General Fund Financing, Earmarking, Economic Stabilization, and Welfare

Abstract

Discussion has been made concerning pros and cons of the ways of financing public projects via either earmarking or general fund based upon a public finance approach. The paper studies the implications of desirability of earmarked and general fund based upon economic stabilization in a two-sector growth model. Regardless of the nature of public goods, earmarked tax contributes to aggregate stabilization, while general fund may be destabilizing and cause fluctuations. The underlying mechanism in favor of earmarked taxes against general fund is that general fund creates intersectoral externalities and strategic complementarities that is sufficiently large to exert endogenously persistent and recurring fluctuations in aggregate activities in the absence of shocks to fundamentals. Earmarked taxing generates only sector-specific externalities that are too small to exert local indeterminacy. In a calibrated version, we compute the level of long-run welfare and the results reflect favorably upon the use of earmarked taxing.

Intersectoral Spillovers, Relative Prices and Development Traps

“…Externalities in production may be in the form of aggregate externalities (Benhabib and Farmer, 1994; Farmer and Guo, 1994), sector‐specific externalities (Benhabib et al, 2000; Mino, 2001) and intersectoral externalities (Drugeon et al, 2003; Chen and Lee, 2009). Thus, the externalities are assumed to take the following forms where is average capital in sector x , is average capital in sector y and is average capital in the economy at time t .…”