TAXATION – Is hypothecation really shameful?

Even at the smartest dinner parties, you may hear someone speak of hypothecation. Any Treasury mandarins present will blush at the word.

So what’s the big idea? And is it really so shameful?

Hypothecation means saying where tax revenues will go to before you collect the money. In its strongest form, it means returning the taxes to the people who paid them: spending the money from petrol taxes on roads, for example.

There is a weaker form, spending the money in roughly the same field: petrol taxes might go towards funding public transport. Then there is the weakest form, spending the money in a specified field that may have nothing to do with where the tax came from: the pre-election proposal from the Liberal Democrats to add a penny to income tax in order to spend more on education would come into this category.

Making taxes more acceptable

Governments are always a little bit tempted by hypothecation. The reason is that it makes taxes look more acceptable. No one minds going into a shop, deciding what they want and then paying for it because you see what you are getting in return.

Similarly, if you can see that you are getting something specific in return for a given amount of tax you might feel happier about handing over your money. Even someone with no children can believe that having good schools is worthwhile. If the tax goes towards something which the taxpayers are already using, as with taxes on petrol going towards better roads, so much the better.

That, unfortunately, in itself is a problem. Hypothecation can confuse the public and private sectors in taxpayers’ minds. If something is funded by taxes we must be careful not to pretend that its provision, through taxes, is on a par with freely buying something in a shop.

There is another problem with setting aside particular tax revenues for particular purposes. The tax might raise more money than the purpose needs. If, for example, we use a tax on power generation to fund research into sources of renewable energy, we could have revenue coming in long after the research has become self-funding from commercial application of its results. The tax would need to be abolished pretty quickly to avoid this.

We must also ask whether hypothecation is real. The government uses a wide range of taxes, but most of the money goes into one great pool. Does it really mean anything if, say, a particular billion pounds from motorists is earmarked for roads? If it were not earmarked, the revenue would go into the pool and some other billion from the pool would go to the roads. But given that it has been earmarked, all that happens is that the billion goes to the roads and another billion in the pool, not needed for roads, can be used for something else.

There is no real difference for the motorists who pay the billion nor for the road-builders who spend it. All that has happened is that, in the black box of government, the money has gone through one set of accounts rather than through another.

Surely there must be something to be said for hypothecation? Yes, there is. If it existed on a very large scale, people would be much more aware of where public expenditure goes and therefore more involved in the political debate.

Understanding expenditure

Imagine looking at your payslip and seeing your income tax broken down into education, health, defence and so on. You would probably think harder about public expenditure priorities.

There is already food for thought on your payslip.

You see both income tax and national insurance. The national insurance fund is not yet entirely separated from general public expenditure: it gets a grant from the Treasury.

But the fund is trying hard to be separate. And it is a fund to pay for specific social security benefits, not for general public expenditure.

So is this #45bn bit of hypothecation genuine? Yes, if it creates a genuinely separate system of national insurance and benefits – a part of the state which can do its own thing independently of the rest of government.

But of course Martin Taylor is looking at the scope for integrating the tax and benefits systems. We will see whether hypothecation is an idea whose time has come, or one whose time has passed.

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