Merging National Insurance and Income Tax – maybe this time?
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.