N | a-zofinequality

National Insurance

National Insurance (NI) is a tax on earnings from work that entitles those who pay it to certain benefits, most notably the state pension but also allowances for maternity leave, bereavement, and support for people with disabilities or health conditions [1]. NI contributions (NICs) are paid by employees, employers and the self-employed with earnings or profits above certain thresholds; people can also make voluntary contributions to compensate for gaps in their payment history.

Entitlement to benefits is based on an individual’s NI contribution record, for example, people need to have paid NI themselves and/or had it paid by their employer for at least 10 years to qualify for any state pension and to have a record of at least 35 years of payment to qualify for the full pension entitlement [2].

The rates of NI contributions paid by different people in different income bands, as of the 2022-23 financial year, are listed in the following table:

National Insurance rates by class and income band

Source: GOV.UK [3]: employee and employer rates for category A employees, some employees (e.g.

those aged under 21 or over the state pension age pay reduced or no rates); income bands for employees and employers refer to gross salaries, income bands for self-employed refer to profits.

*the boundaries of these income bands are approximate for employees and employers as their rates are really calculated based on weekly or monthly earnings, but all are correct to within a few pounds.

A hidden tax on work.

The vast majority of employees make National Insurance contributions via the Pay As You Earn (PAYE) system, meaning that NICs, along with Income Tax payments, are deducted from their wages before they are paid [4]. Self-employed workers have to calculate and pay their NICs when completing self-assessment tax returns. From the perspective of workers NI may as well be considered a secondary income tax. NI being treated as a separate tax may lead to many underestimating how much tax workers really pay. For example, the basic rate of Income Tax is quoted as 20%, however any employee paying Class 1 NICs as well is really paying a rate of 33.25% on income from employment in the £12,571-£50,270 bracket.

This administrative separation has led to NI being described as a “stealth tax” with governments who want to raise revenues without increasing the headline rates of Income Tax instead increasing NICs in the hope that it will draw less attention. While no Chancellor has increased the basic rate of Income Tax since the 1970s, in 2002 Gordon Brown raised the standard rate of employee NICs from 10% to 12% [5] and in 2018 Philip Hammond raised the threshold at which NI rates are reduced to 2% to £50,000 [6]. Most recently, in 2022 Rishi Sunak increased all NI rates by 1.25%, breaking an explicit promise made in the 2019 Conservative manifesto; from 2023-24 this 1.25% charge will be converted into a new Health and Social Care Levy which, unlike NI, will also be paid by state pensioners who are still working, just to complicate matters further [7].

A 2017 YouGov poll found that a proposal to fund increased NHS spending by increasing the basic rate of employees’ NICs by 1% was significantly more popular than a proposal to do so by raising the basic rate of Income Tax by 1%; the former supported by 53% and opposed by 26%, the latter receiving just 42% support and 37% opposing [8].

There are some notable differences between how NI and Income Tax are administered which benefit some workers and penalise others. Whereas Income Tax liabilities are calculated annually on the basis of an individual’s income from any and all jobs they have, NICs are charged on a weekly or monthly basis and are calculated on a per job rather than per person basis. This means that employees can pay more or less NI depending on whether their income varies over the course of a year, whether they are paid by one or multiple employers, and whether they are employed for an entire year or just part of it. For example, someone who only works for six months in a given year may be paid less than £9,876 annually but nevertheless have to pay NICs for each month their income exceeded £823. The net effect of this tends to cost low-paid workers and those who for whatever reason have only worked for part of a year, while benefiting people with multiple jobs and people with relatively high and fluctuating incomes such as people who are paid bonuses [9].

Arguably the stealthiest part of all is employer’s NICs. Employers have to pay 15.05% on top of any wage they pay to an employee in excess of £758/month. This is not deducted from wages but an additional cost, meaning that the cost of employing people is higher than their nominal wage. For example, to pay an employee an average income of £30,000/year will actually cost their employer £33,146; the more someone is paid the greater the proportional cost of paying the requisite employer NICs. While the formal incidence of this tax (the responsibility to pay it) falls on employers and so it is not normally considered a tax on incomes, it does affect how much an employer can afford to pay their employees and so the real incidence at least partially falls upon workers; if employers were not required to make these contributions many could afford to pay higher wages [10].

Who gets out of paying NI?

The self-employed pay lower rates of National Insurance than employees. Self-employed workers pay Class 2 NICs, a small weekly fee, if they make profits of more than £6,725/year and Class 4 NICs which are applied to the same income brackets as Class 1 (employee) NICs but with a lower standard rate of just 10.25% rather than 13.25%. The self-employed also do not have to pay employer NICs on their own earnings.

