mixed in terms of the effectiveness of revenue earmarking in affecting the expenditures in targeted areas. Although earmarking practices are quite rampant at the central government level as well, evidence on the flypaper effect on this level is rare, probaby due to the lack of appropriate analytical framework and relevant data.
In this vein, the Korean experience provides an excellent case study in that this country has made heavy use of revenue earmarking at the central level with corrensponding special fund accounts. Furthermore, Korea’s speical accounts can be conveniently classified into separate groups with different characteristics of budget processes, allowing for investigating the channels through which budget institutions affect the efficacy and efficiency of reveunue earmarking.
The goal of this paper is to provide some systematic evidence as well as an analytical framework on whether and how budget institutions affect the stickiness of earmared revenues. Using a panal data set comprising 50 special fund accounts in the Korea’s cosolidated central governement for the period 2001-2008, we estimate the extent to which an incrase in earmarked revenues affect the expentiture level of a targeted account (stickiness). In the process, we also examine whether earmarking significantly influences the flow of funds out of this account– evidence of revenue flungiblity. As for possible theoretical explanations for our empirical results, we focus on various budgetary charectristics which could render “fiscal autonomy” with respect to the operations of a given account. These include flexibility of budget adjustments across time and items, the number of spending ministries involved in the oprations of an account, and the role of the finance minister as the central budget authority.
Our estimation results show that special fund accounts with relatively high autonomy(flexibility) in terms of inter-temporal and inter-item adjustments have a tendancy to keep earmared revenue within their boundaries. Prominent in this process is the balance of power between the finance minister (MOF) and spending ministers (SPM). Specifically, special accounts that are controlled by a single spending minister appear to have more fiscal autonomy, keeping earmared revenues within the account boundary. For those specal accounts in which earmarking revneues are shared among several ministries and the finance minister’s grip is strong, in constrast, earmarking appears to affect inter-account transfers rather than the expenditure level, implying the fungibility of dedicated revenues. Our results are robust to a wide range of model specifications. (2026, forthcoming)
Earmarking in Theory and Korean Practice
Richard M. Bird and Joosung Jun
University of Toronto and Ewha University
Working Paper 05-15. Georgia State University
Abstract
In the first part of this paper we present a non-technical analysis of earmarking. We then briefly review some international experience with earmarking and its apparent results. The main new contribution of the paper is the concluding description and evaluation of the nature, efficacy, and effects of earmarking in Korea.
Earmarking – assigning revenues from designated sources to finance designated expenditures – is an old and popular practice in many countries around the world. In Section 1, we set out a taxonomy of earmarking to set the stage for discussion in Section 2 of the reasons why countries might decide to earmark particular revenues. In Section 3 we review briefly some international experience with earmarking and its apparent results. Against this general background, in Section 4, the main new contribution of the paper, we describe the perhaps surprising amount of earmarking in Korea and present a preliminary evaluation of its efficacy and effects. A brief Section 5 concludes.
Keywords: earmarking; benefit taxation; Korea
Fragmented Budget Systems and Fiscal Performance: Evidence from South Korea
This paper empirically examines how a fragmented budget system affects fiscal deficits, focusing on the role of fiscal autonomy in terms of own-source revenue, expenditure flexibility, and intertemporal budget adjustment. Greater revenue autonomy implies that the fungibility of earmarked revenues is not the primary determinant of fiscal performance. Using a panel dataset of Korea's consolidated central government special accounts, we test the hypothesis that fiscal autonomy enhances fiscal stability.
The results show that, in accounts with "sticky" earmarked revenues, predetermined revenue sources contribute to maintaining budget balance by supporting both revenue generation and expenditure growth. In contrast, in accounts with "fungible" earmarked revenues, the principal effect of earmarking is to reduce political resistance to taxation, thereby strengthening revenue-raising capacity. We further find that fiscal autonomy is most effective in promoting fiscal discipline when budgetary authority is shared between the finance minister and the spending minister under an institutional framework of effective checks and balances. (2026, forthcoming)