More than 10 million people who protect themselves against sickness or unemployment by taking out insurance cover on their personal loans or credit card debts are to be taxed on any benefits they receive.
The new - and previously unannounced - tax on loan protection comes after the Government's U-turn on mortgage insurance on Tuesday.
Annual premiums paid for loan protection cover are four times those of mortgage insurance. Borrowers taxed at the basic rate will now have to pay up to 25 per cent more to obtain the same cover, which at the moment costs up to £20 a month for a three-year, £5,000 loan.
Should they become unemployed, the tax will be deducted from any benefits paid to them by their lender.
Higher-rate taxpayers will have to tell the Inland Revenue the amount they receive and pay the difference. No decision has been made on whether the tax will be applied retrospectively.
Those who become unemployed and are unable to increase cover on loans they had already taken out may not be able to meet their repayments.
Gordon Brown, the shadow Chancellor, said: "This is another sting on taxpayers. They pay for their premiums out of taxed income and since last October they already have to pay additional insurance premium tax of 2.5 per cent. Now they are to be taxed on any benefits they receive."
Total annual premiums paid for loan protection are about £1bn - four times the £250m of annual business involved in the Government's high-profile climbdown on mortgage protection insurance on Tuesday.
At Abbey National the cost of cover on a £5,000 loan over three years costs about £19 a month. Nationwide, the United Kingdom's second largest building society, charges £16 a month for the same amount. About 50 per cent of its borrowers take out the insurance. "We think it is terribly unfair on borrowers," a spokesman said.
An Inland Revenue spokeswoman said a decision had recently been made to treat loan protection in the same way as health insurance policies, where benefits are taxed after the first year. She confirmed that the Government's mortgage U-turn will not apply to such policies.
Tony Baker, deputy director general at the Association of British Insurers, said: "What the Government is doing is penalising the prudent.
"If it is trying to transfer responsibility to the private sector then it is sending the wrong message to people."