It’s not a new concept, but tax hypothecation is back under the spotlight. Most recently it’s been discussed to address the challenge of funding the rising demand on health and social care services in the UK. How can you understand the benefits and drawbacks? Are there ways in which it might be an useful addition to the Chancellor’s tool box? Listen to Tax Partner, Barry Murphy, Stella Amiss, Head of Tax Policy and Caroline Macfarland, Director at Common Vision (CoVi) discuss and explore some of the findings of the PwC sponsored CoVi report on hypothecated taxes.
Hello, my name is Barry Murphy, a Tax Partner at PwC, and welcome to the latest episode of our Talking Tax podcast, where we are discussing the most topical issues in the tax system today.
Today, it seems like tax is under pressure from all sides, whether it’s Brexit, whether it’s digitisation, everyone is worried about, is there enough tax to pay for the public services we want and where is it coming from?
People are asking is hypothecation the answer. Big word, but really its ring fence taxes for a specific purpose, think NHS.
I am delighted to say, I am joined by Caroline MacFarland, Founder and Director of Common Vision or CoVi, as is commonly known; and Stella Amiss, PwC’s Head of Tax Policy. Two true experts to talk about this topic today.
Caroline if I turn to you first, hypothecated taxes, it’s not a new concept, or is it?
No, there has been lots of recent political interest and media hype around hypothecation, but hypothecated taxes go back centuries really, and I think it has been labelled a zombie policy, because of the ability to be resurrected from the dead as an idea.
So, why is it interesting now?
I think, hypothecation has been used in various forms in the past. It’s now talked about in the sense of funding health care, because of the public budgeting constraints, and I think it’s seen as something which can help public engagement and participation in the tax system, and that’s why we are interested in exploring the concept.
Okay, so its centuries old, it’s a zombie policy.
So, Stella what’s policy wise, that’s your job, what its relevance today?
Well, today we’ve got quite a few challenges. We see a lot in the media particularly about how new taxes ought to be raised, and how we need new taxes. Now there is a bigger debate about whether that is right or wrong, but let’s assume we do need to raise taxes. Nobody likes paying tax.
Hypothecation or looking at ways in which you can use tax, which is hypothecated, could be a really good way to focus on a particular area, to identify a particular need, and to engage with the public so that they can understand, why taxes might need to be raised in that area. They might therefore feel a bit more willing and understand why they or others might need to be the people, who have to pay that tax.
Picking up on one of Caroline’s points, I think hypothecation has a real place in helping public engagement, and that’s something that we all think could do with more of in the tax arena. It is part of the reason why we have these discussions.
There is not enough discussion around the taxes that we need, and where the funds then come from. Who do you tax and why? But, hypothecation gets to the heart of that.
You said, people are willing to pay more for certain things, is there any evidence behind that?
We’ve seen in some recent surveys, particularly looking at the National Health Service, and every time the public are surveyed on whether or not they would be willing to pay more money if it went directly into the health service; so if the taxes that were raised, were ring fenced and protected for funding the health service, then huge percentages, 70% or 60% votes say ‘yes, people will be willing to pay more tax in that case.’
Okay, so a lot of ifs in there. If it was for this and if it went to that. It’s not new, it’s coming back into vogue, so obviously it isn’t a slam dunk, this will work for everything, and Caroline I know, you and CoVi have a report on this whole area coming out very shortly, so maybe we will start with you.
What are the pros and cons of hypothecated taxes that we need to think about?
I think in terms of the pros it is that sort of public support for raising revenue and for paying taxes really. I think that’s why it is now back in vogue as a concept. There are various cons and a lot of those are around the technicalities of things. The fact that what is seen as a hypothecated tax, may not end up being an actual hypothecated tax.
An example of that is with National Insurance. People assume that National Insurance has hypothecated, because its suppose to go towards healthcare and pensions, but in reality the income from NI doesn’t cover the total cost of these things, so then it can’t be seen as a hypothecated tax in its truest sense.
