Many of the reasons that NI was created are no longer relevant - it's time to scrap the tax
Tax and benefits in this country are notoriously complicated. To its credit, the coalition government is trying to make the system simpler and easier to understand. But there is one area of tax that they haven’t tackled yet, and which should come under their spotlight sooner rather than later: National Insurance.
Since the war, National Insurance has been seen as the way to fund “universal benefits”, payments like the state pension or child benefit that go to all of us, irrespective of our wealth.
Now, with the government’s cuts, at least some of these universal benefits are being changed so that they are only available to certain members of the population. Most notably, George Osborne announced in the October spending review that child benefit will no longer be paid to people on the highest tax band.
The link between National Insurance and universal benefits has been bent, and may be irrevocably broken in the months and years ahead. I think that the system could be made fairer, more transparent and better value for both government and people by getting rid of National Insurance. There are alternatives which would serve us as individuals and a society much better.
What is National Insurance?
National Insurance is a kind of payroll tax, just like Income Tax, which comes straight out of your wages.
You pay it if you’re an employee or self-employed, and aged between 16 and the state pension age (60-65, depending on your age and gender). Employers also make contributions to National Insurance for employees that are earning above a certain threshold.
As an individual, you pay the tax in order to build up your entitlement for certain state benefits, notably the state pension. In order to get a full state pension, men and women need to have paid their National Insurance for 30 years (it's longer if you were born before 1945). If you pay National Insurance for fewer years, then you would get a proportionally smaller pension.
However, when an individual pays National Insurance, that money doesn’t go directly to his or her own pension/benefits. It goes to the payment of the current generation of pensioners and benefit claimants.
A time of uncertainty and reform
Whether you like it or not, it’s certainly the case that the government is being radical with its reforms to pensions and benefits.
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A whole raft of benefits are going to be brought together into a single Universal Credit for benefit claimants.
Meanwhile, major pensions reform is coming soon. It has been mooted that pensioners will receive a standard rate of £140 a week, in place of many means-tested that exist at the moment.
We haven’t seen the detail of this proposal from the government yet, so we don’t know how it’s going to be funded. The present pensions system relies on National Insurance, but we simply don’t know if it will be used to fund the future system.
In a time like this, reforms that once seemed unthinkable become possible. In an interview with MoneyMarketing, the former head of the Pensions Advisory Service, Malcolm McLean, said that it might be time to get rid of National Insurance.
“Being radical, if you wanted to make even bigger savings, you might ask the question whether we really need National Insurance any more...Once National Insurance is not going towards pensions, people will start to wonder just what it is being paid for.”
Governments like this tax
The other issue with National Insurance is that it has seemed to become the favoured way for governments to increase their tax income over the past decade or so.
A 1p increase on income tax is the kind of measure that political spindoctors would do anything to avoid. Their nightmares are filled with pictures of election posters bearing the slogan “tax bombshell”.
Raising National Insurance, on the other hand, tends to be a bit easier. Labour raised it during its time in office. It planned to raise it again if it won the election in May, but was criticised by the Tories, who called it a “tax on jobs”.
The new government has gone ahead with part of this planned increase in the tax, although it has got rid of the rise in employer contributions, arguing that this would hurt business and jobs.
Is this fair? It certainly hits working people hard.
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It also raises again the issue of complexity. Taxes are never going to be the easiest thing to understand, but making them as simple and straightforward as possible tends to reduce confusion and inefficiency. It also massively reduces admin costs: as with any procedure involving tens of millions of people, even small quirks in the system can cost considerable amounts of money.
So, the system is complex. It no longer provides the role that it once did. Large savings could be made, and it could be made more transparent.
Is it time to merge NI with Income Tax?
Both National Insurance and Income Tax are payroll taxes. We could incorporate them without providing too much bother to the individual. Having a single admin structure would probably save millions, if not more. It would be easier to understand, and it would be more egalitarian, as payments would be based on a person's income: the rich pay more; the poor pay less.
One element from NI that may be retained is the practice of keeping track of the number of years that a person has paid the tax. This is crucial for pensions, as it would be unfair if someone worked in the UK for just a few years and then got the same pension for someone who had worked here for 45 years.
Not just a British problem
If it’s any consolation, finding the best way to pay for benefits (and particularly pensions) is proving difficult for almost all developed countries.
It comes as a result of both short term economic factors (the Credit Crunch and recession), but also more long term changes, like the ageing population and an increasingly mobile workforce.
Different solutions will be found in different places. We all should hope that the government gets the best solution right here. In my view, that solution does not involve National Insurance.
Tell us what you think about tax in the UK
Is National Insurance a tax on jobs, or is it the fairest way to pay for benefits and pensions? Let us know your views via the comment box below
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