Have National Insurance Contributions had their day?

Written by Andrew Bithray on 9 September 2015

The world of national insurance contributions (NIC) is a minefield for those of us working in the tax industry, let alone for those workers and employers that have to bear the cost – both financial and administrative – of this bizarre, complex and unwieldy system of taxation.

Class 1 for employees. Class 2 and 4 for the self-employed. Class 1, 1A and 1B for employers. The lower earnings limit. The primary threshold. The upper accruals point. Rebates for those contracted-out. Archaic terminology built on concepts from the last century.

The NIC system was first introduced in 1911 when it was paid as a flat rate by all those who worked, regardless of earnings, and the contributions paid were used to provide basic health and welfare benefits. Following the Second World War and the creation of the NHS, the Government steadily increased the flat rate of NIC until 1961 when the amount of NIC you paid became linked to the amount you earned, in much the same was as income tax is paid. This rate has increased dramatically since then such that contributions for most employees is now 12% of earnings between £8,112 and £42,385 and a further 2% of earnings above this level. Employers face a further NIC burden of 13.8% of any salaries paid above £8,112 per annum.

For many people, NIC are simply a tax by another name. In fact, the NIC thresholds have become so closely aligned to the income tax thresholds that many think that now is the time to merge the two systems. The effect of this, in its simplest terms, is that employees would benefit from their personal allowance up to £10k, pay tax at 32% up to £42k and 42% above that. Of course it is not that simple.

Consideration would need to be given to how the lost tax revenues from employers' NIC are recovered – an employment 'tax' that equates to 10% of all Government revenues. It would also take a brave Government to increase the headline rate of income tax from 20% to 32% – more honest perhaps but politically naive.

The ICAEW has recently published a paper considering four options available to the Government:

Merge income tax and NIC – bite the bullet and go for a full scale merger.

Manage – accept that it's too difficult a problem to fix properly but consider making fundamental improvements that are more than just sticking plaster.

Demerge – return NIC to its roots as a separate insurance-based system that buys benefits.  Arguably the current 'auto-enrolment' of employees into private pension arrangements is a first step towards such a separation and hypothecation.

Make do – continue with the system that has served us for over 65 years, knowing that it may not be wholly appropriate for the future.

The current chancellor has said that a merger of the systems would increase transparency and simplicity and these are certainly laudable aims but they were also the aims of many of his predecessors who found themselves unable to introduce change. Perhaps making people more aware of the very high rate of 'tax' paid by workers in this country might encourage a wider electorate in favour of the case for lower taxation.

Let's hope the Government makes a clear decision soon for the sake of all our sanities.