The effect of the NI rises

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Futher to my blog below on the coming rises in National Insurance Contributions (NICs), which Alistair Darling has penciled in for April 2011, it is worth emphasising the fact that these are not just rises in the rate paid by the employee. The employer rate set to go up as well, from 12.8 percent to 13.8 percent. I suppose the government must think that it is a sensible idea to announce an increased tax on jobs while unemployment continues to rise. I certainly wouldn't put that kind of stupidity past them.

Of course, the real reason that governments tend to like 'employer contributions' is that it allows them to pretend the 'workers' will be unaffected. In the long run though, this is a fantasy. Most firms will have a staff budget, out of which they pay the employee's wages, income tax, employee NICs, and employer NICs. So when governments hike employer contributions, it ultimately results in wages staying lower than they otherwise would have, and employees getting a worse deal.

Indeed, if we're going to be really honest about the income tax burden, we really ought to factor in both employee and employer NICs, and compare the total cost to the employer of an employee with that employee's take home pay. So, taking on the tax system as it will be in 2011 (assuming Darling gets his way):

  • Someone with a salary of £12,574 will cost their employer £13,613 per year. But their take home pay will only be £10,462. That means 23 percent of the total cost of employing them goes directly to the government.
  • Someone on £23,640 will cost their employer £26,206. Their take home pay will be £17,987. That means 31 percent of the total cost of employing them goes directly to the government.
  • Someone on £38,505 will cost their employer £43,122, but will only take home £28,095. That means 35 percent of the total cost of employing them goes directly to the government.
  • Someone on £72,581 will cost an employer £81,901, and take home just £48,395. That means 41 percent of the total cost of employing them goes directly to the government.

This gap between cost of employing a worker and what they actually receive is known as the 'tax wedge'. It is damaging to the economy because it makes many jobs uneconomic, as the gross cost for the employer of providing a reasonable after-tax wage becomes more than the work is worth. This particularly damages the unemployed and low skilled, as it reduces job opportunities. As such, a bigger tax wedge is the last thing we need as we come out of recession.

P.S. In case you were wondering why I used such strange income figures, the salaries above correspond to the average, pre-tax incomes of the 2nd, 3rd, 4th and 5th quintile of UK households.

UPDATE: I'm grateful to a reader who wrote in correcting my fourth bullet point. I had mistakenly put £113,103 as the total cost to the employer and £64,262 for take home pay. These are in fact the figures for somone with a salary of £100,000, not £72,581. The post has now been corrected.