In my opinion
IMO B

For reason that upon negation, I feel B is the option that addresses both the problems .
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Para-

levy of sales tax >>> excess allotment for improvement in education.
In a county of the state -- Representative Smith has prepared blueprints detailing 3 new schools and 2 roadways designed to be unaffected by floods.

Requirement -

the largest obstacle facing Representative Smith's plan to use sales tax revenues to build additional schools in outlying areas of County X

Solution -
Actually, choice E is straight answer, as it tells us that the funds can be allotted only for the construction or remodeling of school buildings, and curriculum improvements, so the proposal of Rep Smith is not covered under the planned expenditure.

But what could be other reason that one can think of-
1) The funds earmarked are less.
2) The original plan does not include such expenditures.
3) There is already excess of schools in the general area.

A. County X has rejected a proposal to establish toll stations along frequently-traveled roads in the county, even though funds raised were to be directed to Representative Smith's project
We are concerned with the government's allocation to Smith's project. So, out of scope

B. Students in County X currently travel an average of 20 miles in order to reach an existing school.
Again, this may be a reason to accept proposal, rather than reject, as roads are bad, and students have to travel on such a large stretch.

C. More densely populated counties in State Y will receive a larger percentage of the total revenues generated by the sales tax increase.
We do not know the cost of Smith's project and the population of county X.

D. Provisions of the sales tax revenue rules allow funds to be used for any project impacting the education of at least 2% of students in County X.
Again nothing about the number of students and what is the likely coverage by this project.

E. The state has stipulated that sales tax revenues designated for education be used only for the construction or remodeling of school buildings, and curriculum improvements.
If the project does not fall into the proposed expenditure, the project would of course be rejected.

E
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Why is the answer E . It is clearly stated in E that the additional funds will be used in construction or remodeling of school buildings

Smith wants 3 new school and 2 roads, where as the funds are for construction or remodel king of school buildings.
So neither NEW schools are allowed nor construction of roads.
What is allowed is school buildings only?
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Official Explanantion

Situation:A lawmaker proposes to use state money to build more schools in outlying areas of County X, where roads are often closed due to flooding. The lawmaker's plans include proposals for both schools and more dependable roads. Reasoning:Which of the following is most damaging to the plan to build more schools? As the passage makes clear, the success of Representative Smith's plan depends on the ability to complete two different construction projects: new schools and new roads. If for any reason there will not be funding available for both of Representative Smith's projects, his plan will likely not succeed. (A) This option, though it demonstrates a lack of additional financing, does not present an obstacle to Representative Smith's plan as detailed in the passage. (B) This option may strengthen the argument for additional schools, but it does not directly address Representative Smith's plan. (C) The amount of revenue directed to other counties in State Y is not directly relevant to a plan for County X. (D) This option would actually strengthen Representative Smith's plan, because it would allow funds to be used for the construction of both schools and roadways. (E) This option correctly identifies the major shortcoming of Representative Smith's plan: if the state will not allow funds to be used for the construction of new roads, then the plan to build both new schools and new means of
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