Transforming National Insurance

The now-withdrawn proposal to raise National Insurance rates for self-employed people from 9% to first 10% and then 11% has achieved one positive thing.  It has drawn attention to the absurdity of the dual system of income tax and national insurance.  Dan Hannan’s piece in the International Business Times makes the point that the retention of National Insurance is done to conceal how much tax people are paying.  He says people would be very angry if they knew that in addition to their basic rate of income tax at 20%, their National Insurance payments took it to a very much higher level.

He is correct, but an honest government should let people know what tax they are paying, even if it changes their readiness to submit to tax increases.  The two taxes on income should be merged.  In the first instance the myth of insurance should be exposed by renaming it a National Insurance Tax, and having it at the same rates and thresholds as income tax.  Income Tax plus National Insurance Tax would together constitute a “Personal Tax’ that people paid on all earnings above the starting threshold.  A basic Income Tax of 20% plus the 12% employee contribution to National Insurance Tax would give a Personal Tax of 32%.

Government could thus merge the two without having the headline basic rate of Income tax leap through the roof.  It would, however, make clear to people what they were actually paying in Personal Tax, and would end the anomalies of having different thresholds and separate calculations.

There is more, though.  In addition to the employee contribution to NI, there is the so-called employer contribution of 13.8%, so-called because in reality it comes from the wages pool paid by the employer and would otherwise be available as wages.  Although it is called an employer contribution, in fact its incidence falls on the employee.  This could initially be renamed the employer contribution to National Insurance Tax.  Personal Tax would then consist of 32% paid by the employee, and 13.8% paid by the employer, for a total of 45.8%.

Once this change had bedded in and yielded savings in simplification, the employer contribution to National Insurance Tax might be given its real name, “Employment Tax.”  It would be seen for what it is: a disincentive to create employment.  It might also add to popular pressure for further simplification of the tax code and to heightened intolerance of government wastage.