Levies, charges, dedicated pots - we have a plethora of taxes that are ringfenced for particular purposes. In this blog, Research Director Aveek Bhattacharya, argues that despite its popularity - such ringfencing should be used more judiciously.
The government’s decision last month to increase university tuition fees had several implications, but one, easily overlooked, is that it represents continued endorsement of one of our biggest hypothecated taxes. If you’re unfamiliar with the term, a hypothecated tax is one where the revenue it generates is earmarked for a particular purpose. Pedants might quibble over whether student loan repayments technically count as a tax, but deducted directly from people’s payslips and funneled to universities, they operate as one, whatever you call them.
The decision wasn’t surprising – in government, Labour has tended to fall in with the technocratic consensus, which in this case is pro tuition fees. What is more peculiar is the way the wonk class, generally highly sceptical of hypothecation, has been so willing to support it for university funding.
Their scepticism is well grounded, and if anything, the experience of tuition fees has demonstrated the problems with hypothecation. The beneficiaries of hypothecation may see their budgets protected at the expense of potentially more needy or deserving causes. Over the course of the 2010s, per student funding for universities rose, even as it fell by 14% for FE college students and 9% for schools. Conversely, they can be squeezed if tax revenue does not rise to meet need, as has been the case in recent months as universities struggle to deal with inflation and a fall in international student numbers.
The temptation is to see this as a bit of an anomaly. The conventional wisdom in Whitehall and Westminster is that the Treasury hates hypothecation, understanding the problems of muddling revenue raising and spending, and so won’t tolerate it. But that conventional wisdom is mistaken – once you start looking for them, hypothecated taxes are everywhere.
Sometimes, hypothecation is merely symbolic or illusory. Most prominently, national insurance contributions go into the national insurance fund to pay for contributory benefits, but the common practice of using government grants to top up the fund with whatever it needs means that in the words of the Institute for Fiscal Studies “the separation of the NI Fund from the main government account [is] more or less meaningless”. Similarly, Boris Johnson’s Health and Social Care Levy (since repealed) was presented as a hypothecated tax to fund the NHS, but raised too little money to have demonstrable impact on health and care spending. The same could be said for the immigration health surcharge.
In other cases, it is unclear whether hypothecation occurs at all. One example we have highlighted at the SMF is the Immigration Skills Charge, which despite its name, does not go to the Department for Education. Similarly, revenue from the soft drinks industry levy (the “sugar tax”) were initially earmarked for programmes to tackle childhood obesity, but have since ben subsumed into general taxation.
Equally, hypothecation can be taken too literally. There is nothing to stop the government directly funding apprenticeships, but in practice it has relied only on the ‘underspend’ from the apprenticeship levy. As a result, small businesses depend on big businesses failing to invest in skills if they are to get any support in taking on apprentices. It is no coincidence that apprenticeship starts have declined.
The broader pattern is the profusion of a panoply of small charges, sustaining little schemes or programmes, protecting them from the question of whether they really represent the best use of money. There is the Agricultural and Horticultural Development Board Levy, which farmers are required to pay to fund an organisation to promote their industry. There is the Horse Race Betting Levy, a tax on betting used to subsidise horse racing. There is the TV licence fee, a perennially contentious and roundabout way of funding public sector broadcasting.
Some of these are more justifiable than others, but what they share is a desire to ringfence a set of activities and insulate them from the scrutiny faced by the rest of the public sector. Given how many are administered by the non-Treasury departments, it seems likely they are a way of wresting some power back from the almighty finance department. The terminology (“levy”, “charge”) deliberately obfuscates the reality of a tax, and in some cases goes a step further by outsourcing the collection and handling of the money. To the extent we as citizens and taxpayers want to ensure public resources are used well, we should resist such efforts.
It would be too rigid to say that hypothecation is never acceptable. It has particular potential as a means of winning public consent on contentious issues. Charges on immigrants for healthcare and skills, for example, can symbolically make salient the contribution migration makes to funding public services.
But hypothecation should be used sparingly and judiciously. Policymakers should be alert to the arbitrary ringfencing of budgets that can be hard to reverse, and particularly conscious of the risk of under-funding worthy causes if their tax does not raise enough. The lot of most administrations, but particularly the current government, is to balance good governance with what plays well with the public. Hypothecated taxation is just another front in the eternal battle between politicians’ technocratic and populist instincts.
