THE RESPONSIBLE TAX LAB

Is the time right for (more) tax hypothecation? Follow the money: Is the time right for (more) tax hypothecation? Contents

Forewords 4

Stella Amiss, PwC UK

Paul Morton, Office of Tax Simplification

Executive summary 5 www.responsibletax.org.uk 1. Introduction 9

2. Arguments for and against hypothecation 13 About the Responsible Tax Lab 3. Hypothecation in practice: A review 17 The Responsible Tax Lab is an ambitious programme led 4. What could (and should) hypothecation achieve? 25 by Common Vision (CoVi) focusing on how businesses and civil society can work together to design and encourage a 5. Conclusions and next steps 36 responsible tax system. Through the Lab we convene people and organisations who want to be proactive and aspirational in developing and providing the practical ideas, tools and resources that would make our future tax system fit-for- End notes 40 purpose. Acknowledgements 44 See more online at www.responsibletax.org.uk

1 Is the time right for (more) tax hypothecation? Forewords Paul Morton, Tax Director, Office of Tax Stella Amiss, Head of Tax Policy, PwC UK Simplification, HM Treasury

The concept of tax hypothecation has become the subject A few years ago there was a provincial tax in a large country of much recent attention from politicians, the press and the not far from Europe called “the tax in support of the local public at large as government wrestles with how best to raise football team”. It may be that this was a particularly popular the funds it needs for public finances, while at the same time way of raising more revenue although those who were not looking to rebuild the trust of taxpayers. soccer enthusiasts might have been less impressed. This is, perhaps, an extreme example of a hypothecated tax, dedicated At PwC we think that the time is right to go back to explore to a particular cause but, in principle, why would an “NHS tax” tax hypothecation from first principles, to discuss possible be any different? objectives and applications in a balanced way that evaluates the benefits along with the limitations of using a hypothecated However, before addressing this question, there is a need for approach. We are interested in exploring whether the potential greater insights into current public understanding of how benefits outweigh the drawbacks to see if some form of taxes are raised and spent - even among highly informed and hypothecation could be a useful addition to the Chancellor’s politically connected individuals as well as other taxpayers and toolbox. citizens. How many people know that total taxes raised in the UK equate to around £10,000 per head? Or that spending on This is why we wanted to work with Common Vision’s health is around £2000 per head or 20% of the total? Armed Responsible Tax Lab, to bring together a range of interested with these facts would a member of the public say that we stakeholders from government, public bodies, think tanks, civil should spend more in total, or more on health or just more society and the accounting and tax profession to debate these out of the same total collected on health? Perception is as issues alongside a review of academic and policy literature. important as anything else in this context. These discussions have been lively and have generated a wealth of insights and views. I hope that this report will prove An important precursor to acting on hypothecation will be to to be helpful in contributing to a wider debate around whether ensure that people can recognise and understand what the tax hypothecation is something that Government should tax system, or individual taxes, exist to do. In the public eye, be seriously considering to help the understanding of, and fairness has become a central requirement of the tax system engagement with, our tax system. although there is of course no single sense of what is fair. In

2 3 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? this context it is unfortunate that many comments and studies on hypothecation are not quite as balanced as they might be. But this report from Common Vision’s Responsible Tax Lab presents the issues in a very objective way and for that reason is particularly persuasive. The arguments for and against are explored methodically and hypothecation is presented not as a silver bullet but as a tool to be deployed intelligently by tax policymakers as one possible element of a well-designed tax system.

Executive summary

4 www.responsibletax.org.uk and commentators of hypothecation are often talking at cross purposes. There is often confusion over what is actually meant by hypothecation, with different understandings of how a specific The speed read... tax (such as a healthcare tax) would work in practice. ‘Strong’ hypothecation – whereby the tax would wholly cover the cost of the The concept of hypothecation, where revenues from specific service - would mean that all spending for the service may be tied taxes would be ringfenced for a particular expenditure purpose to a single tax revenue, while at the other end of the scale, ‘weak’ – and publicly communicated in this way – has become the hypothecation ‘ allows one or both of these conditions need not subject of growing interest and attention from politicians, apply. public bodies and the press. There is a need to more clearly define hypothecation and the It is increasingly cited as a potential way to address the challenge of different ways in which it could be implemented. Section One of funding the rising demand on health and social care services. There this paper explores some of these definitions and the differences is also growing public interest in how hypothecation could act as between them. tool to legitimise tax increases and increase public engagement and Section Two considers the advantages and drawbacks of trust in the tax system. hypothecation in its different forms. It has the potential to generate This is by no means the first time hypothecation finds itself in vogue public trust and confidence in the system if used appropriately, but – over the course of history the concept has repeatedly entered the there are concerns to consider around how hypothecation could imaginations of those looking for new solutions to public funding undermine the social contract which underpins the tax system, and challenges. And hypothecation is already used in various forms and how it could remove government’s flexibility and ability to respond guises in the UK and internationally. Yet it has traditionally been to public finance pressures. unpopular with many policy experts and economists because of Section Three looks at some examples of hypothecated revenue notable challenges, relating to complexity, transparency, and public models, and the parallels that can be drawn from previous perceptions, with which it is associated. As a concept it remains fairly experiences. divisive, with ardent proponents and sceptics, and not many views in

between. Section Four outlines a series of goals for which hypothecation could be used, and the questions, or ‘tests’ that policymakers could apply One of the reasons behind these polarised views is that proponents

