While a tempting way to balance the books, the Chancellor should shy away from incoherent stealth taxes like IPT

Jeremy Hunt has undoubtedly become Chancellor at an awful time. With the Truss Government’s disastrous Mini Budget drastically eroding the UK’s fiscal credibility, as well as a gloomier economic outlook, billions of pounds now need to be found to balance the books. 

Even with the tranche of Mini Budget U-turns already made – including on corporation tax, Income Tax and the duration of energy bill support – more tough decisions on spending restraint and tax rises are set to surface in next week’s Autumn Statement. 

There are no easy options at this point. With concerns about crumbling government services  – in particular the NHS – public appetite for a new round of spending cuts is likely to be limited. And, amid a cost of living crisis with high inflation and rising interest rates, broad tax rises will be particularly painful for households and businesses. 

Given this, the Chancellor may be tempted to implement tax rises by stealth. This includes freezing tax thresholds – such as those related to the different bands of Income Tax - to drag more individuals into higher rate bands over time. 

The Chancellor might also try to shift as much of the burden as possible onto smaller and less well-known taxes – those beyond the heavy hitters of Income Tax, National Insurance, VAT, Corporation Tax and fuel duty.  Indeed, such an approach would be a continuation of the post-financial crisis trend of smaller taxes accounting for a growing share of HMRC receipts, as shown in the chart below.

Smaller taxes account for a higher share of HMRC receipts than a decade ago

Source: Public First analysis of HMRC statistics 

Some of this may be defensible - for example, tax rises that relate to things that have societal costs such as the Betting and Gaming Duty (gambling addiction) and tobacco duties (worse public health). 

But in other areas, the tax rises that have taken place are far harder to justify on economic or social grounds. Since 2010, for example, increases to the standard rate of Insurance Premium Tax (IPT) have seen government receipts from IPT surge by 176% or £4.2bn. Over this time period, the standard rate of IPT increased from 5% to 12%, with the rate increased in 2011, 2015, 2016 and 2017. IPT is now the third largest revenue raiser, outside the “heavy hitters” listed above, after capital gains tax and stamp duty.

Source: Public First analysis of HMRC statistics 

There is perhaps one key reason why IPT has been used to plug holes in the public finances over the past decade. A recent Public First survey on insurance found that just over half of respondents were not really aware of IPT (33%) or not at all aware of the tax (22%), making it an ideal stealth money-raiser for a government looking to balance the books. Despite IPT feeding its way into higher insurance premiums, lack of awareness of the tax means government can get away with pointing the finger elsewhere.  

But this insurance tax grab has come at significant cost - not least in terms of the impact on households and businesses. The standard rate of IPT applies to a wide range of general insurance products, including home insurance and car insurance - often regarded as essential or at least prudent to have. Indeed, it is a legal requirement to have motor insurance.

Modelling that Public First has undertaken, for a new report out today for the Association of British Insurers (ABI), shows that  IPT costs now amount to about £220 per household per year, over double what it was in 2010 (about £90). About half of this relates to insurance products purchased by households directly, with the other half related to insurance purchased by businesses. Unlike VAT, IPT costs cannot be claimed back by firms. These costs are in turn likely to be at least partially borne by households in the form of higher prices as costs are passed on. Further, IPT is a regressive tax, with costs accounting for a greater share of income among lower income households.

% income spent on IPT by local authority

Given the current cost of living crisis, some households may cut back on insurance, leaving them financially exposed to unexpected events such as burglaries. Our polling on insurance, undertaken in September, found that 71% of respondents who purchase insurance are worried about potential increases in cost and nearly a fifth (18%) of respondents know someone who has already cancelled their insurance because of wider concerns about costs. 

By pushing up premiums, higher rates of IPT increase the likelihood of households being underinsured. We estimate that 900,000 households would likely cut back on home contents insurance if premiums rise by 10% or more – leaving them unprotected against unexpected costs such as a fire or burglary.

Our polling suggests that, once people are made aware of IPT, they see it as an unfair tax. Almost everybody (90%) agrees that it is important to keep insurance affordable. When asked if IPT was a good way to increase Government revenue, 42% of people disagreed while only 22% agreed.

Government has lost sight of the original purpose of the IPT, which was introduced in 1994 to compensate for the VAT exemption of insurance, leading to policy incoherence. Given the way insurance operates - paying out under certain events - the “correct” VAT-equivalent tax on households should be 20% of the difference between premiums and payouts. Since IPT is levied on premiums alone, that should equate to a low single-digit rate. Already, the current 12% standard rate is too high and a further increase would depart even more from the original rationale for the tax. It would degenerate into nothing more than an unobtrusive money-raiser.

The Chancellor’s position is unenviable, but it is crucial that tax policy has sound economic and social underpinnings. Plugging holes with stealth taxes - such as through IPT - raises the risk of a more incoherent and unfairer tax system. It also complicates, rather than simplifies, the tax system. Some sneakiness might be needed to raise the necessary revenues, but Mr Hunt must tread carefully.