Plans to reform the state pension system into a single payment of around £140 per week could provide a route to a simpler income tax system, too. Work and Pensions Secretary Iain Duncan Smith is to signal that the Government intends to scrap the current system of a Basic State Pension, Additional State Pension and Pension Credit with a single flat payment. The crucial detail for personal taxation is that it may no longer be linked with National Insurance (NI) payments. The insurance function of NI has dwindled over the decades and, if the link with pensions is removed, NI will wholly act simply as what it effectively already is: an additional form of income tax assessed weekly instead of annually with different thresholds and rates.
Mr Duncan Smith will criticize the complexity and perverse incentives of the pension system in a speech to Age Concern today:
"The state pension system is so complex that most people have no idea what it will mean for them now and in their retirement.
"Too many people on low incomes who do the right thing in saving for their retirement find those savings clawed back through means-testing. We have to change this."
With a consensus of economic opinion that believes business investment and exports are the only realistic sources of growth (due to high levels of both consumer and government indebtedness) a pension reform which removes a disincentive to save could have significant beneficial effects across the wider economy. Perhaps as important is the opportunity such a move presents for simplifying personal taxation by merging the National Insurance system into the Income Tax system. Complexity is itself costly. As well as it forcing everyone to have to spend time working out the tax system, it also imposes an information penalty on economic activity. People often simply discount economic gains by a larger amount than they think is likely because they don’t have the inclination to sit down and work out the exact sums. Faced with uncertainty and risk from a lack of knowledge, we become wary of risk: Better to be on the safe side and assume the worst
Like any change, reform of the pension system will mean some will lose out – such as those in well-paid, steady jobs who can receive as much as £200 per week from the various current state pension systems. While there will be pressure for a new system to minimise the financial impact on those who might be worse off, the Government must also ensure that any change is fair to taxpayers, too. But the government should take the opportunity to dismantle the needless complexity of the dual Income Tax and National Insurance systems of personal taxation.
Too often, increasing complexity in government spending has led to increasing complexity in taxation and vice versa. Attempts to tackle unintended consequences of an initial policy have often met with ‘solutions’ creating still more complexity and a new set of unintended consequences. Conversely, a simplification of tax made possible by a simplification of spending would represent a pleasing reversal of this seemingly unstoppable process. The time to abolish National Insurance is now.