6 7 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? to these when considering whether hypothecation is the best answer. Different means other than hypothecated models may be just as suitable and effective to achieve the same goals. 1. Introduction

Section Five brings together some conclusions. Although it has potential as an idea, hypothecation is not a silver bullet solution, What is hypothecation? whether for revenue raising purposes or as a tool to increase public Examples of hypothecation have been around for centuries, from trust and accountability. There are some circumstances where it Ancient Greece when taxes were imposed on those who used may be used to achieve specific benefits, but there are a number of certain facilities such as roads, harbours or bridges to pay for these fundamentals that must be addressed to underpin the success of any amenities, to the ‘ship money’ tax levied by Charles I in 1634 to pay hypothecated tax. These include good communication and public for naval defence (without Parliamentary consultation) which is said education, not only about the objectives of the specific tax, but the to have provoked the English Civil War. purpose of the tax system overall. As with other tax mechanisms, rigorous policymaking is key to its effectiveness, from the pre- In the modern age, there are numerous examples of taxes that implementation consultation process, to scrutiny, transparency have been described as ‘hypothecated’. Interpretations of their around implementation successes and challenges, and defined precise form, however, will tend to vary between that of ‘strong’, impact measurement. Hypothecation needs to be considered in ‘weak’, ‘wide’, or ‘narrow’ hypothecation, and in some cases the context of how the current tax system works, so any benefits to ‘presentational’ hypothecation which as the description suggests is public trust and accountability would be undermined by an overly not hypothecation at all in its technical sense. complex system, so simplicity is also important. These are challenges, It is often assumed that national insurance is a hypothecated tax but they are also opportunities to take a holistic view of the tax dedicated to funding healthcare and state pensions. However in the system. In this sense perhaps hypothecation is a lever, not a solution, UK, the income brought in from national insurance contributions to reap long-term societal and democratic benefits. doesn’t always cover the total cost of pensions and benefits and therefore cannot be viewed as a strong form of hypothecation, or indeed hypothecation at all.1

More recently there has been growing recent interest and media commentary on a dedicated health tax for the NHS. Recent analysis

8 9 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? of the British Social Attitudes Survey 2017 by the King’s Fund found produces an increase in anxiety and depression), just when revenues that 61% of respondents supported tax rises to increase funding for are falling. It makes no sense to spend more on health... in boom the NHS, of whom 35% supported a separate tax, with 26% happy to times just because revenues are higher.” 3 A ‘weaker’ model would pay more through the existing tax system.2 allow for a ‘top-up’ tax for the NHS but this then may not provide enough of a direct link between the tax and the service provision. This interest amongst policymakers and commentators however, This is why clarity over definitions are important. is by no means new – indeed hypothecation has been labelled a ‘zombie’ policy because of its ability to be resurrected as an idea. Various policy research studies were carried out in the 1990s Definitions of hypothecation and early 2000s, including a study by the Institute of Healthcare Hypothecation is generally defined as the ring-fencing or earmarking Management (then known as the Institute of Health Services of a specific tax, where the receipts from that tax are spent on a pre- Management) which reportedly concluded that general taxation defined public service or benefit. That said, the term ‘hypothecated remained the best way of funding healthcare, but that some form taxes’ can have a number of different meanings.

of social insurance could provide an alternative source if political ‘Strong’ hypothecation – is defined as a tax which wholly constraints prevented general taxation from delivering optimal levels covers the cost of a public service or benefit. Julian Le Grand of resources. (2003) defined the definition of stronger hypothecation as when “revenues from the tax concerned are only used to The key problem with the debate on an ‘NHS tax’ to date, we suspect, fund a particular programme or service, and there is no other is that proponents and commentators are often talking at cross source of tax funding for that programme”. purposes, with different understandings of how an NHS tax would ‘Weak’ hypothecation - is when either one or both of these work in practice, or indeed which particular health or social care conditions do not apply - either the service is funded by services NHS funding presently covers. ‘Strong’ hypothecation – additional revenues as well as the hypothecated tax, or the whereby the tax would wholly cover the cost of the service - would tax revenue is used for other purposes. mean that all public health spending may be tied to a single tax revenue, and therefore is heavily dependent on economic trends as If we are talking about funding an entire public service (e.g. education) via a hypothecated tax, we would be speaking well as the public mood. Additional issues can arise if hypothecated of ‘wide’ hypothecation. Whereas, targeting a specific area taxes create a surplus which then cannot be used for other services. within the remit of education (e.g. nursery education) would The Barker Commission (2014) found that “demands on the health be ‘narrow’ hypothecation. service may well rise in times of recession (as unemployment