Historically the lower rates of self-employed NICs were justifiable on the basis that they provided reduced entitlements; the self-employed could not pay into the old state earnings related pension scheme and therefore could not receive the most generous state pension. However for people who have reached state pension age since 2016 the same state pension rate is available to all, employees and self-employed alike [11]. As a result the self-employed are effectively subsidised by employees, paying less but receiving nearly as much. The cost of this subsidy was estimated at £4.1 billion in 2017/18, greater than the £3.4 billion actually received from Class 2 and 4 NICs [12]. The rapid growth of the number of self-employed over the last decade along with entitlement reforms means the cost of subsidy has been growing over time.

Small-scale employers are able to exploit NI rules to avoid paying employers’ NICs. There is a lower limit of £758/month per job such that if an employer pays someone less than that they do not have to pay any Class 1A/1B NICs. A company or individual who hires, for example, low-paid part-time or zero hours workers might choose to deliberately ensure they pay employees below that threshold resulting in a lower cost to them compared to if they hired fewer people but paid each a higher wage. Sectors like domestic cleaning services have expanded substantially in recent years while the cost of their services have fallen [13] with cleaning and landscaping workers accounting for about 5% of the UK workforce [14]. A well-off household can hire a handful of people to provide domestic services – something that most would consider a luxury – but so long as each individual employee is working part-time and on relatively low pay no National Insurance liability would be generated.

Gig economy employers are able to exploit these rules in a slightly different way: gig economy workers on platforms like Uber or Deliveroo are typically classified as self-employed independent contractors rather than employees, often misleadingly according to court judgments [15]. Doing so means that these employers don’t have to pay any employer NICs, a strong incentive to misclassify workers if you can get away with it. With the number of gig economy workers in the UK having risen to nearly 5 million as of 2019 their rights are an increasingly salient concern [16].

Income derived from wealth is given preferential treatment by the tax system in a variety of ways and getting out of paying NICs is another of them. Small-scale landlords who do not count as “running a business”, for example they have another job and only rent out one property, are exempted from paying self-employed NICs on rental income, and of course even those who do qualify as businesses pay the reduced self-employed rates [17]. Business owner-managers can choose to pay themselves in the form of dividends and/or capital gains rather than a salary in order to benefit from lower rates and to avoid having to pay NICs on their own income. Official forecasts have predicted that lower tax rates for the self-employed and owner-managers will amount to a £15 billion tax relief by 2021-22 [18]. Needless to say, income derived from owning assets such as shares is not subject to NI, only income from employment. This is an important reason why the present tax system imposes much heavier burdens on the proceeds of work compared to those of wealth.

The illusion of contribution.

National Insurance was first introduced in 1911 as a bona fide contributory insurance scheme for workers against unemployment and illness. In its original form workers paid a flat rate of 4d/week while in employment, topped up with 3d from their employer and 2d from the government, and in return were entitled to medical care and a dole of 7 shillings/week if they became unemployed, administered by local friendly societies. The Attlee governments of 1945-51 nationalised the system and expanded the range of entitlements, including introducing the basis state pension [19].

The contributory principle of NI was, for better or worse, gradually eroded over time as most state benefits became universalised, means-tested, or based on conditions such as active job-seeking. NICs are now mostly charged as a proportion of earnings rather than a flat rate, while the benefits provided are not linked to what or how much someone actually contributes. While an individual’s NI record does still determine their eligibility for the state pension and a few other benefits, this practically functions more like a condition whereby people must work for a certain number of years than a genuinely contributory scheme. Furthermore, National Insurance credits allow most people who are in receipt of benefits but not in work to fill out their NI record anyway [20].

NI does not function like a normal insurance scheme either. NICs are paid into the National Insurance Fund which is ring-fenced such that, by law, the government cannot use that money for anything other than specific permitted purposes. In reality, however, the separation between NI and general government revenue and spending is blurred. A fixed portion of the NICs are paid to the NHS rather the NI Fund each year, a relic of NI originally entitling workers to healthcare even though the NHS is now a universal system. If the NI Fund faces a budget shortfall the Treasury is permitted to make a grant to the Fund, effectively redirecting money from general taxation towards pensions and other benefits. If the Fund is in surplus the spare money is ‘loaned’ to the government – in the past it used to buy government bonds, now it is held in the Debt Management Account Deposit Facility – and so helps to fund other government spending [21]. The separation between the NI Fund and the rest of the public balance sheet is largely just a facade at this point; at various times other taxes pay for benefits and NICs pay for other spending.

