Hypothetically Speaking

Hypothecation, or the earmarking of taxes, has enjoyed a vogue in public policy debate since the 1980s, despite the absence of any evidence that it works in practice. Some of this is just rhetoric, e.g. the LibDems' proposal for an extra penny in income tax to be spent on education, while the recent morphing of green levies into "green crap" suggests that any tax is quickly reduced to an undifferentiated burden. Peter Wilby is the latest to suggest hypothecation as a "bold solution" for the ills of the health service - "bold" meaning less contentious than raising income tax. He characterises the environment thus: "The NHS is a monster. Its capacity to consume public resources is without limit. ... Failure to supply expensive drugs that give, at best, an extra few months of life to the terminally ill are denounced by newspapers that otherwise rail against high taxes".

There is no paradox here. If your aim is to dismantle the NHS, then it makes sense to adopt a strategy that seeks to simultaneously undermine the system's twin strengths: economies of scale (which keep unit costs down) and rationing (which limits total cost). Claims that costs are out of control, that we are doomed because of demography, and that there is a bad culture are all attacks on the singularity of the NHS. Stories about postcode lotteries, the efficacy of alternative treatments, and rampant health tourism are all attacks on rationing. Like many others still nostalgic for triangulation, Wilby thinks that there may be a third way between the unacceptable policies of old (the now pejorative "tax and spend") and meek surrender to dismantling: "An earmarked health tax may be one whose time has come, and perhaps a model for financing other strained public services and modifying voters' resistance to taxation".

The closest thing we have to a hypothecated tax is the BBC licence fee, which suggests that this is practical only for consumption goods rather than public goods (though pacifists regularly make the case for diverting their tax from defence spending). In reality, most consumption taxes bear no relation to costs. For example, in the 1920s and 30s vehicle excise duty (aka road tax) raised more than was necessary to fund road building, with the consequence that the Road Fund was raided for other purposes. Today, vehicle and fuel duties together are insufficient to pay for the total cost of road transport once externalities such as pollution are included. This swing reflected the historical shift from an elite pursuit to mass car-ownership, which both hugely increased the cost of the road network and created political pressure to lower the costs of entry.

The standard case for hypothecation is a mixture of transparency ("a clear link" to counter voters' "disconnection"), popular choice (the figment of "accountability"), the dissolution of central power (i.e. Whitehall won't like it), and business-friendly anodynes about customer focus and service delivery. In recent decades this has also been given a pro-social spin, e.g. the "green levy" on energy bills, which suggests that hypothecation can also play a role in providing psychological compensation for social guilt, like charitable giving. The ideological framework is neoliberal: hypothecation is a way of creating artificial markets for public services; the popular mandate is translated into a financial exchange; the compartmentalisation of specific services and associated revenue-raising powers prepares the ground for privatisation (in the sense of outsourcing control of public services to private providers). It is also why hypothecation tends to be popular among those who own assets: focusing tax on consumption and the utilisation of public services distracts attention from the obligations of accumulated capital.

The case against hypothecation is that it is pro-cyclical when demand for public services is broadly counter-cyclical. The chief example of this is National Insurance. In a recession, when demand for social security payments increases, NI revenue declines. Conversely, during a recovery NI revenue increases at just the moment when demand for benefits falls. The link between tax and expenditure cannot be maintained without perverse effects. A more hypothecated fiscal system would also exacerbate the tendency of politicians to become full-time bid managers for vested interests. It would discourage change: redundant services would linger on due to incumbent power (both corruption and the monopoly of media space), while newer service needs would struggle to get attention. Existing services would be under pressure to fragment in order to seek or maintain popularity - e.g. the Army might demand parity with the Navy (and its expensive nuclear subs), while working tax credits might split from JSA.

Full hypothecation, where each citizen allocates their own tax payments by service (aka "tax choice"), is unlikely to happen any time soon, even though this is attractive to advocates of Public Choice Theory and conservatives who think the vote should be limited to those who pay tax. Ironically, if tried, this might produce some unusual results as a consequence of contemporary myths. For example, people might inadvertently allocate increased expenditure on the unemployed as they hugely over-estimate the current cost. Outside of the libertarian fringe, hypothecation is advanced selectively, but in two different modes: either defensively, such as "ring-fencing" health or education, or as a means of imposing the cost of externalities, such as the "polluter pays" principle.

This looks progressive, but in practice it is regressive as it seeks to limit responsibility. Once you start down this slippery slope, it is difficult to resist the inevitable demands for greater choice, i.e. personal opt-outs: I have no kids, so why should I pay for ring-fenced education?; or for more punitive "compensation": the poor commit most crimes, so they should pay for more of the criminal justice system. The fundamental problem with hypothecation is the transactional assumption that underpins it. The reductio ad absurdum is that the rich would never pay any tax because they would never need to make use of public goods; which is just another way of saying that public goods would disappear to be replaced by private goods funded on a subscription basis.

Contrary to popular belief, cultivated since 1945 through both the social democrat contributory principle and the conservative taxpayer rights principle, taxation is not a transaction for services rendered. It is actually a means of redistributing wealth through public goods. When the economic system is rigged, so that equality of opportunity and meritocracy are mere Platonic ideals, the only way of countermanding this bias is through the redistribution of wealth in kind. That is why tax systems in most democracies tend to be progressive: the idea is not that the rich can afford more, but that the poor deserve more. This is why conservative bleats about the large share of tax revenue provided by the top 5 or 1% misses the point. The more they provide, the more they are clearly able to provide.

Peter Wilby falls into the trap of supposing that we need to make tax for the NHS more salient because the majority dislikes paying tax in general but values the health service in particular. The truth is that neoliberalism has allowed the rich to escape tax and thus reduce revenues for public goods. The solution is not hypothecation but increasing the taxation of the rich. This is not a hypothetical solution, let alone an impossible Platonic ideal. We did it before and we can do it again.