Of all the questions about why our tax system is structured like it is, the question whether to merge income tax and national insurance must surely be the most asked – but least answered. Why is that?
Proponents of a merge include Gavin Kelly (Chief Executive of the Resolution Foundation), the Taxpayers Alliance, the Institute of Fiscal Studies, the Centre for Policy Studies, PWC, the Centre Forum (a liberal think tank), Judith Freedman, UKIP. Why, then, has it not happened? They are, as all of the above have pointed out, both taxes on personal income.
The short answer is the enormous political challenges that a merger would involve.
- It would expose a not terribly progressive tax system: once you include primary and secondary NICs, income tax currently starts (for the employed) at over 40% on income above £10,600. And it rises to more than 53% (ignoring for a second the anomaly consequential on withdrawal of the personal allowance for those earning between £100,000 and £120,000).
- It would expose the bias in favour of unearned income – which of course doesn’t suffer NICs.
- It would expose differing rates of tax for the employed and self-employed, sometimes differing by more than 11%.
- It would reveal that raising the income tax personal allowance isn’t the best way to help the poorest.
- And it would demonstrate that we pay really quite high rates of income tax.
How would the Government address the fall-out from each of these challenges? Let’s examine them in a little more detail:
- A not terribly progressive tax system. Will Government reduce the basic rate of tax? It’s difficult to see it pushing up the higher rate or the additional rate. If it did, what would the cost of this reduction be? Could it be a spur for adopting a flat tax?~
- A bias in favour of unearned income. How would living with this bias play with an electorate that has already tagged the Conservatives – unfairly or fairly – as being the party of the rich? Could the Government increase income tax on unearned income without sledge-hammering off the five year tax lock? If it could, how would this play with the very wealthy who already pay a huge proportion of our aggregate income tax take? Taken in combination with the heralded changes to the non-dom rules, would it amplify so-called behavioural effects causing our highest contributors to leave the country?
- What about differing rates of tax for the employed and self-employed? There are those who say the difference is not justified – and that it simply leads to people gaming the system by entering into contracts of self-employment in circumstances that look more naturally like employment. Sometimes they are right to say so. There are others who say we need to reward risk taking. And there’s a very compelling school of thought that, but for the flexibility of the UK labour market, the country would not have enjoyed the huge decline in unemployment that we have seen. What would requiring all of those individuals to be treated and taxed as employees do for the flexibility of the labour market?
- What about the effects of raising the personal allowance? The Government has promised to raise the personal allowance to £12,500 by the end of this Parliament. But even in that world, tax at a rate of 20% would still be paid on the employment income of those who earn £8,000 or more. This Government wasn’t the first to adopt the politically attractive route of cutting the headline rate of income tax rather than focusing on delivering measures that really help the poor. And it won’t be the last. But raising the NICs floor so it matches the income tax floor would be a hugely expensive commitment. Will Government tackle it? It’s not impossible to imagine it might – but certainly not in order to deliver the technical win of unifying the two taxes.
- And, finally, the very high rates of income tax that we pay. People might be surprised to learn that employment income above £10,600 presently bears an effective tax rate of over 40%. One can see that shock as being enormously politically helpful to a party that believes in a smaller state. So there is an argument in favour of merging the two taxes. It would absolutely be a helpful stepping stone on that path. But, gosh, this Government has some rather uncomfortable shoes to don before it takes that first step.
And all of this ignores the biggest political challenge of them all. Those over the state pension age are not presently liable to pay national insurance contributions. Merging income tax and national insurance contributions would require the Chancellor either to render transparent this discrimination – or to take a substantial political hit. I have argued here that now is the moment for the Chancellor to do so. But it’s an undoubted political risk.