Benjamin Franklin once said that “in this world nothing can be said to be certain, except death and taxes.” The former may not have changed much since his time, but tax systems certainly have.
And, here in the UK, it appears that the notion of merging Income Tax and National Insurance is back on the agenda. The government has been investigating the proposal for some time now, and although no conclusion has been reached, it cannot be entirely ruled out.
There would be some merit in combining what are two very similar payments made directly from income. It would be easier and cheaper to collect, and more transparent. But, as always with apparently simple ideas, the devil can be in the detail.
And anyone who has followed Iain Duncan Smith’s attempts to merge various welfare benefits into a Universal Credit will know that the IT systems involved can be complex and expensive to set up. This also means that long term thinking would be required – spend now to save later. And that is an approach governments are generally not good at. They want quick wins, not benefits for the future.
So how do things work at the moment? Well, assuming you are employed by an employer rather than being self employed, it is usually fairly straightforward. Before you even receive your weekly or monthly wage a slice has been paid to the state in both Income Tax and National Insurance. Complex systems of allowances and varying percentage rates are used to calculate exactly how much is paid. But most people only look at the “bottom line” of the pay slip – how much cash will actually end up in their bank account.
Tax is of course a massive political issue. The link between tax and government spending will always be a key part of any election campaign. Low tax may seem good, but it means lower spending and poorer services. Better public provision is welcomed by many but it needs higher tax to pay for it. And just how should the burden of tax be split between the rich and the not so well off?
Income tax was first introduced in the UK in 1799 and was originally seen as a short term measure to pay for wartime expenditure. It was actually abolished in 1802, only to be reintroduced on several other occasions. But from 1842 it has been a permanent feature of our lives.
National Insurance was first introduced in 1911. The original idea, as the name suggests, was that contributions were to be made by workers to a fund that would then pay out if they were made unemployed. In the early days stamps were purchased and affixed to a card that was kept to prove entitlement to benefit. Paying NI is still often referred to as a stamp. When the 1945 Labour Government established the Welfare State, NI was expanded. But it was not until 1975 that it ceased to be a flat rate paid by all employees and became a percentage of income, collected along with Income Tax.
Currently for most working people the first £10,000 of your annual income is income tax free. After that a standard rate of 20% applies up to an income of £31,865. The rate then goes up to 40% and for income over £150,000 to 45%. The top rate has been much higher in the past – it was 95% for the highest earners at one point.
National Insurance is charged slightly differently. Only the first £7,956 of income requires no payment. The standard rate of 12% applies up to £41,868, but income above this level is only subject to a 2% rate of NI. This much reduced rate on higher incomes means that those on low wages pay a larger proportion than those on high wages.
There are many technical challenges in merging the two systems. How much would be tax free? What would the standard rate be? And how much should higher earners pay? There is also the position on pensioners, who currently pay income tax but not national insurance. That could be solved by giving a higher tax free allowance though.
The politics of the situation is very interesting. The Tories are the ones behind this move and it is natural to be suspicious of their motives. A cut in the amount that the better off pay would of course be a natural political move for them. But would a simpler system not make such a move more obvious? Likewise, were a more progressive government to wish to increase the amount that the most wealthy pay it could be done simply and transparently.
So is this a good idea? Well it certainly merits a close look. Simplification and a reduction in administrative costs are both good drivers. But do these outweigh the initial set up costs and the need to combine two systems of computerised records? There is suspicion that the loss of the Insurance principle would be used to stigmatise those on benefits further – although the notion that welfare payments are handouts rather than a return from a system already paid into is widely seen now. And in truth the insurance principle does not really stand up to scrutiny these days: National Insurance is pretty much a contributing to general government spending rather than a fund that pays out to the sick or the unemployed.
There is then some merit in this idea. And we should not reject it out of hand simply because it comes from the coalition government. There are many on the left who have long argued for the same thing. Designing a system that removes the regressive nature of National Insurance payments would make a lot of sense too.
There will be great debate before such a fundamental change is made. But there could be positives from merging the two tax systems that most workers pay.