What is hypothecation?

In simple terms, it means assigning particular tax revenues to a specific public policy goal. In practice, and as we are seeing with the new health and social care levy (HSCL), hypothecation can take many different forms and not everyone will agree with what exactly should be the principles that underlie a hypothecated tax.

Hypothecation has been kicking around as an idea for many years. Back in 2018, there were several commentators backing the idea of establishing a new, specific tax to pay for some or all of the extra funding required by the NHS, although not everyone agreed with the suggestion. An editorial in The Times on 11 January that year suggested that this might not provide the required solution and ended with: “Enter an old, usually bad, idea: hypothecated taxes, defined as levies whose revenues are earmarked for a specific purpose.” More importantly, the government of the time shared this view, so the hypothecation debate was put back into its box and it looked unlikely it would be taken out any time soon.

Two years later, the COVID-19 pandemic struck and threw all accepted thinking out of the window. Eighteen months on from when it started, we now have some idea of its cost – estimated to be around the £400bn plus mark, and still counting. By any standards, this has been an unprecedented increase in government spending outside of wartime. With the government under pressure to try and restore public finances and with the NHS continuing to be under pressure, ideas such as hypothecation, dismissed by government officials only a few years ago, have resurfaced and been used to justify the introduction of the new HSCL.

How did the Prime Minister describe it? “From next April, we will create a new, UK-wide, 1.25% health and social care levy on earned income, hypothecated in law, to health and social care, with dividend rates increasing by the same amount.”

This was confirmed in clause 2 of the HSCL Bill, published the following day. The clause stated that such amounts collected from the levy would be paid directly by HMRC to the Secretary of State (for Health) for the provision of healthcare and social care rather than paid into the consolidated fund, which is subject to control by HM Treasury.

However, although it will be paid directly to the Department for Health, it will still be subject to some control by HM Treasury, which will decide what share should go to health and what share should go to social care, as well as also determining what shares should be received by the four nations of the UK (England, Wales, Scotland and Northern Ireland). Finally, although the dividend tax rate has also been increased, HM Treasury gets to keep that money.

So, although described as a hypothecated tax, how it gets divvied up between health and social care and split around the UK are still questions to be determined by HM Treasury.

Does this pass the test of being a hypothecated tax?

As mentioned above, one of the problems with hypothecated taxes is that there is no generally accepted definition of a hypothecated tax with which most people will agree. To misquote a well-known phrase: “Hypothecation is in the eye of the beholder.” In relation to the HSCL, the fact that the legislation establishes a clear link between what the HSCL will be used for means that it passes the narrow definition of a hypothecated tax.

But hold on a moment. The proportions of the levy to be divided between two separate cost codes, healthcare and social care, are to be determined by the Treasury. There is no indication about how these decisions will be made and precisely what extra costs, etc, will be met, nor what impact this may have on the rest of the funding needed through general taxation.

As for healthcare, the government paper states that capacity will be increased by 10%, but it’s unclear how this will be done and whether we are looking at a temporary or a permanent increase in capacity. The Office for National Statistics (ONS) has estimated that total spending on healthcare in 2020 was 20% higher than in 2019, far higher than in any year since the start of their records in 1997.

Is it enough?

The new HSCL is estimated to raise about £12bn a year for at least a three-year period. These are substantial sums, but are still less than 5% of the total healthcare budget, which the ONS estimated at £269bn. So, while the levy will still raise substantial sums, it will be only a fraction of the sums needed to fund the NHS, and the majority of the funding will still come from general taxation, which will remain under the control of HM Treasury.

Turning to social care, although proposals were announced to ameliorate some of the impacts of social care costs on citizens, we are still awaiting a consultation document about how exactly this might work. Until we see these details, it is difficult to see what the link between HSCL and social care costs will be.

Does any of this matter?

The danger with hypothecation is that it might create as many problems as it solves. An argument advanced in favour of hypothecation for healthcare is that it will engender a proper debate about the level of funding needed for the provision of healthcare and support required for the NHS and allow for informed decision-making about what the NHS should seek to deliver, how much money that will cost and whether it will be good value for money. There seems little likelihood that we will have such a debate and, without it, there is a danger that introducing hypothecation could instead undermine public support for the NHS.

None of these concerns about hypothecated taxes are new. Back in 2012, an Institute for Fiscal Studies (IFS) report noted: “In general, governments should be cautious of hypothecation – tying particular expenditures to particular receipts would probably lead to less efficient patterns of spending, since in principle there is no reason that the most effective ways of raising revenues and of spending them should be linked. Further, in many cases, so-called hypothecation is meaningless as it is often impossible to verify that the revenues were spent in a particular way. Public support could also erode if it was felt hypothecation was being used merely as a presentational device.”

With the proposed new HSCL, the government has gone some way to addressing the concern identified by the IFS about how the revenues will be spent. However, and more importantly, will it pass the public support test? If you take this back to first principles, arguably all that has happened is that the government has created a third tax bucket (the HSCL) that will sit alongside the two, namely income taxes and national insurance. Looked at that way, HSCL looks rather like a presentational device, which the IFS warned about back in 2012.

The UK may now have a hypothecated tax, but the jury is out on whether this is a sustainable approach to the problems of health and social care funding that will enjoy public support. What we do know is that it will introduce considerable extra costs and complexity into the UK tax system that will impact on UK businesses, which are currently trying to recover from the pandemic. There would have been far easier ways to raise the money needed from existing taxation levers without the need to add yet more admin burdens and costs on UK businesses, as well as opening that Pandora’s Box known as hypothecated taxes.

About the author

Frank Haskew, head of the Tax Faculty