10 11 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? There is also what some refer to as ‘presentational’ hypothecation. This describes a situation where the introduction of a new tax, or the increase of an existing tax, is presented publicly as having the purpose of funding a specific service, but for which there is 2. Arguments for and ultimately no evidence of direct correlation between the revenue generated and the amount spent. (For example, in 2002 Gordon Brown said he was raising national insurance contributions to against hypothecation increase NHS spending. However, many have argued that there was no actual link between the tax rise and the increase in NHS spending.) Many would argue that this is not hypothecation at all, Hypothecation has historically met with resistance from but it nevertheless factors into the public debate. both policymakers and economists. From the perspective In terms of how tax hypothecation works in practice, policies would of policymakers, it might be seen as tying the hands of be introduced at the start of each Parliament or via a Finance government and obstructing flexibility in what it can spend, Bill package, in the same way as other taxes, and subject to a when and where. Economists, meanwhile, have tended to Parliamentary vote (although pledges may feature beforehand focus on technical concerns, most notably funding a service in election manifestos). Some analysts have suggested that tax from a specific stream of tax revenue makes that service far too increases for specific purposes could be presented to the public in the form of a referendum4, although this option looks increasingly reliant on fluctuations in the revenue. However, there are also politically unpopular given criticisms of recent referenda in the UK. concerns that hypothecation might give taxpayers a false sense of ownership in relation to the hypothecated tax in question.

The common arguments against hypothecation are summarised below:

• ‘Revenue vulnerability’ - The idea that the ability of the tax base to pay does not always equate with the need for a particular service. Hypothecation leaves it vulnerable to fluctuating revenue levels, particularly during a recession when services might be most needed.

• ‘Tax populism’ - An approach which aims to tie taxes to public

12 13 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? support may mean more revenue for services which are popular The public confidence benefits may be the main issue underpinning with the public, at the expense of those which are most in need more recent popularity of hypothecation. The idea of providing of support.5 Does presenting certain taxes as a ‘choice’ undermine taxpayers with a greater sense of where specific tax money goes the social contract on taxation as a whole? has attracted plaudits from some big names in the world of popular culture. Rapper Jay-Z, for example, spoke about a willingness to pay • Political transitions and ‘policy insultation’ - The idea that more tax “if it went to the things which really mattered”8, while pop politicians may be able to limit the behaviour of their successors group Girls Aloud supported “a breakdown of exactly where our by introducing a hypothecated model which may be difficult to taxes go.” 9 reverse in future years.6

The arguments in favour of hypothecation, meanwhile, often view it There is also evidence that hypothecation would be well received as a means for: by the public, at least in theory. Recent analysis of NatCen’s British Social Attitudes survey data by the King’s Fund has shown a notable • Transparency - offering clarity to taxpayers on how and where rise in public support for a hypothecated tax for the NHS.10 In 2017, money is spent. 35% said they would ‘pay more through a separate tax that would go • Accountability - allowing the public to hold the government to directly to the NHS’ if there was an increase in NHS spending, up from their spending promises and guaranteeing that money will be 24% in 2014. The same research holds that support for increasing spent on a particular service. taxes to fund the NHS transcends both income and age brackets.

• Amplification- the narrative accompanying the tax may reinforce On the other hand – and as hypothecation’s detractors have the behavioural change which the tax seeks to address.7 noted - the positives listed above could arguably also be achieved through other means and not solely through the implementation of • Predictability - earmarking the revenue from taxes may allow a hypothecated taxes. Still, it is an interesting topic of debate in which degree of predictability of future revenues. we find one line of reasoning being used by both those in favour • Broader public engagement - research has shown that the public of hypothecation and those against its use, as is the case with its might be more amenable to new and increased taxes if they supposed political and democratic implications. value the service being funded. This is true of recent discussions around a hypothecated tax for the NHS. Public support and Currently, governments are elected and then mandated to set taxpayer morale contributes to the perceived legitimacy of the taxation policy based primarily on their election manifestos, but tax system and may help reduce the ‘tax gap’ on this basis. also in response to emerging political, economic and demographic

14 15 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? factors. In the UK, taking decision-making powers away from the Treasury in favour of allowing the public to, for example, vote on or influence tax policy in a more direct manner, has been described as 3. Hypothecation in both a benefit and a risk to democracy. “In principle hypothecation represents a fundamental shift practice: A review in the democratic nature of society, given that at present the elected government is responsible for allocating resources, and has to account for its decisions to the electorate. The job of Where has hypothecation worked and where do problems politicians might become just a matter of lobbying voters on arise? This section looks at examples and experiences of the future uses of tax revenues before a referendum.” hypothecated revenue models in the UK and elsewhere. - House of Commons Library, 08/05/02, The National Insurance TV license fees (UK) Contributions Bill – Bill 130 of 2001-02 – Research Paper 02/32 TV licence fees are an example of taxes which are levied on users There is a further consideration about levels of current public of specific services (any household who accesses TV broadcasts or trust in the political system. If public distrust for government and downloads via BBC iPlayer), revenue from which is earmarked for decisionmakers is high it can impact on people’s willingness to pay the BBC, making up over 70% of the BBC’s total income. This allows tax. In this context, a stronger case for tax choices and/or limiting the the public to make a direct link between their fee and the service power of government could be made. Conversely, those who do not or entertainment they receive from the BBC. The direct connection hold confidence in a voting public can argue that adding an element between those paying and those providing the services also make of choice into taxation from the payer’s perspective would be an the BBC more accountable for how licence fees are spent. It has unnecessary risk and one which could heighten levels of conflict therefore been referred to as a, “form of shared investment.”12 In between single-issue campaigners competing to have their causes a 2016 survey, 41% felt that the fee was still the best way to fund funded by the state. the corporation, while 29% believed that the licence fee should be scrapped.13 That said, as around 30% of the revenues are not raised by the license fee, significant changes to the BBC funding can be made outside of this ‘hypothecated’ model meaning it is not ‘strong’ form of hypothecation.

