Income tax and National Insurance merger: Possible losers

Robert Powell
by Lovemoney Staff Robert Powell on 30 November 2011  |  Comments 21 comments

The government is planning to simplify income tax and national insurance. However one group could be set to lose out from the changes...

Income tax and National Insurance merger: Possible losers

Two words most of us would rarely put together: tax and simple. And this is probably why the government has a whole office dedicated to coaxing these terms together.

Yes, the Office of Tax Simplification has wasted no time demystifying our approach to tax. Its first publication: an extremely complex 82 page paper recommending the merging of income tax and national insurance (NI). Sigh.

On the back of this report, the government has begun examining the feasibility of integrating the two systems.

However if this does go ahead, one group could suffer.

Difference in rates

Commentators and accountants have pointed out that the self-employed could lose out if a full merger of the two tax systems is pushed through.

This is because national insurance contributions (NICs) for employees and the self-employed are, as it stands, levied differently. The self employed pay class four (percentage) NICs (more on flat-rate NICs later) at 9% on profits between £7,225 a year and £42,475 and 2% on profits past that.

Employees on the other hand pay NICs at 12% on earnings between £7,228 a year (£139 per week) and £42,484 a year (£817 per week) and 2% on earnings above that level.

Income tax is obviously levied for both employees and the self-employed at a blanket rate.

So while income tax is identical for employees and the self-employed, NI is different, with the self employed paying less (as a percentage of their income anyway). This could throw up problems, depending on how the two taxes are integrated.

For example, if a full merger goes through and a ‘mega-tax’ of 32% is born, the self-employed who are currently paying NICs at a 9% and income tax at 20%, would lose out.

But this isn’t the only potential problem for self-employed workers.

Qualifying years

NI contributes towards your State Pension. However, to be eligible for the full basic State Pension (currently £102.15 a week) you’ll need to have built up sufficient contributions through qualifying years of work or benefits claims.

The self-employed are also eligible for the State Pension. However the class four, percentage contributions do not go towards it. Instead the self-employed pay class two NICs for their State Pension: this is a flat rate of £2.50 a week. That way, the self-employed can keep up their contributions regardless of their profitable income.

An integration of NI and income tax could throw a spanner in the works if this flat rate – and cost-effective option – is scrapped. If a straight percentage ‘mega-tax’ is levied across workers, the self-employed could start to see gaps opening up in their qualifying years. A flat rate would also not take into account possible variations in self-employed income.

Say hypothetically a self-employed person worked seven days a week for a full year, earned a lot of money on a high rate and paid a large amount of NI; but then did not work at all for the next year. Under a solely flat percentage levied profit rate of NI, this would potentially only count as one qualifying year, despite the person having paid over-the-odds due to their abnormally high income in the first year.

But the self-employed aren’t the only people being put at risk by these proposed changes.

More potential losers

Anyone who does not pay NI but still has an income (and hence pays income tax) could also lose out if a tax integration went through. This would include pensioners and those that live off savings.

People who work in more than one job simultaneously could also lose out if one rate was passed across multiple employments.


The Treasury has said it will proceed with caution when introducing any amalgamation of NI and income tax. In fact, a full merger is not even on the cards, so don’t expect a 32% ‘mega-tax’ anytime soon. The devil really will be in the detail.

The government has also made assurances that self-employed workers, pensioners and savers will not be adversely affected by any changes. However it seems inevitable that whenever changes like this are pushed through, some groups always suffer.

So is it worth doing?

Political economy

The aim of this merger is to bring more transparency to the tax system and allow people to see just how much they are paying in tax. It comes alongside proposals to give every taxpayer online access to their tax records.

Perhaps I'm being cynical but I suspect lthis might not be the Government's only motive. If NI and income tax are brought in line and the rate of tax for most people is viewed as 32% and not 20%, it’s likely that the public attitude towards government spending will increase in both criticism and hostility. This could bring about a shift in preference across the balance of tax cuts and state spending.

As James Forsyth put it, writing in the Spectator, “this move would be a matter of political economy”.

In other words, the motives, along with the practical steps for this tax change, could be anything but simple.

Your take

Should income tax and national insurance be merged?

Have your say using the comment box below.

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Comments (21)

  • matchmade
    Love rating 38
    matchmade said

    I think income tax and NI should be merged: the idea that NI payments ever went into some kind of insurance scheme was always false. If a proportion of our taxes went into an independently-managed national investment scheme, as apparently they do in Norway, and this scheme was invested for profit and improved national infrastructure (keep a large proportion of our money for the good of this country, as the Government is trying to persuade private pension funds to do), and dividends taken to pay for state pensions and unemployment and sickness benefits, then I might be persuaded that National Insurance was a tax worthy of its name. But right now, RichardG, it only pretends to be something that "goes towards" your entitlement to benefits. How anyone can be unaware of NI nowadays escapes me, when even a basic rate taxpayer will lose 20% to income tax and another 12% to NI - NI has become an ever-larger proportion of your monthly taxes as an employee.

    Great idea by organgrinder to merge the taxes but compensate pensioners with a higher tax threshold, and for more tax bands like they have in the United States and Canada.

    To get around the problem where self-employed people's profits vary, year on year, you could merge income tax and NI, but keep the notion of Class 2 NI for buying pension-only entitlements. I don't understand the difference though between Class 2 and Class 3 (voluntary contributions) - why the difference, other than to keep tabs on the self-employed? It would be simpler to say, if you're an employee or a higher-earning self-employed person, you pay 32% or whatever it is for the merged income tax, and everyone else (people working overseas, housewives, people living off savings and rents, low-profit self-employed, company directors on a low income, etc) can top up their 30 year pension entitlement whenever they feel like it, using a voluntary scheme like Class 3.

    I agree completely with those who complain self-employment and "employment via your own company" are fiendishly complicated. On the face of it, rewarding people to keep their profits in their companies by giving them lower tax rates on dividends up to the higher rate threshold is a good idea, so that their companies grow and grow on a compound basis and hopefully provide employment too. This is why I set up my own company and pay myself a miniscule income and only take a small amount in dividends. However the process for extracting your profits during the company's growth, perhaps to fund a house purchase, and when you retire or wind the company up is so complicated and continually-changing, and you've paid so much to accountants each year along the way, you often wonder why you bother.

    Report on 02 December 2011  |  Love thisLove  0 loves
  • MK22
    Love rating 169
    MK22 said

    Seeing as we have computers these days (I know the Government hasn't spotted it yet, but give them time), all we need to do is set a minimum income below which no tax is paid and then have a continiually changing tax rate until a maximum income is reached beyond which the tax take doesn't increase. So no silly step changes like we have at the moment. And income is defined as everything you receive, from a UK employer or if you live in the UK. Your employer gives you a £20k car, that's £20k on your income for the year. Your employer gives you a lease car costing £8k a year that's £8k more income. You employer gives you £1M worth of shares, that's £1M on your income. Simples.

    We could do the same for companies, tax nett income earned in the UK. And if your company receives goods or services from a non-UK part of the organisation, unless you can prove an international trade in those goods and services you cannot set their cost off against your nett income. So if you are a foreign owned TV company and you buy programmes from your foredign owner you cannot charge their cost against your income unless you can prove that the charge is a genuine market cost (unlikely!).

    And can someone explain why we employ people to pay Government employees and then employ another group to take back some of that pay in tax? Reduce the salaries to a nett of tax level and then just pay that with no deductions.

    Report on 02 December 2011  |  Love thisLove  0 loves

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