www.parliament.uk/commons-library | intranet.parliament.uk/commons-library | [email protected] | @commonslibrary BRIEFING PAPER Number 4517, 17 July 2017 National Insurance contributions (NICs): an introduction By Antony Seely Inside: 1. Rates, receipts, benefits 2. The National Insurance Fund 3. The contributory principle 4. Integrating NICs & income tax 5. The Coalition Government’s approach 6. The Conservative Government’s approach Appendix: main features of NICs
National Insurance contributions (NICs): an introduction
By Antony Seely
Inside: 1. Rates, receipts, benefits 2. The National Insurance Fund 3. The contributory principle 4. Integrating NICs & income tax 5. The Coalition Government’s
approach 6. The Conservative
Government’s approach Appendix: main features of NICs
Number 4517, 17 July 2017 2
Contents Summary 3
1. Rates, receipts, benefits 4
2. The National Insurance Fund 10
3. The contributory principle 15
4. Integrating NICs & income tax 22 4.1 The 1998 Taylor Report 22 4.2 The case for and against integration 25 4.3 The 2007 review on further alignment 30 4.4 The 2010 Mirrlees Review 33
5. The Coalition Government’s approach 37 5.1 Assessing the case for integration 37 5.2 Reforms to NICs (2010-2015) 43 5.3 The OTS report on employment status 47
6. The Conservative Government’s approach 53 6.1 Summer Budget 2015: the Tax Lock 53 6.2 The OTS report on aligning tax and NICs 56 6.3 Budget 2017: NICs and the self-employed 64
Appendix: main features of NICs 73
Contributing Authors: Richard Keen, social security statistics
Cover page image copyright: 1st December 1942 - The Beveridge Report by Bradford Timeline. Licensed
3 National Insurance contributions (NICs): an introduction
Summary National Insurance contributions – NICs, for short – are paid by employees, employers and the self-employed, and are used to fund contributory benefits: the state pension, contributions-based jobseeker’s allowance, contributory employment and support allowance, maternity allowance, and bereavement benefits. In turn entitlement to contributory benefits is based on someone’s National Insurance payment record. Receipts from NICs go into the National Insurance Fund, which operates on a ‘pay as you go’ basis: broadly speaking, this year’s contributions pay for this year’s benefits. A fixed proportion of NI receipts are not paid into the Fund but go to the National Health Service.
The first part of this paper gives an introduction to National Insurance system: the base and rate structure of NICs, the operation of the NI Fund, and the connection between a person’s contributions into the Fund with their entitlement to receive benefits paid out of the Fund – the ‘contributory principle’ as it is known.
The second part of this paper looks at the major reforms made to NICs since the late 1990s, and in particular, the consideration by successive governments of the case for merging NICs with income tax. It has been argued that despite the operation of the NI Fund, and the contributory link between payments made and benefits received, this charge is no different in kind to other national taxes, and that fully integrating NICs with income tax would be fairer, simpler and more efficient. The issue has been considered, off and on, for almost twenty years, and even though there have been a number of changes to bring NICs and income tax into closer alignment, there remain considerable difficulties to a full-scale merger.
Number 4517, 17 July 2017 4
1. Rates, receipts, benefits National Insurance contributions (NICs) raised an estimated £125bn in 2016/17. This compares with estimated Exchequer receipts from income tax of £175bn, and £121bn from VAT.1
Employees are liable to pay primary Class 1 National Insurance contributions (NICs) on their earnings if they exceed the lower earnings limit (LEL). The LEL is set at £113 per week for 2017/18.
A zero rate of NICs is charged on earnings between the LEL and the primary threshold (PT), which is set at £157 per week. A notional primary Class 1 NIC is deemed to have been paid in respect of earnings between LEL and PT to protect benefit entitlement.
Earnings above the PT are charged NICs at a rate of 12%, subject to a cap at the upper earnings limit (UEL), which is set at £866 per week. Earnings above the UEL are charged NICs at a rate of 2%.