16 17 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? What qualifies as a tax in the first place? these on to the end user, as with VAT.

The word ‘tax’ is an umbrella term which may be used The word ‘tax’ is often used interchangeably with interchangeably with other words; the various terms ‘duties’, ‘tariffs’ or ‘levies’, but these tend to be used when are by no means used uniformly in the public debate. discussing a tax imposed by the state on particular The OECD working definition of a tax is a compulsory, goods or assets. A ‘levy’ might also be used to refer to a and unrequited payment to the government – that is voluntary payment, which is not enforced by the legal taxpayers must pay their taxes by law, and they do not system and which individuals or companies can opt-in receive something bespoke in return. or opt-out of. A ‘charge’ is generally also specific to an issue or service, and is often not exacted or managed “Taxes are compulsory, unrequited payments, in cash nationally by the national revenue authority (such as or in kind, made by institutional units to government the London congestion charge, managed by Transport units; they are described as unrequited because the for London). By avoiding certain patterns of behaviour government provides nothing in return to the individual people (e.g. not driving in central London on weekdays), unit making the payment, although governments may individuals can minimise their liability for these charges. use the funds raised in taxes to provide goods or services Levies or charges are more likely to be temporary or to other units, either individually or collectively, or to the one-off, whereas taxes tend to be regular or ongoing community as a whole.” contributions. None of these definitions necessarily - OECD Glossary of statistical terms11 imply hypothecation because the revenue collected does not have to be earmarked for a specific purpose Direct taxes are paid to the government by individuals (although they may be more likely to be presented or organisations based on their own wealth or earnings as such in the case of levies or charges) and there is (such as income or corporation tax), whereas indirect no hard-and-fast rule about whether each definition taxes which are applied to and paid by an intermediary requires collection into a consolidated fund or a specific (e.g. a manufacturer) who then adds the amount of the fund, which is why the terms are often conflated in the tax paid to the value of the goods or services and passes public debate.

18 19 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? Social care funding in the UK and abroad the Local Government Association.17 (Germany and Japan) There are international examples of hypothecated social care As discussed earlier, it is often assumed that revenues from national funding in places such as Germany and Japan. Germany introduced insurance are ringfenced for healthcare and pensions, whereas in social care insurance in 1995 and moved to fund it with individual fact this is not the case. salary deductions that were then matched by an individual’s employer. The fund was in a healthy state 20 years later when it was New calls for the use of hypothecation in relation to NHS and/ said to hold €8.3 billion in reserve.18 In Japan, since 2000, people over or social care funding have gathered pace since 2017. A ‘weak’ the age of 40 in Japan have been obliged to pay into an elderly care form of hypothecation was proposed in the 2017 manifesto of the insurance system and, in addition, there is a system of co-payment in Liberal Democrats when it spoke of earmarking an additional 1p place for state medical services.19 in additional income tax for “identified priorities”, such as social care.14 The same year, the Communities and Local Government Many have argued that these models have addressed some of Parliamentary Committee recommended that a funding review the major challenges faced by the UK’s system successfully.20 In dedicated to social care funding should encompass consideration of 2017, the Local Government Parliamentary Committee expressly hypothecation and whether the introduction of the social insurance recommended looking into the feasibility of “introducing models seen in Germany and Japan would be feasible.15 In 2018, compulsory social insurance, publicly owned and administrated, three politicians from three different parties included hypothecation on the German or Japanese model” in order to increase revenues solutions such as renaming national insurance and channelling it for social care.21 However, any move to use hypothecation to raise into a dedicated ‘National Health and Care Fund’ when making their additional funding for social care would be a big change to the 10 recommended principles of long-term funding for NHS and social current system and could add to problems of alignment seen care.16 between health and social care.22

Beyond the political promises, a ‘truer’ form of hypothecation Devolution and local hypothecation can be found in practice in the social care precept used by local Can we draw parallels between hypothecation and devolution? government. Introduced in the UK in 2016, the social care precept If, for example, the UK grants Scotland, Wales, Northern Ireland allows local authorities to raise revenues for the specific purpose of or even some cities control over taxes and spend, this could be funding social care. In 2018/19, this is estimated to bring in an extra construed as a ‘weak’ form of hypothecation if the devolved taxes £548 million for funding social care services this year, according to

