NICs: The end should be nigh

Michael Johnson of the Centre for Policy Studies has authored a paper NICs: The End Should Be Nigh, in which he claimed the abolition of NICs was necessary because the national insurance fund into which they are paid is close to running out.

In his paper for the centre, Mr Johnson claimed the status quo was detrimental to democracy and that the complexity of the tax system reduced the likelihood of the electorate appreciating what their total tax burden was.

Vestiges

He believed the introduction of the single-tier state pension in 2016, would be an ideal time to scrap NICs because it would be when “the last vestiges of the contributions-based principle for benefits entitlement disappear”.

He said: “The Government Actuary’s Department recently forecast that the National Insurance Fund (the Fund) will be exhausted by 2035/36.

“But other evidence points to the Fund’s exhaustion as soon as next year.”

Mr Johnson claimed there would be no justification for HM Revenue & Customs to continue to collect the insurance premium.

The removal of NICs would leave the goverment with a significant challenge: how to plug a £110bn shortfall in revenue, the amount collected in employer and employee NICs in 2012/13

Mr Johnson said: “We are suggesting four proposals. The first is the introduction in 2016 of a new residency-based, rather than contributions-based, state pension in 2016.

“Second, employee NICs and income tax on earnings should be replaced with a single earnings tax, ideally set at 32 per cent, 42 per cent and 47 per cent [currently, NICs are charged at 12 percent on earnings between £153 and £805 a week. A further charge of 2 per cent applies to all earnings above that].

“Third, HMRC should offset the loss of NICs by higher corporation tax, dividend tax, earnings tax and VAT receipts.

“Fourth, the chancellor should use the Autumn Statement to introduce this earnings tax.”

Mr Johnson quotes Mr Martin who said NICs were “riddled with anomalies, complexity and a lack of cohesion”.

He said: “For UK businesses national insurance is a staggeringly complex system, with some 60 different categories into which employees may fall.

“Combining NICs with income tax to become the single earnings tax would make the total tax burden on earnings more transparent.”

Having an earnings tax would, claimed Mr Johnson, provide an opportunity for a more informed public debate about what was fair when it came to deciding how to tax low and high earners.

What could really spell the end for NICs, Mr Johnson said, was the exhaustion of the national insurance fund.

The fund was set up in 1948 and is invested in UK gilt-edged stock.

Mr Johnson said: “There are no other assets so, in essence, the fund is an accounting creation and merely an extension of the Treasury’s balance sheet.”

He claimed the fund has been rapidly shrinking, from £53bn in 2008/09 to £29.1bn in 2012/13.

“The Fund balance is in stark contrast to the GAD’s 2005 review, which projected a balance of £103.3bn for that year.”

Because the GAD did not foresee the financial crisis, it is likely the fund could be exhausted by 2016.

Mr Johnson said: “The GAD has recently published new financial projections. It predicted the fund will need a Treasury grant during 2014/15, because its size is expected to fall below a sixth of annual benefit expenditure; and it will be exhausted by 2027/28.”

He said the fund was, in effect, “underfunded” because wages had not kept in line with inflation. For example, the Bank of England’s latest Inflation Report (August 2014) reported robust employment growth, but also “a continuing and unexpected weakness in wages”

Mr Johnson said earnings had fallen by 11 per cent in real terms before the financial crisis, and that even since then, the Bank of England had consistently over-forecast wage growth in its quarterly Inflation Reports.

He said: “According to the Office for National Statistics, annual nominal earnings growth was just 0.3 per cent in the three months to May, well below the current inflation rate of 1.9 per cent, and the Chartered Institute of Personnel and Development has expressed similar sentiments: “Weak real wage growth could be here to stay.”

To its credit, Mr Johnson said the GAD’s latest review of the national insurance fund (July 2014) had remodelled itself on the consequences of using 0 per cent (over CPI) to 2020.

Based on this, fund exhaustion would be expected in 2016. “Given that wage growth in Q2 of 2014 was 1.8 per cent below CPI, fund exhaustion could be imminent,” he said.

Mr Johnson said the government would face a choice – either that benefits are further watered down, or Generation Y, in particular, will face rising taxes.

Putting an end to NICs and integrating whatever remains of the fund back into the Treasury would then be politically attractive.

Making up the shortfall in funding would have to be through taxation. This is because tax income derived from state and private pensions, capital gains, property, savings and dividends do not attract NICs.

Mr Johnson urged that the HMRC be asked to forecast the impact of ending employer NICs, taking into account the subsequent increases in earnings tax receipts, VAT receipts (higher wages would lead to more consumption) and corporation tax receipts.

He said: “Ending employer NICs would be consistent with the observation of Gregory Mankiw [chairman and professor of economics at Harvard University] that companies are more like tax-collecting conduits than taxpayers.”

Ending NICs would also put an end to corporate tax evasion, Mr Johnson claimed. He said: “It would put an end to the futility of paying for two Houses of Parliament to debate and legislate for tax-raising powers, only to be thwarted by an army of expensive tax consultants in the employ of corporate Britain.

“Amazon, for example, paid a mere £2.4m in UK corporation tax – on 2012’s UK sales of £4.2bn.

“The forthcoming 2014 Autumn Statement on 3 December, presents the ideal opportunity for the chancellor to flag an intention to end NICs. With a general election imminent, there would be insufficient time for implementation, and hence the chancellor would have no obligation to commit to a timetable.”

Mr Johnson added: “The national insurance fund is essentially a conduit for passing NICs from today’s workers to the older generation in the form of the state pension. Fund exhaustion is inevitable, merely confirming what we already know, namely that today’s workers are passing too much to today’s pensioners.

“Sending the state pension age into retreat is intended to address this, but too late to save the fund.”

Steve Danson, chartered financial planner at Banks Wealth Management in Lancashire, said: “The tax system in the UK is incredibly complicated. Suggesting that NICs and income tax are combined sounds, in theory, like a good idea.

“But we have seen other examples – pension simplification in 2006 made things more complicated. Any change that promises to make things fairer has to be well thought out.”

Adviser view

Steve Danson, chartered financial planner at Banks Wealth Management in Brinscall, said: “The tax system in the UK is incredibly complicated. Suggesting that NICs and income tax are combined sounds, in theory, like a good idea.

“But we have seen other examples – pension simplification in 2006 made things more complicated. Any change that promises to make things fairer has to be well thought out.”

Samantha Downes is a freelance journalist

Key points

■ The merger of national insurance contributions and income tax is long overdue.

■ The national insurance fund has been rapidly shrinking, from £53bn in 2008/09 to £29.1bn in 2012/13.

■ Ending employer NICs would be consistent with Gregory Mankiw’s observation that companies are more like tax-collecting conduits than taxpayers.

Class 1 NICs deductions from employees’ pay (2014/15)

Earning band, £ per annum

Category £5,772 to £7,956 £7,956 to £40,040 £40,040 to £41,865 Above £41,865

A 0% 12% 12% 2%

B 0% 5.85% 5.85% 2%

C N/A N/A N/A N/A

D 1.4% rebate 10.6% 12% 2%

E 0% 5.85% 5.85% 2%

J 0% 2% 2% 2%

L 1.4% rebate 2% 2% 2%

Source: Centre for Policy Studies

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