Prior to 6 April 2016 employees were charged a reduced rate of NICs if they had contracted out of the state second pension (S2P). These arrangements have ended with the introduction of the new ‘single-tier’ state pension, and the closure of the additional state pension.2
Employers pay secondary Class 1 NICs on employee earnings at a rate of 13.8% on earnings above the secondary threshold (ST). The ST is set at £157 a week for 2017/18. Employers also pay Class 1A or 1B on employees’ expenses or benefits at a rate of 13.8%.
In the 2013 Autumn Statement the Government announced that from April 2015 it would abolish employer NICs on earnings for employees under 21, on earnings up to the higher rate threshold.3 From this date a zero rate has applied to earnings on this category of employee up to the ‘upper secondary threshold’ (UST), set in line with the UEL.
In December 2014 the Government announced that it would abolish employer NICs up to the UEL for apprentices aged under 25, with effect from April 2016.4 Consequently a zero rate also applies to earnings on this second category of employees up to a new ‘apprentice upper secondary threshold’ (AUST), which is also aligned with the UEL. The UST and AUST are set at £866 per week for 2017/18.
Self-employed people pay a weekly flat rate Class 2 NIC (set at £2.85). They may apply for exemption from paying class 2 contributions if their annual profits are less than the level of the ‘small profits threshold’ (SPT), set at £6,025. In addition they may be liable to pay a separate Class 4 profits related contribution. Class 4 NICs are charged at a rate of 9% on profits between a lower annual profits limit (£8,164) and an annual upper profits limit (£45,000 – all figures for 2017/18). Profits above the upper limit are charged NICs at a rate of 2%.
1 OBR, Economic & Fiscal Outlook, Cm 9419, March 2017 p104 (Table 4.6) 2 For details see, The new ‘single-tier’ State Pension, Commons Briefing paper
SN6525, 30 August 2016. 3 Autumn Statement, Cm 8747, December 2013 para 1.195 4 Autumn Statement, Cm 8961, December 2014 para 2.53
5 National Insurance contributions (NICs): an introduction
Further to these categories, individuals may be entitled to make voluntary Class 3 contributions to ensure that they qualify for basic retirement pension and bereavement benefits. Class 3 NICs are charged at a weekly flat rate, set at £14.25 for 2017/18.5
NICs are charged on earnings from employment and self-employment only. By comparison income tax is charged on one’s total income which includes savings and investment income, state and occupational pensions as well as earnings-replacement benefits. UK residents in the UK and others with income in the UK are liable to pay income tax, whereas only people over 16 and under state pension age working in the UK are liable to pay NICs. An employer’s liability to pay secondary Class 1 NICs in respect of earnings paid to or for the benefit of an employed earner is unaffected by the employed earner’s attainment of pensionable age.
A majority of the receipts from NICs are paid into the National Insurance Fund, which is separate from all other revenue raised by taxation. The Fund is used exclusively to pay for contributory benefits.
One portion of the income from NICs are not paid into the Fund, but go to the National Health Service. For example, in the case of Class 1 NICs, the NHS allocation is 2.05% of earnings between the primary threshold and UEL, and 1% of earnings above the UEL. The Government Actuary’s Department has estimated that NICs will raise just over £125 billion in 2017/18, of which £101.8 billion will go into the NI Fund and £23.7 billion will go to the NHS.6
In the early-2000s the proportion of health spending accounted for by NICs rose substantively.7 In his 2002 Budget the then Chancellor Gordon Brown proposed that UK NHS spending should rise from £65.4 billion in 2002/03 to £105.6 billion in 2007/08. Several tax measures were introduced, by far the most important of which were increases in the rates of NICs from April 2003.
For employees the rate of NICs rose by 1 percentage point to a rate of 11% on all earnings between the primary threshold and the UEL – and a new 1% rate was charged on earnings above the UEL. For employers the rate of NICs rose by 1 percentage point to a rate of 12.8% on earnings above the secondary threshold. For the self-employed the rate of NICs rose by 1 percentage point to a rate of 8% on all earnings between the lower profits limit and the upper profits limit – and a new 1% rate was introduced on earnings above the upper profits limit. It was estimated that taken together these changes would raise around £7.9 billion in 2003/04.8
5 Government Actuary’s Department, Report to Parliament on the 2017 re-rating and
up-rating orders, January 2017 pp22-23 6 op.cit. pp29-30 7 The share of NHS spending in England accounted by NICs rose from 12.1% to
18.4% from 2000/01 to 2006/07 (DoH Departmental Reports Cm 5103 May 2001 para 3.16 & Cm 6814 May 2006 para 3.36)
8 Budget 2002, HC 592 April 2002 p121, pp154-5. Further detail on this reform is given in, Library Research paper 02/32, 8 May 2002.