20 21 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? fund expenditures that are under the direct control of the devolved – are earmarked as contributions to the Special Energy and Climate administrations in question.23 This opens up the possibility of looking Fund. The creation of this fund is said to ensure that revenue is truly at the merits of locally hypothecated taxes. hypothecated to spend on climate change initiatives – for example in 2013, the fund allocated 19% of its budget (€260.8m) to ‘building A good example comes from Wales, which took control of land restoration and energetic urban renewal’ and 9.5% (€132.4m) to transaction tax and landfill disposals tax in April 2018 but has also ‘energy efficiency’. However, while receipts from the EUETS might be been looking at how it can develop and secure the necessary powers ‘hypothecated’, the payments made under the scheme are not taxes for other new taxes.24 25 This has included a poll carried out on social under the OECD definition, as companies receive something specific media and which attracted roughly 1,000 responses that was used for the money they pay into the fund. to gauge popularity for an initial shortlist of ideas.26 These ideas included a disposable plastic tax and a vacant land tax – the former Behavioural taxes of which proved to resonate most strongly with voters and the latter Although disputed in principle by some free-market economists, the of which has been named as a priority for testing the Wales Act 2014 tax system is frequently used to either encourage or disincentivise powers.27 certain behaviours, and communicated in this way. The extent to which these examples could be viewed as Tobacco tax is one example. Gordon Brown’s announcement in 1999 hypothecation depends on whether the tax is raised for a specific that additional revenue raised from real increases in tobacco duties purpose, and whether it aligns to a specific spending area. would be allocated to health expenditure is an example of weak Germany’s Special Energy and Climate Change hypothecation. This is because it is hard to link the rise in duty to the Fund government’s increase in health expenditure - tobacco duty rose by 5% in real terms in 2000, yet the extra revenue generated would only A number of EU economies have made a commitment to recycle the represent a little under 5% of the increase in spending on the NHS proceeds of the EU emissions trading system (EU ETS), a pillar of EU that same year.28 climate policy that uses a ‘cap and trade’ mechanism which allocates or auctions greenhouse gas emission allowances to companies The sugar tax on soft drinks, implemented in April 2018, is an within the scheme (and fines companies who exceed these example of a hypothecated tax because the revenue generated is allowances). The vast majority of Germany’s revenues raised from this earmarked for activities in schools and breakfast clubs. The tax is process – at an estimated worth of €18bn between 2014 and 2020 levied on manufacturers who decide whether to pass the costs onto

22 23 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? consumers. Part of the rationale for the policy was to discourage people from buying sugary drinks by making them more expensive, but another result has been the reduction of sugar content in products, meaning that the predicted revenue generated from the 4. What could (and tax has fallen from an original Treasury forecast of £500m to £240m a year.29 This shows that success in terms of impact may not always be tied to income raised. should) hypothecation

The plastic bag ‘tax’, a 5p charge for plastic bags introduced in England in 2015 (charges were introduced in the rest of the UK achieve? Questions for earlier than this) is contested as a hypothecated tax because, despite its link to environmental causes, those charging for the bags do not hand the money over to the government but are expected to make policymakers donations to environmental and community-focused charities.30 That said, it has frequently been referred to as a tax in the media and by politicians, demonstrating that this sort of public framing can There is a key distinction to be made as to whether we are simultaneously lead to support and criticism for the so-called ‘tax’ discussing hypothecation as an effective technical solution to itself. funding concerns or as tool for improving communications and public engagement around tax. Supporters and opponents of the concept often refer to just one aspect and not the other – but there are arguments both ways. Technical challenges are not insurmountable, but it is also important to remember that different means other than hypothecated models may be just as suitable and effective to achieve the same goals.

24 25 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? Goal: Revenue certainty for specific services

As discussed previously, one of the benefits of hypothecated taxes has been seen as the promise of revenue for specific services. This use may be most effective when there is a clearly identifiable pool of users on whom the charge is levied (such as the users of a specific transport service) or on a universal service that does not cause disagreement across the political spectrum or successive governments. However if ‘strong’ hypothecation is used, this model may undermine revenue certainty if tax is tied to economic performance. And revenue certainty is not true of taxes which aim to change behaviours such as reducing smoking or the use of plastic bags, as successful taxes of this nature would eliminate specific behaviours and therefore the tax itself!

Questions and considerations:

• Is there a defined user group who benefits directly from the service and would they view the charge as legitimate? • If a universal service, does it have sustained support across the political spectrum therefore reducing the need or likelihood for the ongoing revenue stream to be contested by new governments? • Would the intended benefit of the tax be undermined or strengthened by ringfencing where revenue is spent? For example, would people stop using a specific public service if an individual usage charge was levied, or would they feel entitled to certain ‘anti-social’ behaviours (such as littering if the tax was communicated as a litter-picking fee)?

26 27 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? Goal: More public support for tax increases

Arguably, the ability to ‘follow the money’ in where taxation has been spent by a government could boost transparency and become the backbone of rebuilding public trust in taxation and in redefining the social contract between tax authority and taxpayer.

However, these positive outcomes could be translated into negative ones if there is a lack of public support for a policy, such as defence spending. Even popular causes could result in the sense that hypothecation introduced is seen as being a ‘fraud’ – i.e. if the direct link it communicates between a tax collected and how this money is spent is seen as being misleading. Or if those making the decisions are not seen to be doing so in a legitimate, transparent or ‘fair’ way. This is where open consultation and taxpayer education is important.

Questions and considerations:

• What are the fundamentals of good tax policy making – from formulating policy to scrutinising impact and effectiveness – that should be applied to hypothecated models?31 • What other taxpayer education initiatives could be employed to strengthen the social contract on tax and allow the public to scrutinise government economic policies? • Is public support more likely if the governance of a proposed hypothecated fund remains with elected politicians, or should revenues be overseen by an independent board or public body? • Would the requirement for public accountability imply a trade-off between the simplicity of ‘strong’ forms of hypothecation, with the flexibility of ‘weaker’ models? • What time limitations or sunset-clauses could be introduced to produce a ‘short, sharp’ effect that kick starts public support, but without leading to eventual decreases in taxpayer morale if the hypothecation ‘leaks’ into other areas?

