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.

Consultation

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)

  • targetblack
    Love rating 3
    targetblack said

    As a self employed small business owner, at risk of losing out, I completely support the idea of merging these two revenue streams.

    Only when we can see in the most simple form how much the government takes from the average earner will there be a stronger push by the general population to reduce public sector spending.

    Importantly complex tax systems only serve to cost the tax payer more due to the need to employ the aggressive ineffective bloated public sector tax administration department. We would realise a huge saving if we simplified more of the tax systems.

    Once this is done how long before vehicle tax, fuel duty and congestion charging are merged. Not long I hope.

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  • RichardG
    Love rating 3
    RichardG said

    This can only be a good idea. I agree with targetblack that the tax system is complex and needs to be simplified.

    The same goes for business taxes. It seems daft that companies like Boots now pay very little tax because of moving to Switzerland. If the tax was simplified it might not be worth their while to do such a thing.

    UK UnCut claims that since Boots, bought out by private equity firm Kohlberg Kravis Roberts in 2008, moved its headquarters to Switzerland, the tax it pays has dropped from 33% to 3%, saving £150m a year.

    I think this is something to do with interest payments being treated as some sort of tax break.

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  • freeman67
    Love rating 0
    freeman67 said

    The big danger is ensuring that pensioners do not lose out, they are growing in number and tend to vote more than the younger generations, they are therefore politically important and in addition I am not sure that merging the systems is going to save money given governments lamentable record in managing IT projects, just look at the attempt to implement the NHS IT system great idea, but it doesn't work

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  • rbgos
    Love rating 84
    rbgos said

    I'm with targetblack - I would also lose out personally, for similar reasons, but this still makes good logical sense to me.

    As for those who live off their savings, investments, and/or inheritance, yes, they currently avoid NI altogether on that income. Rather than pandering to these groups who look like they'd lose out with a merged tax, my view is that they should be damned grateful they got the free ride they did for as long as they did, and now is the time to start paying as much as everyone else.

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  • RichardG
    Love rating 3
    RichardG said

    rbgos - I think you completely misunderstand National Insurance. It is meant to be something to cover pensions. When you retire you therefore stop paying it as you start collecting your pension.

    You still pay tax on your savings and investments like any taxpayer unless you are able to opt out of paying tax because you don't breach the tax threshold. Therefore I suspect the same would be true of the merged Tax and NI. Savings are taxed at a different rate anyway and when you fill in a Tax Return the you either pay more or get a rebate depending on your circumstances.

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  • bob13south
    Love rating 2
    bob13south said

    I agree with tax simplification. I've also just become a pensioner, but I'm continuing my self-employment as I still have debts to pay off (mainly mortgage). With my OAP and private pensions, I'm now paying more income tax than ever, which I accept. But I'm horrified to think that I may be going back to paying NI as well. I've faithfully kept up NI payments to ensure as good as possible OAP and in fact paid far more than the minimum years required. Also having kept in good health, hardly ever used the NHS.

    Now all that (continuing) effort to provide for myself and family is going to be hit even in my old age! I for one will look seriously in the next General Election at any party that will refuse to enact this proposal!

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  • nosbort
    Love rating 160
    nosbort said

    To avoid the NI to tax change causing an increase in tax for the self employed they can just switch to being a limited company and pay the appropriate minimal amount (currently around £475 per month) to themselves as salary and take the rest as dividends, hey presto, the tax rate drops to the small business CT rate of around 20% with no income tax payable until hitting the upper rate band and NI costs nothing for a full contribution

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  • Perry525
    Love rating 26
    Perry525 said

    Everyone accepts that NI is just another tax.

    As such it is pointless employing thousands of people who merely duplicate each others work, we the tax payers will save millions of gbp in getting rid of these people, who then can do something useful and productive.

    If we have Road Tax added to the cost of petrol, hundreds more can go.

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  • Grayham
    Love rating 9
    Grayham said

    One simple way to overcome the problem of those past retirement age is to give them an even higher tax free threshold, thus removing for many the NI issue. However for those who earn a lot would find that they might have to pay more

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  • Steviebaby1959
    Love rating 34
    Steviebaby1959 said

    @ nosbort

    It is not quite that simple a task.

    Once you become a Limited Company you are liable for Capital Gains tax on business assets, you have to register with Companies House in Cardiff, file Company Tax Returns and pay Corporation Tax. In addition you are also required to complete a tax return for the year you stopped trading and started a new company, you will also need to deregister as self-employed and stop paying self-employed Class 2 National Insurance contributions and now starting a limited company, of which you will be a director, then you will be an employee of the company, this means you will have to register as an employer and set up and run a PAYE scheme. If you're a company director you'll need to complete a Self Assessment tax return each year, and a P11D, a benefits and expenses tax form.

    After you've finished faffing around for weeks and weeks with the paperwork, going round and round in circles with Gov't bodies, you'll wonder why you ever bothered.....

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  • nitnot
    Love rating 5
    nitnot said

    All the insurances I have bought over the years have been supported by a policy document explaining exactly what I can claim and the circumstances under which I will receive a payout. Not so National Insurance! Many years ago I asked for a copy of the policy explaining my and my employees entitlements under the cover which NI was supposed to provide. Other than being told that there was no policy document and that 'everybody has to pay it' no answer was forthcoming. My accountant simply said " it's not real insurance - just another form of taxation which they hope you won't notice"

    Well I noticed it including the fact that I also had to pay 'employers contributions' which was counter productive as this amounts to nothing more than a tax on employment. Result: I employed far fewer people than were really needed to run the business efficiently and I frequently turned down major contracts due to lack of staff. My existing staff refused to work overtime because they said "we'll only lose most of it in tax and we'd prefer to spend the time at home with the wife and kids" What's changed, anything?