There is that confusion bit, where you say that a tax is hypothecated, but actually it’s only presentational, its framed like that, and it doesn’t actually happen, and so that undermines the public support that it is supposed to create in the first place. So, there is something around that.
The other really strong objection that we found across our consultation on this issue, is around tax populism. So, the idea that if people can pick and choose where their taxes are going, then that undermines that social contract as a whole and tax is seen as single item spends rather than a collective pot for the public good. So, there is something around there as well, which is quite important.
It is not that hypothecation can’t work, but there are lots of other fundamental issues that need to be addressed to make it work in practice.
In that consultation you mentioned that we know is part of that report, was there a really strong sense of, ‘well can I trust that someone will stick to what they say this is tax for, using the example of National Insurance?’
How strong was that feeling?
I think there is a fundamental language issue actually around the debate on hypothecation. People are talking at cross purposes about very different things. In the report we identify the differences between strong hypothecation and weak hypothecation, for example, wide and narrow, lots of other ways that people talk about hypothecation, but really they are not talking about the same thing.
Strong hypothecation means that a service is tied to a single tax revenue, that then has no other forms of funding. Whereas, a weak model might involve some sort of top up tax so that the service has more money than it already gets.
I think that’s one of the problems. People are talking about very different things, and they think they might be agreeing that hypothecation is a good thing, but actually they are talking about very separate models. To go back to your question, that then has an impact on the confidence in the issue on the whole.
As you look at tax policy, Stella, is there anything in what Caroline said that you will go at absolutely that’s an issue, or how would you view it from policy perspective?
I think the point that Caroline made about the tax populism is a really important point. That did come out very strongly in the discussions that we were having. If people can pick and choose, and contracting, if you like, with a particular issue, but then decide we would want to contribute to another issue, that is actually equally important, but for a particular sector of the population, might not be.
Somebody might be really happy to pay for healthcare, but not so happy to pay for environmental taxes. So, if you create a culture, where people think they can pick and choose, that becomes very difficult for anybody to manage on a go forward basis. So, I completely agree with that.
One of the other real plusses that comes out of it, is from a public engagement perspective that the transparency and accountability that you would get with the hypothecated tax, because if people can see that the funds are going in somewhere, then actually they can hold the Government, or whoever the tax raising body is in that case, to account.
If it looks like the money raised isn’t enough, or they can see where it gets spent. So, there has to be some real proper dialogue between the need that the Government needs to raise funds, or how much do they need and what do they need it for, and then when it gets paid over by a tax payer, they then feel a bit more of engagement and ownership in the process.
So, might be a bit more willing to see that the government are doing what they say they are going to do.
But huge issues that you are saying of potential opt-out; I want to pay for this, I don’t want to pay for that, and that may or may not in general wider trust is one thing I am hearing, but the transparency piece is very important.
The government has done some work on trying to make it transparent in the way your taxes go, what’s been the public’s engagement on that, just as a snap shot?
Again, we know, Caroline and I have both done different kind of surveys, and I think it came up in on this particular topic as well. The government do send out, tax payer’s statement, that demonstrates where all the taxes go, and they send that out annually the summary of your taxes individually.
What we are finding now that people don’t understand it, and if they do understand it, actually it doesn’t mean anything to them. It’s not transparent enough. It’s too abstract in terms I think I would say. I mean, Caroline, I don’t know if you agree with that.
Yes, and I think there is lots of issues and challenges with the annual tax statement, but I think there is also an opportunity there to make more of that, and develop that as a communications tool about the tax system. Maybe that would address some of things that proponents of hypothecation are trying to address.
So, there is lots of other fundamentals that we need to get right in public communication and taxpayer education is definitely one of those fundamentals.
So, it has been around for ages as a concept. It has had its ups and downs. There is a huge demand about transparency. Let’s make it practical.
Are there some examples, we can all latch on to that make it more real about some of these concept you described, Caroline?