28 29 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? Goal: Better public understanding of the tax system

As we have discussed, hypothecation has huge potential for engaging with the public on tax. It opens up the possibility of helping taxpayers understand exactly why a tax is collected and how it will be spent. This, in turn, might allow taxpayers to feel more invested in a system of taxation – even if they are not having a direct say in how a tax is hypothecated, they can feel reassured that they are making a positive contribution.

On the other hand, these outcomes need not be pursued by hypothecation alone. For example, more could be made of HMRC’s Annual Tax Summary – a transparency initiative that aims to communicate to individual taxpayers how their taxes are spent with the use of a colourful pie chart - of which people are often unaware or which raises more questions than it answers.

Questions and considerations:

• What does the public expect in terms of information, communication, and transparency of the tax system? How does this differ across different generations, life stages or backgrounds? • How can we achieve balanced media reporting and responsible public debate when it comes to tax decision-making? How do we achieve clarity and understanding of whether policy proposals are for ‘strong’/ ‘weak’, or ‘wide’/’narrow’ hypothecation? • Even if further hypothecated models were introduced into the tax system, what sort of public education process would need to accompany such measures? • What are the opportunities afforded by new technologies to encourage taxpayer engagement and interaction? • Does public communication around tax policy require more fundamental simplification of the tax system, and does hypothecation by definition introduce more complexity to the tax system?

30 31 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? Goal: Effecting wider change beyond the collection of tax revenues

As some behavioural taxes have demonstrated, hypothecation may be a useful way of ‘amplifying’ a specific message both to consumers and taxpayers, but also others indirectly affected. The Behavioural Insights Team has commented that the greatest gains of the new ‘sugar tax’ are likely to come from ‘reformulation’ – i.e. the tax’s effect on companies cutting the sugar content of their products to avoid the tax32 - as opposed to simply shifting consumer purchases.

Politicians also often propose taxes as a way to re-distribute resources across socio-economic groups or generations (an increase on inheritance tax that would fund a government grant for young people, for example). However, the limitations here are that the proposed impacts are often hard to measure and evaluate, whether that is social mobility targets or the living circumstances of young people.

Questions and considerations:

• Could tax hypothecation be used to address an immediate need or desired behavioural change as opposed to being seen as a long-term solution? What time limitations or sunset clauses could be applied on this basis? • Who are the parties directly and indirectly affected by the tax and what is the desired impact on each group in the short and long term? • If the tax is being used for short-term resource redistribution, what other mechanisms are in place to prevent similar structural inequalities arising again in the future?

32 33 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? Goal: Participatory decision making

Possibly one of the most underexplored uses of hypothecated taxes could be the application to citizens’ direct involvement in decision making. The usual discussions of hypothecated taxes overlook an important normative question: Why shouldn’t people have a stronger stake in the decision making process over where our collective taxes are spent? In which case, what would an approach to public expenditure decision making look like beyond participation in elections? There are lessons here from participatory budgeting examples whereby members of the public have a say in how public budgets (or part of them) are spent.

Originating 30 years ago in Porto Alegre, Brazil, participatory budgeting activities and methodologies are used to guide deliberation on how a public or local budget is spent. In 2016 Portugal was the first county to announce a participatory budget on a national scale, in the form of a €3m pot open to proposals from the public on how it should be used, which would be subject to a vote from other citizens on which ideas are adopted.

Participatory budgeting methods have been used to varying effects but they are growing in uptake and in popularity in a disintermediated world where citizens are increasingly accustomed to making direct decisions facilitated by new technologies.

Questions and considerations:

• Is the desired outcome of citizen participation a more effective tax system, or is it one which has support from the greatest number of people? • Is it possible (and desirable) to discourage citizens from making taxation decisions based on self-interest and the services which benefit them as individuals? What mechanisms might avoid populist decisions that impact on the most vulnerable or excluded in society? How might disagreements within and between different communities of interest be managed? • Is it feasible to involve all members of the electorate in a decision about national tax policy, or would representative panels or citizens’ juries be a more suitable process? • Would a stronger engagement with tax decisions increase or decrease public participation in politics more generally, and would this overly ‘politicise’ the concept of taxation and undermine the social contract?

34 35 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? principle of Parliamentary sovereignty, where elected politicians are unable to reverse the decisions of their predecessors.33 For 5. Conclusions hypothecation to work in its ‘truest’ sense, it also becomes least flexible to changing public priorities.