7 National Insurance contributions (NICs): an introduction
Source: Government Actuary’s Department, Report to Parliament on the 2017 re-rating and up-rating orders, January 2017 pp29-30 (Appendix D)
Notes:
1 All figures are gross of recoveries by employers of Statutory Maternity Pay, Statutory
Paternity Pay including Additional Statutory Paternity Pay and Statutory Adoption Pay,
and, for births due after April 2015, Statutory Shared Parental Pay.
2 Contracting-out ceased from April 2016 but some small amounts of rebates will be
recovered in 2016-17.
3 In the 2013 Autumn Statement, the Government announced its intention to introduce
class 3A NICs – to allow current pensioners (i.e. those who would not be eligible for the
single-tier state pension because they would reach State Pension age before it was
introduced on 6 April 2016) an option to top up their Additional State Pension record
through a new class of voluntary National Insurance contributions. The offer was time-
limited, to run between October 2015 and April 2017.
4 These figures appear in Table 5.1 in the main report.
5 Figures may not sum to totals shown due to rounding.
*
Employees’ contributions entitle them to the range of contributory benefits, including contributions-based jobseeker’s allowance, incapacity benefit, retirement pensions and bereavement benefits. The flat rate Class 2 contributions of self-employed people entitle them to all benefits apart from jobseeker’s allowance, though Class 4 contributions do not count towards benefit entitlement.
In the 2017 Budget the Chancellor Philip Hammond confirmed that, following an earlier consultation exercise, Class 2 NICs would be abolished from April 2018, and that self-employed contributory benefit entitlement would be accessed through Class 4 and Class 3 NICs. The Chancellor also proposed a two-stage increase in the rate of Class 4 NICs, from 9% to 10% in April 2018, and to 11% in April 2019. The Chancellor argued that it was fair to reduce the differential between the rates of NICs paid by employees and by the self-employed, in part because the introduction of the new state pension now meant self-employed workers could build up the same entitlement as employees.9 However, a few days later Mr Hammond reversed this decision to increase the rates of Class 4 NICs, on the grounds that it would have breached the Government’s tax lock pledge not to increase the headline rates of income tax, VAT or NICs.10
Subsequently in the Queen’s Speech on 21 June the Government confirmed it will introduce legislation in the 2017-19 Session to provide for the abolition of Class 2 NICs, although it has emphasised that “this legislation does not relate to the discussion of Class 4 contributions at the time of the Spring Budget 2017.”11
9 HC Deb 8 March 2017 cc813-4 10 HC Deb 15 March 2017 cc420-1. For more details see, Spring Budget 2017: a
summary, Commons Briefing paper CBP7919, 17 March 2017. 11 Cabinet Office, Queens Speech 2017 : background briefing notes, June 2017 p34
There are three elements to social security expenditure:
─ Contributory benefits – entitlement for which is dependent on the claimant’s NI record;
─ Income-related / means-tested benefits (such as Housing Benefit, Pension Credit or Tax Credits), which are non-contributory and depend upon the income of the claimant and their personal characteristics such as age and family type;
─ Benefits which are neither contributory nor income-related (such as Disability Living Allowance and Personal Independence Payment) which are available to all people who meet some qualification criteria.
Over the thirty years from the late 1970s, contributory benefits declined in importance relative to other categories of government benefit spending. The share of expenditure accounted for by contributory benefits fell from 65% in 1978/79 to a low of 52% in 2010/11. Since then, State Pension spending has driven an increase in the contributory share, so that it is forecast to be 58% this year (2017/18), rising to 60% by 2021/22.
Total spending on contributory benefits in Great Britain (including overseas recipients) is forecast to be around £102 billion in 2017/18 (out of total benefit and tax credit spend of £179 billion). Around £94 billion of the contributory spend is accounted for by contributory benefits received by pensioners (mostly the State Pension). Working-age people receive around £8.5 billion of contributory benefit spend this year (consisting of contributory ESA, Statutory Maternity Pay and Maternity Allowance, Bereavement benefit and contributory JSA).