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  • bengilda
    Love rating 100
    bengilda said

    NIC is a tax, no more, no less, and quite a complicated mess. It is costly to both employers and to the government (taxpayer) to operate.

    While it will be ideal to merge it into another existing tax to make for simplification and huge administrative savings, it is not necessarily the best option to add it to income tax.

    A good contender to cover all, regardless of income and employment status, would be to add a 1/2% to VAT as an add on, to be separated off by the VAT office and passed to the pension administration.

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  • organgrinder
    Love rating 4
    organgrinder said

    The problem is that tax and NI are applied with different rules. My view is that tax should be paid by those earning money or making profit. NI on the other hand doesn't discriminate and employer's NI in particular hits hardest on those employers with large numbers of staff, not large amounts of profit.

    The different tax treatment also allows some high earning sole traders to incorporate and draw down most of the profit in dividends which are not subject to NI.

    I am in favour of the amalgamation because it will spread the burden more evenly and in particular it will be paid by those making the most money or profits. The mega tax of 32% is nonsense because it just adds the current NI and tax percentages and the actual rate could be much lower.

    This is a golden opportunity to revamp the whole tax system - pensioners could be protected by having higher age related personal allowances but those pensioners on £40K and upwards would pay a bit more (would anyone deny that Sir Fred should contribute a bit more from his £500K pension). We could have more tax bands and in the end we would have a much much fairer tax system. If it's fair I have no problem with it and if it cuts out a massive amount of tax planning and anti avoidance legislation then the savings will be there for everyone to benefit from.

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  • easygoing
    Love rating 170
    easygoing said

    Lambs to the slaughter! It all sounds so easy, all we have to do is put a few more billions into the pockets of firms like Crapita and sit back and wait. . . and wait. . . and wait. Income tax is a tax and NI is an insurance, hardly the same thing and whilst the revenue lines have become blurred over the years it is still possible to identify the separate amounts raised. Once it all becomes one homogenous pot then all transparency disappears. It is just another way of blurring the issues. The road fund tax became an instance of where a tax was raised to fund the building and maintaining the road infrastructure, slowly over the years it has become part of the general taxation pot.

    A simpler example is the one about raising the cost of using the Dartford crossing. They have given up trying to hide the price rise as a congestion busting exercise and now have renamed it a tax to fund a new crossing. No indication of if or when this will be built but keep stumping up the extra lads we might get around to it some time. There have been so many lies about this over the years. Not exactly on topic I know but an indication of how they play the game.

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  • develyn
    Love rating 7
    develyn said

    It is the pensioners who will be hit hardest. They will struggle more and more as inflation bites into fixed incomes. If you then make them pay a combined NI and Tax they will be sorely tried.

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  • oldhenry
    Love rating 343
    oldhenry said

    This is an absolute travesty. It is intended to tax pensioners who the government hates. This can be seen as they have reduced the RPI linking to CPI and the lowering of fuel allowance. Thay have also taken away the coach travel concession. The thin end of the wedge. There is no doubt that the whole aim of this is to bring the 'unearned' income ( in their view) within the NI net. I don't doubt it will go through as the government are so desterate for money to waste on their pet schemes, funding foreign dictators.

    They have knocked the stuffing out of pensioners already by allowing swinging energy price increases to fund middle class Solar Panel payouts ( note Cameron's wife's dad has a large installation) and the extension of the tax regime will be a godsend for the Treasury.

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  • ripoffbritain
    Love rating 0
    ripoffbritain said

    As my user name suggests I am sceptical. I am not sure if it is RIPOFFBRITAIN or RIPBRITAIN. Why don't we get the benefits we pay out right first, too many frauding the government on hand outs and too many immigrants taking the p.i.s.s. I still work at 65 and don't pay NI if they merge once again the honest pay for the fraudsters. I am glad i am not 20 and just about to embark on 45 years working in the UK.

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  • Grobbendonk
    Love rating 28
    Grobbendonk said

    Er, sorry, you've said "self employed", "national insurance" and "income tax" in an article and not mentioned IR35. That travesty of a third tax affects a significant proportion of the self-employed and makes the situation for us a lot more complicated.

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  • coloratura
    Love rating 81
    coloratura said

    I agree with ripoffbritain. If they really wanted to make tax easy they could simply charge us all a percentage of what we earn (or on our profits if self-employed). As MP's don't have to supply receipts for their expenses, they could simply make a flat rate expenses allowance for everybody else as well - if you spend more you lose out but if you spend less than the threshold you make a gain. Same thing with a flat rate for all for National Insurance (no charge to pensioners). How easy and money-saving could that be. No forms that people can't understand, no complicated computer systems, no different tax bands and less costly administration.

    I suspect, however, that the system is deliberately complicated in order for successive Governments to make more money - the name of the whole game - and yes, I believe the "Credit Crunch" was engineered in the same way. No longer ripoffbritain though but ripoffworld.

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  • 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.

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  • 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.

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