There is also the issue of desirability for a direct link between the This report seeks to represent, compare and contrast a range tax system and the political process – a democratic process is vital of views about tax hypothecation, while avoiding the pitfalls to taxation but strong political links also undermine support for in the public debate that are caused by varying definitions and taxation - in many countries the distinction between the whims and heated political arguments. There are a range of issues to think wills of elected politicians and the independent stability of the tax about when considering hypothecation as a means by which system as a whole is seen as imperative to ensuring taxpayer trust. to raise taxation, and it is clearly not a silver bullet to public support or engagement in the tax system. All this does not mean however, that hypothecation is completely unworkable as a concept. Although tax is a social obligation, there Future work from the Responsible Tax Lab will explore the feasibility are ways to ensure it is perceived less as a burden by taxpayers. It still of specific blueprints for hypothecated taxes. We also hope to look stands that the value and appeal to citizens in terms of being able to more deeply at public understanding of the current tax system, ‘follow the money’ may result in gains in public trust and confidence, and how different presentational and practical frameworks would if implemented correctly. This may be even truer of younger citizens, contribute to this. who expect straightforward, accessible and transparent information One of the biggest concerns around hypothecation is the risk of in relation to other economic issues. undermining the social contract on which the tax system is built. It is clear that there are fundamentals which would underpin Any process which allows the perception that individuals can choose the success of any hypothecated tax. These include good which taxes they can pay, or leaves room for ‘moral’ objections and communication and public education, not only about the objectives refusals to pay tax, does not serve the system as a whole. Tax for of the specific tax, but the purpose of the tax system overall. more popular services or segments of the population can have Rigorous policymaking also needs to be considered, from the pre- unintended consequences for society as a whole. implementation consultation process, to scrutiny, transparency Another key risk lies in removing a government’s flexibility and around implementation successes and challenges, and defined ability to respond to public finance pressures, or undermining the impact measurement. To be effective, hypothecated taxes may

36 37 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? need to be seen as mechanisms for ‘short, sharp’ interventions that than involve all members of the electorate. would help kick-start change on an issue whilst also ensuring public Importantly, hypothecation needs to be considered in the context of approval. how the current tax system works. Any benefits to public trust and What do these considerations mean in the context of the current accountability would be undermined by an overly complex system, public debate? Hypothecated taxes need not address all of the goals so simplicity is also important. But to be more radically effective we set out in this paper. But it is important that policymakers are hypothecated taxes must account for the wider systemic forces at clear about their intention and how this will be achieved, that the play relating to behavioural change, democratic engagement and risks are accounted for, and that ringfenced models are not used as a public trust. These are challenges, but they are also opportunities ‘sticking plaster’ for more fundamental challenges. to take a holistic view of the tax system. In this sense perhaps hypothecation is a lever, not a solution, to reap long-term societal We would challenge the idea that hypothecation could be used and democratic benefits. for the broad purpose of ‘the NHS’. There is too much uncertainty about what these tax increases could cover, and whether this would entail an extension of, or improvements to, existing services. Failure to equate the increase in taxation with specific services or outcomes would undermine public support of the tax. Instead, any new healthcare tax would have greater success if ringfenced for a particular service or objective such as elderly care, preventative health, or mental health for example.

We would also encourage further exploration of the opportunities to innovate and think creatively alongside any eventual implementation of hypothecation, rather than hypothecating taxes in their traditional forms and formats. The success of hypothecated taxes would be strengthened through participatory budgeting elements. There is potential for the devolution process to link to hypothecation on this basis, whilst participatory decisions at a national level may need to take place through panels or juries rather

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9 Sophie Heawood (2006) Get lost, Cameron https://www.newstatesman. com/node/166013 [accessed June 2018] 1 Maric Glaser (2017) We assess the hyperbole about hypothecated taxes https://www.tax.org.uk/media-centre/blog/media-and-politics/we-assess- 10 Harry Evans (2018) Does the public see tax rises as the answer to NHS hyperbole-about-hypothecated-taxes [accessed April 2018] funding pressures? https://www.kingsfund.org.uk/publications/does- public-see-tax-rises-answer-nhs-funding-pressures [accessed June 2018] 2 Harry Evans (2018) Does the public see tax rises as the answer to NHS funding pressures? https://www.kingsfund.org.uk/publications/does- 11 OECD (2001) Glossary of statistical terms, https://stats.oecd.org/glossary/ public-see-tax-rises-answer-nhs-funding-pressures [accessed June 2018] detail.asp?ID=2657 (accessed August 2018)