9 National Insurance contributions (NICs): an introduction
Not all contributory benefit expenditure is predicated on the payment of National Insurance contributions. This is because there are circumstances when individuals are credited with NICs without having actually paid them: either from claiming credits when, say, on Jobseeker’s Allowance, or from being on earnings above the LEL but below the primary threshold (as earnings in this band are charged NICs at a zero rate.)
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2. The National Insurance Fund The majority of receipts from NICs are paid into the National Insurance Fund, which is separate from all other revenue raised by taxation. The Fund is used exclusively to pay for contributory benefits, and operates on a 'pay as you go' basis: broadly speaking, this year’s contributions pay for this year’s benefits. Indeed, retirement pensions account for over 90% of benefit expenditure from the Fund.12 The Government has no powers to use NICs to fund anything else.13
In their survey of the UK tax system, the Institute for Fiscal Studies comments, “The NI Fund is notionally used to finance contributory benefits; but in years when the Fund was not sufficient to finance benefits, it was topped up from general taxation revenues, and in years when contributions substantially exceed outlays (as they have every year since the mid-1990s), the Fund builds up a surplus, largely invested in gilts: the government is simply lending itself money. These exercises in shifting money from one arm of government to another maintain a notionally separate Fund, but merely serve to illustrate that NI contributions and NI expenditure proceed on essentially independent paths. The government could equally well declare that a fifth of NICs revenue goes towards financing defence spending, and no one would notice the difference.”14
The Government Actuary advises on the level of contributions necessary to meet expected benefit expenditure. The NIF annual accounts explain that a working balance is necessary to deal with short term fluctuations as the NIF has no borrowing powers:
The National Insurance Scheme is financed on a pay-as-you-go basis with contribution rates set at a level broadly necessary to meet the expected benefits expenditure in that year, after taking into account any other payments and receipts, and to maintain a working balance. Changes in contribution levels in response to the needs of the Fund take time to implement, therefore a working balance is necessary because the NIF has no borrowing powers.15
The origins of the Fund were set out in a report on the NI system by the Social Security Committee in 2000:
The National Insurance Fund was established in 1911, reformed in 1948 and assumed broadly its current form in 1975, when the separate National Insurance (Industrial Injuries) and National Insurance (Reserve) Funds were merged with it.
From 1948 its income came from three sources:
• the national insurance contributions paid by individual contributors;
12 Report to Parliament on the 2017 re-rating and up-rating orders, January 2017
(Table 5.2) 13 Part XII of the Social Security Administration Act 1992 contains the statutory
authority for the Fund; section 163 specifies that payments out of the Fund may only be made to finance a list of specified benefits.
14 Institute for Fiscal Studies, A survey of the UK tax system, November 2016 pp14-5 15 National Insurance Fund Account 2015/16, HC 691, October 2016 p3
11 National Insurance contributions (NICs): an introduction
• employers’ national insurance contributions;
• the state (in the form of the Treasury Supplement, which accounted for just under a quarter).
Over time, the level of the Treasury Supplement was gradually reduced. It was abolished after 1988-89. Thereafter the Fund’s expenditure was met wholly from workers’ and employers’ contributions and a small amount of investment income. This arrangement did not prove flexible enough to meet unexpected demands and from 1993-94 an Exchequer subsidy for the Fund was therefore established in the form of the Treasury Grant.
The Grant is paid out of the Consolidated Fund into the National Insurance Fund. The maximum Grant available in any tax year is set by primary legislation at 17 per cent of the National Insurance Fund’s annual benefit expenditure. The maximum amount of Grant available—but not, necessarily, taken up—for each tax year is set by the annual contributions re-rating order. The amounts of Grant voted in the main Supply Estimates and paid into the Fund each year are those estimated in the Government Actuary’s report on the annual social security benefits up-rating and national insurance contributions re-rating Orders. But the maximum level of Grant which can be made available to the Fund in a year is prescribed at a prudently higher level (by the contributions re-rating order).
