Should the Government abolish National Insurance? According to a new report from the Centre of Policy Studies, the answer is an emphatic yes.
If the DWP follows through with its plans to reform the state pension and introduce a universal, single flat-rate pension, the CPS argues that the removal of the contributory principle from the state pension as a result removes the last justification for continuing with NI.
The reports says the NI system is “complex, cumbersome, misleading and ramshackle” and riddled with “anomalies and inconsistencies”.
Hargreaves Lansdown pensions analyst Laith Khalaf says you will not find many people in the industry disagreeing with this discription. “The NI system has been a cont-ributory system for the state pension but as we know it is a hideously complicated one. It is not as if the rules for NI have not been changed mid-game anyway.”
The CPS says one of the biggest problems with the system is the growing gap between what is being paid in and what people actually get for their money.
The report says: “The contributory principle has become threadbare and those paying NICs might well be surprised to learn how little they get back in return. The only logical solution to these problems – particularly if the state pension is to be replaced by a universal pension, available to all – is to end the pretence that there is a real contributory basis to benefit entitlements and to merge the income tax and NIC systems.”
The report argues that despite the huge amounts of revenue raised by National Insurance, taxpayers are not actually getting what they pay for.
National Insurance raised £97bn for the Government in 2009/10, just over 20 per cent of all Government tax receipts. But of this, only £61bn was paid out in pension benefits, with a further £7bn paid out in incapacity benefits.
Of the remaining funds raised, £20bn was paid directly to the NHS, a universal benefit rather than a contributory one. In addition, NI is being used via a system of rebates to help pay for new green taxes on employers.
The CPS says a further issue with the NI system is the gap between contributions and the value of benefits paid out. With the exception of S2P or Serps, which are for now linked to contributions, most of the other benefits paid for out of NI are flat-rate benefits. However, flat-rate contributions were abandoned in the 1960s and taxpayers make NI contributions based on a percentage of their income.
Neither is NI used to fund all forms of benefit. In fact, excluding pensions, NI now makes up a minority of benefit funding.
As a result, the CPS report says the only sensible conclusion is to scrap the current system and move the funding of benefits into general taxation.
But any move to scrap NI and increase income tax would be a sensitive one.
The CPS acknowledges as much in its report and says despite seeing an increase in the headline rate of income tax, this would be more transparent and make the Government more accountable in its taxation policy.
Centre for Policy Studies director Jill Kirby says: “The merger of tax and NI would lead to a much higher headline rate of tax. Such a step would provide a simpler, more transparent and more honest approach to taxation. Politicians wishing to raise taxes would no longer be able to hide behind the device of raising NI rates. David Martin recommends that the proposed merger should be accompanied by an overall tax cut.
Indeed, such a merger would surely intensify pressure to cut tax rates and to keep taxes low, thereby incentivising work and generating prosperity for all.”
But many others are not so sure. Khalaf says he does not think people would object to an effective renaming of NI as income tax. “It does not matter what they call the stuff which is disappearing from your pay packet. The fact that it is going out is what matters. Whether you call that, income tax or National Insurance, I don’t think that matters to the average man in the street.”
But he says scrapping NI would open up a potential new avenue of taxation.
“At the moment, you stop paying National Insurance when you reach age 65. If you move it to an income tax basis, this opens up the possibility that you pay that tax past your 65 birthday and with the default retirement age about to be abolished, that could be a pretty smooth move for the Government in terms of raising additional revenue. Instead of people stopping paying NI they would be paying 11 per cent extra income tax instead.”
But other commentators say income tax is such a contentious subject that no Government would be brave enough to introduce such a change.
Standard Life head of pensions John Lawson says at least one new tax would have to be created to pick up the gap left by scrapping employer NI contributions.
“NICs are charged on both employers and employees, so you cannot roll that naturally into income tax, there still has to be a payroll tax which is paid by the employer. So I don’t know how you cope with that.”
Despite agreeing that the contributory principle for benefits was broken a long time ago, Lawson says the fragmented nature of the pension system makes it impossible to remove all the elements of contributory-based pensions.
He says despite Webb’s proposed reforms, he does not think all Serps or S2P entitlements will be scrapped.
“You would still have people with entitlements that were calculated on a band of earnings related to NI bands, so you would have to retain those within the system somehow. So would it simplify the system that much?”
But both Lawson and AJ Bell director of marketing Billy Mackay say the political risk involved in any reform make it extremely unlikely.
Mackay says: “No matter which way you look at it, from a political point of view, even though you would be scrapping NI, you would have no option to increase income tax to pay for it.”
Lawson says: “The biggest risk here is political. You would have to say to people that income tax is 30p in the pound rather than 20p in the pound and for a higher-rate taxpayer, it is 50p and 60p.
“Saying that our top rate of income tax is 60 per cent is very difficult to do. You can see the lengths that politicians have gone to in previous election to say they would not put up income tax.It is a very sensitive area for the electorate.”