Let’s merge income tax and national insurance to build a more progressive tax system
Any strategy for personal taxation of a Labour government should be to implement a progressive tax system which seeks to increase the money that low and middle income earners have in their pockets each month.
And for good reasons: both moral and economic.
If one earns more, it is one ought to be their civic responsibility to contribute more as a proportion of their income or wealth to the society they live in than those who earn, or have, less.
It also makes good economic sense. With more money in their monthly pay cheque, low and middle income earners are far more likely to spend their increase income. Lower rates for these individuals can also encourage work, reduce welfare dependency and support long-term, sustainable economic growth.
One of the achievements of the 2010–15 Coalition government was increasing the personal allowances for income tax from £6,475 at the beginning of the Parliament to £10,000 at the end. As of August 2018, it currently stands at £11,850.
But the threshold at which one begins to make national insurance contributions has been continuously far below personal allowances for income tax — currently standing at £8,424.
Furthermore, as the Office for Tax Simplification identified in 2016, a further problem relates to the fact that income tax and national insurance are calculated in different ways. To quote directly from the report:
- Income tax is calculated on someone’s income for the whole year, by adding all their jobs together. The tax free allowance is deducted from their total income for the year, and they pay tax on the rest. If an employee receives company benefits, such as a car or health insurance, they do not pay national insurance on these benefits but they will pay income tax.
- National insurance is calculated separately on each pay packet from each job. A tax free allowance is given on each pay packet from each job. This means that if someone has two jobs at the same time, they get two tax free allowances.
These two problems together mean that some people are unable to build up a sufficient number of qualifying years for obtaining a state pension. This despite that fact that, for all intents and purposes, national insurance is essentially a second form of income tax.
A future Labour government should therefore seek to gradually align, and then merge, income tax and national insurance into one, unified income tax — The New Income Tax — with a single tax-free allowance.
Doing so would have a number of advantages:
- Increase honesty and transparency in our tax system: Many voters are now tired of repeated promises from numerous political parties not to increase either income tax or national insurance, only to increase the other. People would also truly understand that, at least initially, their true income tax rate was 32% for basic rate tax payers (42% for higher rate tax payers)rather than the disaggregated 20% + 12% (or 40% + 2%).
- Significantly reduce the administrative costs of our tax system: National insurance is an extremely complex system. There are 60 different categories into which employees may fall, and 20 different rebates for pensions. Complexity in taxation puts employers off employing people and conceals the truth about tax from those who pay it. There would be a huge saving for business and the exchequer if they only have to pay and collect one tax instead of three. All the different rules, from assessment periods to how expenses can be deducted, could be consolidated.
- Use the merger to create an all-round, fairer tax system: Perhaps most fundamentally, merging income tax and national insurance must not be a policy measure taking in isolation. This New Income Tax could also be applied to dividend and capital gains income. With respect to the wider tax system, I have also proposed the introduction of a land value tax (more of which you can read here). This would therefore facilitate a lower income tax rate for those on low and middle incomes. Similarly, there should be wider reforms to the way we tax corporations, treat inheritance and capital gains, and encourage pension saving, to name just a few things.
Furthermore, the Institute for Fiscal Studies (IFS) has also said that the integration of the systems of income tax and NICs would produce a major improvement to the structure of the personal direct tax system in the UK. It would be more coherent, and reduce the scope for tax.
That isn’t to say that there are zero potential downsides to merging income tax and national insurance. These could include:
- Implementation: A comprehensive IT project would be required to implement a new tax system. While I propose that such this merger should take place over an appropriate period of time (say, seven years), it would be imprudent to ignore the problems the Department for Work and Pensions faced when introducing Universal Credit.
- Employers’ contribution to the social security system: Yet, this could be easily resolved by implementing a Payroll Tax for employers.
- The potential break of the contributory link to the social security system: It has been not unreasonably argued that national insurance sanctifies the contributory principle and that doing away with it could empower (Conservative) governments to reduce social security benefits. I would counter that, in the first instance, the idea that NICs are ring-fenced into a special fund that specifically pays for the NHS and state pensions is, ultimately, pure fantasy. It is simply a matter of fact that all tax revenue is pooled together to fund today’s Government’s expenditures.
That said, it would be wrong to dismiss the contributory system completely. Instead, the social security system could be re-wired, so that it is the New Income tax contributions that affect the social security benefits that one can claim. - How to treat pensioners: Whilst it would not be justified to raise the tax burden on the poorest pensioners, there is no doubt that, with an increasingly ageing population, we as Britons need to have a frank and honest conversation about how the overall tax burden is shared between generations. This ought to mean the richest pensioners contributing more to the services that they will ultimately be far more likely to use (for example there is no good reason why people who have surpassed the state pension age should not pay national insurance on any occupational income). In any case, a potential remedy, this could be to exempt the state pension from the New Income Tax.
- The public relations challenge in communicating the changes to the British public: This would be no mean feat; a lot of effort would need to be dedicated to explaining to the public about the reality of the changes.
Yet, I believe these issues would all be ultimately surmountable (and could be revisited in more detail in a future piece).
So come on, Labour — and be truly radical.