Examples of where hypothecation exist.
I will go back to the language issue. There are examples of where some kind of hypothecated model exists, but whether it is seen by everyone as hypothecation in its truest form is debateable.
TV licence fee is one example. They are levied on users of specific services, i.e., TV broadcast or downloads, and the revenue is earmarked for the BBC, and makes up over 70% of the BBC’s total income.
That allows the public to make a link between the fee that they pay and the service that they receive, and that has clear pros and cons in how people perceive the BBC actually. So, it’s a good example of something that does happen in a very direct way. Not seen as hypothecation in its truest form, because revenue for the BBC also comes from elsewhere too.
Social care funding in Germany and Japan is another example in the international space, where Germany introduced social care insurance in 1995 and moved to fund it with individual salary deductions that were then matched by an individual’s employer, and the fund was ring fenced as an independent fund that would then be used for social care. So, that’s one example.
Similar model in Japan, where people over the age of 40 are obliged to pay into an elderly care insurance system, and there is also a system of co-payment for medical services.
So, those are examples of where money is put aside for a very specific health or social care purpose, and it varies on how broad or narrow that definition of the purpose of the tax is.
So, really revolves around being really clear about what it’s for. I suppose, if we think about political dynamic can a new administration change what the original deal was, all of that makes it very complex.
If we were just to move to wrapping up, before we had to go down the hypothecated route in the UK, Stella and Caroline, where would be a good place to start, and how would you do it?
One recommendation from each of you.
I think my conclusion from the work that we’ve done, is that, you couldn’t do something which is sustainable, because of some of the arguments against why hypothecation might not work.
Taking Caroline’s example, if we had a great big surplus fund in healthcare, and you have dire needs somewhere else on the budget, it would be really hard for a government to say we are not going to touch that ring fencing.
So, I think, I am not sure it’s an ongoing solution to any one particular problem. I think, if we are going to do it, you address a particular immediate need, where you want to change or influence behaviour, but you do it with a timeline. You could say, like, for the next two or three years, we are going to raise this tax, and all the money that we’ve raised, is going to go to jump start a particular initiative or to fund a particular industry, in doing a particular behaviour, and investing in jobs in a particular area or something like that, but you have an end date to when it is going to finish, so that it wouldn’t continue in that way. So, a short sharp solution for me.
Real accountability because of being transparent and short enough to see the end point, I like that. Caroline?
I think before any hypothecation model, we need to ask, why, that’s very fundamental. What is the purpose of exploring this opportunity?
Is it because of revenue certainty, is it because of public engagement, and that’s really important, because as I said earlier, there are other ways of addressing those challenges, and we need to get those fundamentals right.
So, any hypothecated model will need to be caveated with the principles of good tax policy making as Stella mentioned, having that implementation review or clause. Also, taxpayer education and good rigorous communications, whether that’s public consultation or other educational activities.
A simpler tax system would help people to understand what’s going on with hypothecation model. So, that’s also another fundamental that should be considered.
I think, something that we haven’t discussed is the potential for participatory budgeting models to be used in conjunction with hypothecation, because if we can have a situation where we have more citizen deliberative discussion on how taxes are raised and spent, then that would help iron out some of the other challenges in the tax system. I think there is a real opportunity then not just to hypothecate a tax for the sake of it and just do it like people have always done, but actually think differently and a bit more creatively about how the public can be engaged in that decision making process.
True democracy in action, maybe.
Caroline, Stella thank you for that. It is a fascinating topic. I am not sure if there is an easy answer, but what I have heard is opening up the debate more widely in the public, getting more engagement, so we are all clear on what taxes we are paying and why, has to be a good thing.
I am looking forward to seeing more in the CoVi report that’s coming out.
Thank all of you for listening, and I hope you will leave any comments you want on the podcast website and indeed do look out for a copy of that CoVi report, join the discussion.
Thank you for listening.