Tax and Fiscal Policy

Merging National Insurance and Income Tax – maybe this time?

That grandly Dickensian-sounding outfit, the Office of Tax Simplification, has recommended merging national insurance and income tax. This proposal, first mooted as long ago as 1943, has been kicked around by various Chancellors. Nigel Lawson gave it serious consideration in the 1980s, Alistair Darling thought about it for a while and George Osborne launched a consultation in 2012. Will we finally get some action?

On the face of it, the arguments seem clear. National insurance (which dates back to 1911) no longer covers the costs of the benefits it was set up to finance. It misleads the public, who in large numbers still seem to imagine state pensions are paid from a fund accumulated from past contributions. National insurance is complicated, with rates and cut-off points which don’t match up with income tax rates and bands. It creates discontinuities in effective marginal tax rates which can have a disincentive effect.

It’s costly to administer. In the early days national insurance payers were a distinct group from income tax payers: prior to WWI there was no overlap. So different systems made sense. Today most workers pay both imposts: net pay and the government’s total take is what counts. A unified system would be cheaper to run.

The system involves employer as well as employee contributions, again a bit of a fiction which confuses employees into thinking that somebody else is paying for their benefits – Lloyd George’s famous ‘9d for 4d’. In reality its effect is that of any payroll tax: the incidence falls on employees in terms of lower net wages and/or less employment.

On grounds of transparency, then, merger is sensible. It would create cost savings for employers and government. Moreover, if a new consolidated income tax rate was applied, it could be applied to the self-employed, those working after state pension age and pensioners, redressing some inequities and increasing the tax base.

That of course points to one danger. There would be winners and losers: if older people (who are more likely to vote) lost out, there might be electoral consequences. Another problem is that scrapping NICs would mean that there would be no distinction between those who had paid contributions (and were thus entitled to higher benefits) and those who hadn’t. Unless the level of contributory benefits was cut, the welfare bill would rise. If welfare spending was to be kept at the same level, however, benefit rates would have to fall for people who had been paying in for many years.

Furthermore, with the current concerns about migration, scrapping NICs might mean new migrants would be entitled to the same benefits as longstanding residents. Not what David Cameron has been chasing round Europe for.

There are ways round these problems. But they would not be quick or easy to implement. If George Osborne bites the bullet on this he may go down as a great reforming Chancellor. But he may also scupper his chances of becoming Prime Minister, given the likely furore in the short to medium term. I can’t see him doing it.

Prof Len Shackleton is a Visiting Fellow at the IEA, and professor of economics at the University of Buckingham. A shorter version of this article was first published in City AM.

Suggested further reading: Merging National Insurance Contributions and Income Tax: Lessons of History (pages 2–13) by Alan Peacock and George Peden, Economic Affairs Vol.34.1, pp. 2-13.

Editorial and Research Fellow

Len Shackleton is an Editorial and Research Fellow at the IEA and Professor of Economics at the University of Buckingham. He was previously Dean of the Royal Docks Business School at the University of East London and prior to that was Dean of the Westminster Business School. He has also taught at Queen Mary, University of London and worked as an economist in the Civil Service. His research interests are primarily in the economics of labour markets. He has worked with many think tanks, most closely with the Institute of Economic Affairs, where he is an Economics Fellow. He edits the journal Economic Affairs, which is co-published by the IEA and the University of Buckingham.

3 thoughts on “Merging National Insurance and Income Tax – maybe this time?”

  1. Posted 11/03/2016 at 14:18 | Permalink

    Although I have been studying the British tax system for more than fifty years now, I only really came to appreciate the impact of National Insurance when my earnings after my 65th birthday (shortly before my retirement) were no longer liable to National Insurance tax. (I use this term even though Margaret Thatcher — herself formerly a tax lawyer –once denied that National Insurance was a tax!) The net amount I received shot up — alas, only for a few months. If (basic rate) income tax and national insurance were amalgamated, and if the same total amount of revenue needed to be raised, then presumably the basic rate of income tax would have to go up to offset the ‘abolition’ of a separate national insurance tax. But since over-65s would now, for the first time, be liable to the ‘national insurance’ portion of the new income tax basic rate (including the so-called employers’ contribution as well as the so-called employees’ contribution), maybe the increase wouldn’t be quite as much as one might have expected. Should there be a special allowance for over-65s to offset this increase in tax rate? Probably not. Although I am still irritated by my USS pension being index-linked now to the CPI not (as formerly) to the RPI, on the whole I agree with those who claim that pensioners have done rather well during the last eight or so difficult years. (I think young Philip Booth is in the forefront of this group.) Any important change is likely to bring losers as well as winners — and although I would regard myself as being as conservative (small ‘c) as most people, the prospect of life without any changes is hardly very interesting. But I bet Len is correct in supposing the the Chancellor will funk it. His record as a ‘reforming’ Chancellor is not good.

  2. Posted 11/03/2016 at 16:32 | Permalink

    Of course he will funk it, because combining the two taxes would make it clear just how high the effective rate of “income tax” really is. And that is the last thing he would want to do.

  3. Posted 13/03/2016 at 09:24 | Permalink

    As the linkage between NI paid and benefits received barely exists, merging the two makes perfect sense. The alternative is the opposite, to run NI as an insurance company. But that opens doors to privatisation, competition and premiums set at discretionary levels if taken to its logical conclusion. Rather than run scared of the grey vote, perhaps the chancellor needs to explain to everyone how the country needs to be run on a sustainable basis and that we all need to pay for it. Other parties likely agree with this.

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