Appendix 4: Hypothecation
In paragraphs 179–182, we noted that some witnesses had proposed hypothecated taxes as a way of generating additional funding for the NHS. Some of the arguments for and against such hypothecation are set out below.
Definition of hypothecation
The hypothecation of a tax is the dedication of revenue raised from a specific tax for a particular programme or service.308 The evidence highlighted three kinds of hypothecation, which included:
(1)‘Soft hypothecation’. This involves a commitment to spend any additional revenues from a given tax or change in tax to a specific cause.
(2)‘Hard hypothecation’. This involves assigning a proportion of a given revenue stream to a specific programme.
(3)‘Full hypothecation’. This involves allocating all of the revenue from one tax to a specific programme.309
The case for and against hypothecation
The strongest advantage of hypothecation appeared to be the greater transparency it would provide of the link between taxation and government spending, which witnesses suggested could help improve the public’s understanding of the tax burden and the amount spent on a service, therefore enabling more of a debate on how much the electorate are willing to pay. Lord Macpherson of Earl’s Court outlined this argument in more detail:
“… the introduction of hypothecation could strengthen public understanding of the trade-offs between taxing and spending at least in relation to health spending. And it might make more palatable the likely tax increases which will be necessary to deal with the demographic pressures which are likely to become increasingly visible during the course of the 2020s. At a time when trust in government has declined, and many citizens feel a disconnect between the taxes they pay and the services they receive, it could help revive citizen engagement. This would be the case especially at election-time, when political parties would have a chance to set out their plans for any hypothecated tax and health spending as a whole.”310
The key disadvantage to hypothecation appeared to be concerns that it would potentially undermine the ability of governments to deal with economic cycles. Lord Macpherson of Earl’s Court stated that:
“The case against hypothecation is that it is inherently inefficient. Governments need the flexibility to allocate resources as they see fit, unconstrained by trends in individual taxes, some of which are more buoyant than others while others are more cyclical. It would also constrain changes to the hypothecated tax for wider economic and distributional reasons.”311
Giving effect to hypothecation
The evidence suggested that income tax, National Insurance contributions (NICs) and VAT raise sufficient revenue to be plausible candidates for a hypothecated tax for health spending, with a number of witnesses suggesting the most viable options to be NICs. Lord Macpherson of Earl’s Court outlined the various implications of using NICs to fund the health service:
- Many taxpayers already think NICs fund the NHS, which is partially right as some 20% of NIC revenues (£21 billion in 2014–15) are allocated to the NHS, the rest going into the National Insurance Fund to pay for contributory benefits, such as the state retirement pension. This might provide a “good starting point” for any debate about the levels of taxation and health spending.
- For a hypothecated tax to be seen as fair, it could be argued that as many adults as possible should pay it. Lord Macpherson of Earl’s Court stated: “Since old people are likely to be the main beneficiaries of increased spending on the NHS … there is a strong case in fairness for bringing the NICs base more into line with income tax. However, this would have major distributional implications, and the revealed preference of successive governments has been to tread carefully when it comes to the integration of income tax and NICs.”312
How a hypothecated tax for the NHS might work
We received evidence on how “full” hypothecation might work for the NHS. Lord Layard suggested that National Insurance could be turned into “National Health Insurance (NHI).” He explained the process for how this might be implemented:
(1)“Decide the share of Gross National Product to be spent on health on average over the parliament and thus compute its forecast value in [monetary terms].
(2)Phase the expenditure over the Parliament.
(3)Fix the NHI tax rate for the Parliament to raise the (expected) total over the Parliament.
(4)If in a year Tax exceeds Expenditure, put it in a stabilisation fund; if Expenditure exceeds Tax, finance it from this fund (if possible), otherwise by borrowing. At the end of the parliament, close the fund and transfer the debt to the consolidated National Debt.”313
308 Centre Forum, India Keable-Elliott, Hypothecated taxation and the NHS, (December 2014): http://www.centreforum.org/assets/pubs/hypothecated-taxation.pdf [accessed 28 March 2017]
310 Ibid.
311 Ibid.
312 Ibid.