What the think tanks are saying: Is this the end of National Insurance?

The Centre for Policy Studies (CPS) is a Conservative think tank, founded by Margaret Thatcher and Keith Joseph in 1974. In November last year, it published an article by David Martin entitled Abolish NICs – towards a more honest, fairer and simpler system [PDF].

In the forward, Jill Kirby (at the time Director of the CPS), said: “National Insurance (NI) has become income tax by another name. Yet… it is riddled with inconsistencies”

Do the arguments presented in David Martin’s paper indicate the beginning of the end for National Insurance Contributions? Certainly, the arguments are pretty compelling.

The paper summarises its arguments as follows:

Coalition proposals for a universal flat-rate pension effectively remove the last justi?cation for our National Insurance system. Whether we like it or not, the contributory principle underlying National Insurance Contributions (NICs) will shortly be super?uous.

In any case, NICs are riddled with anomalies, complexity and a lack of cohesion. They can reward the pro?igate while penalising the thrifty. They can discourage saving. They can be unfair. They can impose high marginal rates on low earners. They have been used to disguise tax increases.

They should be merged into the income tax system once an overall tax cut is affordable.

The paper goes into a great deal more detail, and I recommend a read if you want a taste of how labyrinthine the National Insurance system is.

The Coalition is already undertaking considerable reform to simplify the benefits system, from Ian Duncan Smith’s Universal Credit to Steve Webb’s universal flat-rate pension. Merging National Insurance with Income Tax would be a logical next step.

This isn’t the first time such a reform has been proposed, but it has, in the end, not happened. But this time may be different.

So why isn’t it already being proposed?

There are two main problems:

  1. Any reform would involve removing anomalies. As these anomalies benefit some people, the reform would create losers.
  2. If Income Tax and National Insurance Tax were merged into a new Income Tax system, the combined rate would be higher, even though the actual tax rate would be the same. There would be a temptation for an opportunistic opposition to claim that it was a tax increase.

This second problem could, perhaps, be reduced by careful presentation. Initially, by integrating income tax and National Insurance in every way except in name. That way, people would still pay National Insurance contributions and Income Tax, but almost all the complexities for employers, tax accountants and the tax office would be removed.

The paper also proposes merging Employer’s National Insurance Contributions with income tax.

Again, if carefully presented, it would be clear that this was not a tax increase. A new Employer’s National Insurance tax could be added to pay slips, but, simultaneously, pay increased so that the final after tax salary remained identical.

At some point in the future, these three taxes could be merged, when the presentational reason for having separate taxes no longer applied.

To solve the first problem, the paper proposes that the reforms are introduced at the same time as a tax cut, so that the changes could be presented as part of a tax cutting budget.

So what should Liberal Democrats think of this proposal?

I think we should welcome it. The current complexity is something that independent experts have long complained about, and long suggested removing. It adds administrative costs to employers and the state, it creates absurd anomalies, and it makes the tax system nearly impossible for a lay person to understand.

I would be less happy with a tax cut, unless it were a further increase in the income tax threshold.

However, this isn’t necessarily a big problem. As we approach 2015, we Liberal Democrats will increasingly need to differentiate ourselves from the Conservatives.

If the political narrative becomes that the Conservatives want a small tax cut, whereas we want to invest the proceeds of growth in improving public services, I see that as an opportunity.

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13 Comments

  • This if it happens is well overdue!

  • Liberal Neil 24th Feb '11 - 1:09pm

    Employees’ NI is, in effect, a second income tax, but less progressive.

    Combining the two would have to go hand in hand with changes to the combined rates to make the system smoother and more progressive overall. But this is a good thing and much more transparent.

  • The merging of NI and ENI into income tax is long, long overdue. It is an indication of Labour’s weakness on tax that they didnt do this obvious thing in their first or second term. The probably devious motive for this was that it allowed them an “income” tax that they could raise (as the did) while still pretending to stick to their manifesto commitment to “not raise income tax”.

    Doing the merge should be bracketed into the raising of the allowance, so that the public sees the better of it. This gives another chunk of tax that need to be raised to the £10k threshold, if there is any spare money in the treasury before 2015.

  • Liberal Neil 24th Feb '11 - 3:53pm

    It would be sensible to doa package of reforms in one go – combine income tax and NI, raise the bottom threshold and smooth out the bands at the same time.

    The result would be that the same overall total would be raised, there would be huge savings in running the system and, because of the way income is distributed, most taxpayers would gain.

  • Colin Green 24th Feb '11 - 4:11pm

    NI is only charged on earnings, not savings. If the two were simply added together, tax on savings would go up by the current rate of NI. Savers wouldn’t be quite so keen on this.

  • Andrew Duffield 24th Feb '11 - 5:02pm

    “So what should Liberal Democrats think of this proposal?”

    We should be switching tax off productive earnings (including NI) and on to unearned income instead – ideally by continuing to raise the earnings threshold, so low earners benefit most, improving employment prospects too – eventually phasing out deadweight taxes on productivity altogether.

    A “more honest, fairer and simpler system” requires a systemic change of direction – onto the Liberal heading just described – not a superficial re-arrangement of the fiscal deck chairs.

  • One of the problems with merely combining Income Tax and NI Contributions is that pensions would be subject to a much higher rate of tax than at present, as they are not presently subject to NICs.

    That wouldn’t be the intention, would it?

  • Colin & Simon – clearly there’s a need to build a list of those anomolies that are taxed but not NI’ed and mitigate in some way. Don’t pensions and savings currently have different thresholds for income tax to earned income? If so, it might be possible to offset the increase by tweaking their allowances.

  • George Kendall 24th Feb '11 - 10:14pm

    Thanks for all the comments, guys. Some really interesting points, some of which I haven’t really thought through an answer to.

    As I’m tied up with the Barnsley campaign, I don’t have the time to properly grapple with them. So I’ll just respond with a couple of instant reactions.

    I can understand the argument for reducing the “productive taxes”: that people working hard is a good thing, we should tax things that aren’t a good thing, so we should make sure that income tax is not high.

    But I believe that the heavier share of the burden of supporting public services should fall on those with the greatest ability to pay. I’d hate to live in a society like the UK was before Gladstone, when a lot of the tax burden fell on the poor. So I favour progressive taxes, and the most progressive tax is income tax.

    The issue of the effect of merging NI and income tax on pensions is an excellent question. The obvious first stage reform would be to have a different income tax rate for pensions. It would make the system a little more complicated, but still *vastly* simpler than the gordian knot we have now.

    In future, there will be the vexed question of whether changes to the rate of income tax would apply equally to both pensions and earned income. We might end up with a Chancellor bringing in different increases/decreases for the two, which would create some interesting politics. But whatever is done, it would also be far more transparent than the smoke and mirrors that goes on in budgets today.

  • Oap Ensioner 18th Mar '11 - 2:53pm

    Pensioners (state and occupation) do not pay National Insurance on their pensions. Increasing income tax would hit them more than any other sector of the population.

  • Margaret Jensen 21st Mar '11 - 10:34pm

    Pension and savings are taxed at 20%. Public service pensions were frozen last year.The enhanced age allowances for over-65s are clawed back from any income over £22,000. The change to a 32% tax rate would mean pensioner incomes cut by 12%. Any M.Ps volunteering a 12% cut in salary? Thought not.

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