The maximum Grant is set so that, if in that year the Fund’s income from contributions is lower than expected or its expenditure is higher than forecast, additional amounts of Grant may be paid into the Fund, subject to Parliament approving the necessary Supplementary Estimate. This might arise when, for example, the level of unemployment is markedly higher than expected. The actual amount of Grant drawn by the Fund each year is usually well below the maximum that may be made available. For example, the maximum Grant for 1998-99 was set at 2 per cent of benefit expenditure in that year (£900 million); the actual Grant required by the Fund for that year was nil.16
From the late 1990s, contribution income of the Fund consistently exceeded payments so that the balance of the Fund’s balance grew steadily (from just under £10 billion in 1998/99 to £50.6 billion in 2008/09). However, the impact of the recession reversed this trend.17
In 1992 the Government Actuary stated that the Fund should have a balance of at least one-sixth of benefit expenditure, as “the minimum level recommended with a view to ensuring that a reasonable working balance is maintained.”18 In January 2015 the Government Actuary estimated that without a Treasury grant the balance on the Fund in 2015/16 would be £9.4 billion, though the minimum working balance would be £16 billion. In the event a Treasury grant of £9.6 billion was made, so that the balance of the Fund at 31 March 2016 was £23.2 billion.19 In January 2017 the Government Actuary estimated that the
16 The Contributory Principle, 7 June 2000 HC 56-II 1999-2000 pp 175-6 17 NI Fund Accounts 1975-2014, Commons Briefing paper CBP797, 20 May 2014 18 Dept of Social Security, Social Security Bill 1992 - Report by the Government Actuary
on the financial provisions of the Bill, Cm 2097 26 November 1992 para 9 19 National Insurance Fund Account 2015/16, HC 691, October 2016 p4
balance on the Fund would be £21.2 billion for 2016/17, without any Treasury grant, and that it would rise consistently in future years.20
During the period when the surplus grew so strongly, many commentators made suggestions for using it to increase government expenditure, such as raising the level of the basic state pension are often mentioned. In April 2008 Kelvin Hopkins MP put down an EDM to this effect which 56 Members signed.21 For its part the Labour Government took the position that the surplus was not a reliable source of government funding, as noted in answer to a PQ:
Paul Flynn: To ask the Secretary of State for Work and Pensions what estimate he has made of the increases in the basic state pension payable in each year from 2009-10 to 2012-13 if surpluses in the National Insurance Fund were reallocated to state pensions.
Mr. Mike O'Brien: National insurance contributions (NICs) and associated social security benefits operate within the Government’s fiscal rules designed to ensure sound public finances and when there is a surplus it is invested in public services. Any surplus of NICs over social security benefits in any one year (the NIF surplus) is not therefore an extra resource available to spend.22
The Labour Government reiterated its position in a second answer in February 2009:
Mr. Swire: To ask the Chancellor of the Exchequer what assessment he has made of the merits of using future national insurance fund surpluses to fund an increase in the state pension.
Mr. Timms: I refer the hon. Member to the answer given by my right hon. Friend (Mr. O'Brien) the Minister for Pension Reform on 5 March 2008, Official Report, column 2605W. Any increase in the basic state pension has a cumulative impact on Government spending going forward. The Government consider the short-term use of the surplus on the national insurance fund in this way to be unsustainable in the long term.23
The Fund’s surplus was discussed in a debate in Westminster Hall in October 2003, when Paul Flynn MP argued that “a significant part” of the Fund was “being salted away in Government stocks.”24 In response Ruth Kelly, then Financial Secretary, argued that the surplus should be retained to accommodate unforeseen circumstances:
The national insurance fund provides security for those contributory benefits. It is ring-fenced and cannot be used for other Government expenditure. It is reviewed every year by the Government Actuary, who reports to Parliament on the effect of any changes to contributions or benefits and on the state of the fund … The accounts to the fund are audited by the National Audit Office and published annually. The national insurance fund is, therefore, a clear and transparent mechanism for
20 Report to Parliament on the 2017 re-rating and up-rating orders, January 2017
(Table 5.4, p14) 21 EDM 1443 of 2007-08, 28 April 2008. 47 Members signed a similar motion put
down earlier in the same Session (EDM 298 of 2007-08, 19 November 2007). 22 HC Deb 5 March 2008 c2605W 23 HC Deb 10 February 2009 c1852W 24 HC Deb 21 October 2003 c217WH
13 National Insurance contributions (NICs): an introduction
demonstrating the link between national insurance contributions and contributory benefits …
The fund is clearly in a healthy state. Income from contributions is more than enough to cover expenditure on benefits … The Government Actuary's latest report shows that the balance at the end of 2003–04 is likely to be nearly £20 billion. That number needs to be set in context. During the current year, the fund's income is expected to be £63 billion and expenditure on benefits about £60.5 billion, 80 per cent. of which will go on retirement pensions. The difference, which is added to the balance, is only about £2.5 billion. Last year, the difference was £3 billion, and that is a small proportion—about 4 per cent.—of the amounts flowing through the fund.
