National Insurance is archaic, confusing and opaque. Abolish it

March 21, 2011 4:35 PM

George Osborne has a 'secret plan' to merge National Insurance (NI) into Income Tax according to Thursday's Independent, a story followed up in the weekend papers. National Insurance, which raises approximately £100 billion annually will be abolished while Income Tax, which raises about £150 billion, will be raised to compensate for the loss of tax revenues. The Office of Tax Simplification’s survey of businesses found almost unanimous support for the idea, which would save both business and HMRC money in administration costs. An unnamed minister told the newspaper:

"The changes to benefits could tip the balance in favour of merging tax and national insurance. It would be a radical reform and lasting legacy for the Government. We don't want to be remembered for cuts, cuts and more cuts."


The changes in question are the replacement of various benefits with a ‘Universal Credit’ and the introduction of a single flat rate state pension, both of which will break the link between NI contributions and benefit payments obliterating the bulk of the already scrawny last vestiges of its insurance function and making it what it effectively already is: a second income tax with different rates, different thresholds and different applicability and, in case all that isn’t already needlessly opaque and complicated enough, it’s split into separate payments for employers and employees, too.

Combining Employee's NI (scheduled to rise from 11 to 12 per cent in April) with the basic rate of Income Tax (currently 20 per cent) would be a great step forward for transparency and simplification leaving us with a new Income Tax rate of 31 or 32 per cent, a number much closer to the truth. But to be truly radical, the so-called Employer's NI ought to be abolished, too. To make up for the lost tax revenues from someone earning a regular salary of £30,000, assuming salary levels rise to the extent Employer's NI is no longer collected,  Income Tax would need to be set at just over 39 per cent. This percentage is produced by dividing the total tax amount by the true income (£33,108, a combination of both the salary and the employer’s NI contribution) less the Personal Allowance (all rates and thresholds 2009-10).

Salary: £30,000

Employer’s NI: £3,108
Employee’s NI: £2,671
Income Tax: £4,705

Total Tax: £10,484

The above calculations are very rough and do not account for employers’ or employees’ pension contributions, which would increase the rate required for the Treasury to take the same money. They also don’t account for the fact that there are a plethora of different rates for the self-employed, married women and others, as you can see on this HMRC table. These lower the required percentage, as would applying the new rate to income from savings and dividends, which are both currently administered separately. But it does show how the rate would be less than a simple combination of the three existing rates for a typical basic rate employee (20, 12.8 and 12.8 per cent).

Also at the Independent, Sean O’Grady produced an interesting graph of the effective marginal tax rates from a combination of Income Tax, employee’s NI and tax credits showing the bizarre complexity and irrationality of the system. A merger would significantly simplify the system we all face but would be a brave move for the Chancellor that would draw attention to how much tax we really do pay. It’s perfectly possible to work out what our employers pay in their employer’s NI contributions and then add this to the separate Income Tax and employee's National Insurance figures to find out how much tax we pay. But how many of us do? Reform would mean the calculation would be done for us, showing on each payslip our true pre-tax income rather than maintaining the pretence that employer’s NI is somehow a mysterious other only to be known by the payroll department and HMRC.

The Chancellor should rise to the challenge and lay bare to each one of us how much we earn and, in one single number on our payslips, how much direct tax we pay. Listen to the IFS and your own Office for Tax Simplification and businesses up and down the country. Abolish National Insurance, Mr Osborne.

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