Earmarked Revenues and Spending Volatility: The Case of Highway Finance

Over the last decade, state governments have experienced two recessions (including the recent ―Great Recession) which have resulted in significant disruptions in state budgets and highlighted the volatility of the personal income tax and general sales tax. Since infrastructure maintenance funding may be particularly vulnerable to budget cuts during recessions, it is important to identify more stable revenue sources and budgetary institutions. One of the distinguishing characteristics of highway finance in the United States is the heavy use of earmarked revenues linked to highway users. Our key research question is whether an increase in the share of highway funding from earmarked revenues will reduce the volatility of highway budgets.

To answer this research question, we have collected extensive data on state highways, state finances, and other socio-politico-economic characteristics of state governments over a 30-year period, and developed an empirical model drawing from previous research in state and local public finance. We found that earmarking of revenue in state highway funds is significantly related to highway expenditure; however, the relationship is more nuanced than we originally hypothesized. An increase in the share of highway funding from transportation-related revenue sources or an increase in the share of transportation-related revenue from motor fuel taxes are associated with a decrease in volatility of state highway spending.

On the other hand, an increase in the share of transportation-related revenue used for highways is associated with an increase in budget volatility. Since the major alternative use of state transportation-related revenue is to fund local roads, this result indicates the importance of examining state-local intergovernmental finance on highway spending volatility in future research.