3 Barker Commission on the Future of Health and Social Care in England, A 12 James Heath (2014) Why the licence fee is the best way to fund the BBC New Settlement for Health and Social Care: Final Report, King’s Fund (2014) http://www.bbc.co.uk/blogs/aboutthebbc/entries/9637e45d-c96c-36c6- cited in India Keable-Elliott, CentreForum (2014) Hypothecated taxation and 9e3f-af141e81cab4 [accessed April 2018] the NHS https://www.centreforum.org/assets/pubs/hypothecated-taxation. pdf [accessed April 2018] 13 Mark Sweney (2016) Survey shows 29% think BBC licence fee should be scrapped https://www.theguardian.com/media/2016/dec/16/bbc-licence- 4 Geoff Mulgan and Robin Murray (1993)Reconnecting Taxation, Demos fee-survey [accessed April 2018] https://www.demos.co.uk/files/reconnectingtaxation.pdf?1240939425 14 Lillie Wenzel et al. (2018) Approaches to social care funding https://www. 5 Julian Le Grand (2003) Motivation, Agency and Public Policy: Of kingsfund.org.uk/sites/default/files/2018-03/Approaches-to-social-care- Knights and Knaves, Pawns and Queens and O. Doetinchem, World funding.pdf [accessed June 2018] Health Report (2010) Background Paper 51, Hypothecation of tax revenue for health http://www.who.int/healthsystems/topics/financing/ 15 Secretary of State for Communities and Local Government, Government healthreport/51Hypothecation.pdf and Fabian Society Commission on Response to the Communities and Local Government Select Committee Taxation and Citizenship (2000) Paying for Progress: A New Politics of Tax for Report: Adult Social Care (2017) https://assets.publishing.service.gov.uk/ Public Spending government/uploads/system/uploads/attachment_data/file/650562/ CM9501_web.pdf [accessed June 2017] 6 C. Brett and M. Keen (2000) Political uncertainty and the earmarking of environmental taxes, Journal of Public Economics, 75, pp.315-340. cited 16 Nick Boles MP (2018), Ten principles of long-term funding for NHS and in Jeremy Jackson (2013) Tax earmarking, party politics and gubernatorial social care https://www.facebook.com/notes/nick-boles-mp/ten-principles- veto: Theory and evidence from US states. of-long-term-funding-for-nhs-and-social-care/1522885904504144/ [accessed June 2018] 7 Vaze & Sunderland (2014) The economic case for recycling carbon tax revenues into energy efficiency 17 Local Government Association (2018) Extra council tax income in 2018/19 will not protect under-pressure local services https://www.local.gov.uk/ 8 Faiza Shaheen (2017) Tax is getting a bad rap – it’s time to sex it up https://

40 41 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? about/news/extra-council-tax-income-201819-will-not-protect-under- for a new Welsh tax https://gov.wales/docs/caecd/publications/180213- pressure-local-services [accessed June 2018] new-tax-ideas-poll-en.pdf [accessed June 2018]

18 Sarah Neville, Leo Lewis and Guy Chazan (2017) UK social care 27 Welsh Government (2018) Developing new taxes in Wales https://gov. inquiry looks to Japan and Germany for solutions https://www.ft.com/ wales/funding/fiscal-reform/welsh-taxes/developing-new-taxes/?lang=en content/3507b50c-0276-11e7-ace0-1ce02ef0def9?mhq5j=e2 [accessed [accessed June 2018] June 2018] 28 Antony Seely, House of Commons Library (2011) Hypothecated taxation 19 Ibid. http://researchbriefings.parliament.uk/ResearchBriefing/Summary/SN01480 [accessed April 2018] 20 David Kingman (2017) England’s social care crisis: could Germany have the answer? http://www.if.org.uk/2018/03/27/englands-social-care-crisis- 29 Nick Triggle (2018) Soft drink sugar tax starts, but will it work? http://www. germany-answer/ [accessed June 2018] bbc.co.uk/news/health-43659124 [accessed June 2018]

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26 Welsh Government (2018) Informal poll about the four shortlisted ideas

42 43 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? Acknowledgements Sponsored by PwC

This workstream from the Responsible Tax Lab was sponsored by Editorial PwC.

Report by Caroline Macfarland, Director, Common Vision. This report At PwC, our purpose is to build trust in society and solve important was compiled and edited by Caroline Macfarland, based on working problems. Through our Paying for Tomorrow campaign we are group meetings and consultation. Any errors are the responsibility of committed to contributing to the debate on building a tax regime the author. that is fit for the future. Through this campaign we aim to gather a With thanks wide range of views in taking a strategic look at the tax system. As

With thanks to those who participated in our working group such, we hope that this study will help kick start broader thinking meetings: Alice Lilly, Institute for Government; Robert Palmer, Tax and debate around what type of tax system we need and whether Justice UK; Abby Gilbert, London Borough of Redbridge; Frank hypothecated taxes have a role to play. Haskew and Ian Young, ICAEW; Reema Patel, Nuffield Foundation; Ben Gershlick, Health Foundation; Elaine Kelly, Institute for Fiscal Studies; Richard Harries, Power to Change; Antonia Jennings, Economy; Faiza Shaheen, Centre for Labour and Social Studies; Mike Hyland, Grant Thornton and John Cullinane, Chartered Institute of Taxation.

Special thanks to Stella Amiss, Neville Howlett, Laetitia Lynn and Guilherme Pereira, PwC UK; Paul Morton, OTS; Richard Murray, Kings Fund; Ian Wood; Clare Payne, Barrow Cadbury Trust; Iain Campbell, Association of Revenue and Customs; Grace Stevens, Legal & General for their comments and feedback on drafts of this report. Thanks also to Tim Dhoul, Joe Skelton and Matthew Crowley from Common Vision.

44 45 www.responsibletax.org.uk Is the time right for (more) tax hypothecation? About Common Vision

Common Vision (CoVi) is an independent, not-for-profit think tank launched in 2014. We explore issues which require long-term,

Published in September 2018 by Common Vision UK, a company intergenerational solutions and which require solutions to reach limited by guarantee registered in England and Wales, number beyond conventional partisan debates or sector-driven interests. We 08837291. use creative and crowdsourced methods to promote civic engagement and policy understanding beyond a politically active minority, and to build a vision of society based on the common good. The text in this document is licensed under a Creative Commons AttributionShare-Alike 4.0 International License. www.covi.org.uk THE RESPONSIBLE TAX LAB