As my hon. Friend said, the then Government were sufficiently confident of the state of the fund in 1989 to abolish the Treasury supplement. However, by 1993— just four years later—legislation had to be introduced to provide for a Treasury grant to prevent the fund from running out of money. That clearly illustrates how wrong it is to take a short-term view of the fund … I am arguing that, although a surplus might appear very large at any point time, it is not right to assume that it will not be needed for the purposes of the fund in future … Events—some of them, perhaps, inspired by the Government, in which instance there were obviously aggravating factors—can mean that the surplus turns around very quickly. I am cautioning against viewing a surplus above the 16.7 per cent. margin that the Government Actuary specifies as unnecessary and available to be spent.
The Minister went on to argue that the surplus on the fund was not wasted, because it was invested in government debt:
There is a more significant point. The balance on the fund is not wasted. The hon. Member for Northavon (Mr. Webb) made that point. Any surplus in the fund is used to buy gilts, which provide security for contributory benefits and reduce the Government's need to borrow elsewhere. It is a mistake to think that there is a pot of money that could be used to fund spending on another purpose.25
Since 2007 the Fund has been invested in the Government’s ‘Call Notice Deposit Account’, administered by the Debt Management Office, rather than any part of it being held in gilts.26 This is an overnight account facility, which pays interest to the Fund at the prevalent Bank of England bank rate. The Fund has maximum liquidity for withdrawals (or deposits) out of (into) the Fund on a day-to-day basis. It is worth emphasizing that these funds are being held in this account on loan – much as with the purchase of gilts: there is no question of the Government being in a position to use this facility to extract money from the Fund as an extra source of revenue. In addition, the new arrangements minimise transaction costs, whilst still retaining zero credit risk and the guarantee that the Fund will always earn a fair and observable market rate of interest.
In March 2010 the House debated the legislation to uprate the state pension for the year 2010/11; on this occasion, the nature of the Fund’s 25 op.cit. cc231-232WH 26 National Insurance Fund Account 2006-07, HC 466, 30 April 2008 p26; Debt
surplus was mentioned by the then Liberal Democrats spokesman on work and pensions, Steve Webb, who was Pensions Minister in the Coalition Government:
The law only requires the balance in the fund to be one sixth of annual expenditure on benefits. The actual balance in the fund is about two thirds of annual estimated benefit payments. So pensioners' groups always ask us where the money has gone. When we find out where it has gone, it is a bit of surprise. A little bit of the money goes to the National Health Service, but the law says that most of it must go towards national insurance benefits, pensions and so on. But at the rates in the order, it cannot all be spent on national insurance benefits and pensions. They are not big enough to spend all the cash on, so the balance keeps rising year after year.
Where does the money go? My understanding is that the fund is a bit like a soft bank that lends money to the rest of public sector, so that the Government need not borrow it from elsewhere. Of course, when the Chancellor said in a recent Budget that he would increase national insurance contributions to help fill the hole in the Budget, he was doing so to spend that money not on national insurance benefits and pensions, but on others things, presumably. How can the fund be used as a label and a soft way to raise tax, when the money is not spent on national insurance benefits and pensions? … Is that really what Beveridge had in mind? Did he think that the national insurance fund would essentially become a kind of easy credit option for the Government? We have come an awful long way since the start of the contributory principle.27
15 National Insurance contributions (NICs): an introduction
3. The contributory principle The UK’s contributory system for financing social security benefits was established in 1948, following the recommendations of Sir William Beveridge’s 1942 report Social Insurance and Allied Services. Beveridge described his plan for social security as: “first and foremost a plan of insurance - of giving in return for contributions benefits up to subsistence levels, as of right and without means test, so that individuals may build freely upon it.”28
To fund this plan, he proposed a tripartite scheme of contribution, based on the more limited scheme of national insurance introduced in 1911, and drawing on the contributory principle which, in his view, accorded with “the wishes and feelings of the British democracy.” The principle might be stated in this way: “that a material part of the total cost of maintaining income under the plan shall be met from monies contributed by citizens as insured persons, on the basis of each individual paying the same contribution for the same rate of benefit.”