Similarly, the NI Fund does not cover the cost of future spending that beneficiaries will be entitled to. Instead, the Fund operates on a “pay-as-you-go” basis – current contributions fund current pay-outs. When a worker pays NICs they are not really saving up for their own pension, contrary to what they might believe, they are paying today’s pensioners on the basis that, in return, future workers will pay for their pension. At any given time the NI Fund is only expected to maintain a balance of at least one-sixth of projected annual expenditure to cover short-term fluctuations [22].

Policy: merge NI with Income Tax.

The economist James Mirrlees, who led a comprehensive review of the effectiveness and efficiency of the UK tax system in 2010-11, said of National Insurance:

“National Insurance is not a true social insurance scheme; it is just another tax on earnings, and the current system invites politicians to play games with NICs without acknowledging that these are essentially part of the taxation of labour income. The two systems need to be merged.” [23]

Mirrlees was far from the first or last person to suggest such a merger. Conservative Chancellors Nigel Lawson and George Osborne both reportedly considered the idea [24]. Think tanks such as the Institute for Fiscal Studies, which published the Mirrlees Report, and the Taxpayers’ Alliance have endorsed the idea [25]. In their 2019 General Election manifesto the Green Party proposed merging not just National Insurance and Income Tax, but also Capital Gains Tax, Inheritance Tax and Dividend Tax into a single “consolidated income tax” [26].

Merging Income Tax and NI would create a much simpler system which would be easier to understand and to administer. The increased transparency of a combined system would make the actual tax burden workers face clearer and dissuade governments from exploiting the separation to play tricks, such as when Labour pledged in their 2001 manifesto not to raise Income Tax rates only to raise NIC rates instead the next year.

A combined system would also be easier and cheaper to administer, both reducing the costs faced by businesses in trying to comply with two separate taxation systems and the costs for government in collecting each tax [27]. At the time of the Mirrlees Review the government estimated that tax collection cost 1.24p per £1 of Income Tax and 0.35p per £1 of NICs, while business paid 0.6p per £1 paid via PAYE and individual self assessments likely cost far more [28]. An integrated system would likely reduce these costs significantly.

A merger would also provide an opportunity to even out some of the disparities and inequalities produced by the current NI system. A single tax could charge employees and the self-employed at the same rate as well as ending the different accounting of Income Tax and NIC liabilities, among other efficiencies.

Integrating NI with Income Tax would likely be controversial in many respects, however. While many would benefit, others would lose out; the self-employed and people with multiple jobs for reasons described above, but also pensioners who currently pay Income Tax but do not have to pay NICs on their pension income. Such drawbacks could be counteracted in various ways though, for example by lowering overall rates and providing specific tax reliefs to groups such as pensioners to ensure that they are not faced with excessive tax increases.

Even if a full merger is not on the cards, NI should at least be reformed and adjusted to eliminate the disparities with Income Tax. Aligning self-employed and employee NIC rates has been proposed and even came close to being implemented before and the idea should be revived. A report by the Office for Tax Simplification, a government think tank tasked with reviewing the complexities of the tax system, has recommended reforming NICs so that they are calculated in the same way as Income Tax; they also suggested that employers’ NICs should be replaced with a simple tax on total payroll costs in order to equalise the cost of full-time and part-time work [29].

1 https://www.gov.uk/national-insurance/what-national-insurance-is-for

2 https://www.gov.uk/new-state-pension/your-national-insurance-record-and-your-state-pension

3 https://www.gov.uk/national-insurance/national-insurance-classes

4 https://www.citizensadvice.org.uk/debt-and-money/tax/how-to-pay-income-tax/the-pay-as-you-earn-paye-system/

5 https://www.theguardian.com/business/economics-blog/2015/jul/26/time-to-look-at-national-insurance-the-ultimate-stealth-tax

6 https://www.independent.co.uk/news/business/analysis-and-features/budget-2018-national-insurance-tax-stealth-icome-chancellor-statement-finance-economy-a8610951.html

7 https://www.bbc.co.uk/news/uk-politics-58436009

8 https://yougov.co.uk/topics/politics/articles-reports/2017/01/12/majority-people-would-support-raising-national-ins

9 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/567492/OTS_final_report_print_file.pdf

10 https://iea.org.uk/employer-national-insurance-contributions-are-a-hidden-tax-on-our-pay/

11 https://www.ft.com/content/e38a47d6-f1df-11e6-95ee-f14e55513608

12 https://commonslibrary.parliament.uk/research-briefings/cbp-7918/#_ftn16