As a consequence, Beveridge argued, general taxation should meet part – but only part – of the cost of any scheme:
Contribution means that in their capacity as possible recipients of benefit the poorer man and the richer man are treated alike. Taxation means that the richer man, because of his capacity to pay, pays more for the general purposes of the community. These general purposes may, and in practice they must, include bearing a part of the cost of social security; if security is to be based on the contributory principle, they cannot include bearing the whole cost.29
The report summarised the case for funding from individual contributions as follows:
• The insured persons themselves can pay and like to pay, and would rather pay than not do so. It is felt and rightly felt that contribution irrespective of means is the strongest ground for repudiating a means test.
• It is desirable to keep the Social Insurance Fund self-contained with defined responsibilities and defined sources of income. The citizens as insured persons should realise that they cannot get more than certain benefits for certain contributions, should have a motive to support measures for economic administration, should not be taught to regard the State as the dispenser of gifts for which no one needs to pay.
• To require contribution on an insurance document for each individual has administrative convenience, particularly for a scheme which, while it covers all citizens, takes account of their different ways of livelihood, and classifies them, giving different benefits according to their needs. Contribution provides automatically the record by which the insured
28 Cmd 6404 November 1942 para 10 29 Cmd 6404 November 1942 para 273
Number 4517, 17 July 2017 16
person’s claim to be qualified for any particular benefit can be tested.30
Turning to the third part of the scheme’s funding, Beveridge made three arguments for levying contributions on employers as well as on employees and taxpayers:
• An employer’s contribution should be “regarded as a proper part of the cost of production, maintaining the labour force that is necessary both when it is actually working and when it is standing by.”
• It was in the employer’s interest that their employees should have security – against the risk of unemployment or sickness – and that they should “feel concerned for those who work under their control.”
• It was necessary to “give to employers a definite status, based on contribution, for making representations as to the administration of social insurance and its possible improvement.”31
Many commentators have observed that Beveridge’s plan was not fully realised, even at the outset, and that since its introduction “the national insurance scheme has been undermined, both directly as a result of successive governments’ policies and indirectly as a result of economic and social change.”32
Nevertheless some have argued that the contributory principle remains important. In June 2000 the Social Security Committee completed an enquiry on the principle, and in evidence to the Committee Frank Field MP argued, “for those paying for welfare, a significant advantage of the contributory principle over simple funding by taxation is the inherent transparency of making a designated contribution.”33 The Government Actuary took a similar view, pointing to the greater scope for parliamentary accountability:
From the point of view of parliamentary control I would say that the National Insurance Fund has a very important function because it does focus through the uprating process, the annual review and the reports that we do in connection with that, on whether there is a proper approach being taken to the benefits uprating, whether they are being considered adequately in relation to the income, and that gives Parliament quite a good influence in principle over the way in which the scheme is developing in a way which would be much less so if there was not a Fund and this was all general budget expenditure.34
In their report the Committee observed that the eligibility requirements for contributory benefits were both detailed and complex:
30 Cmd 6404 November 1942 para 274 31 Cmd 6404 November 1942 paras 275-6 32 Social Security Committee, Fifth report: The Contributory Principle, 7 June 2000 HC
56-I 1999-2000 p xvi 33 HC 56-II 1999-2000 p 126 34 HC 56-II 1999-2000 Q 285 p 160
17 National Insurance contributions (NICs): an introduction
The contribution rules are complex, requiring the contributor not only to have paid contributions on a certain proportion of earnings, but also to have paid the contributions during a particular tax year, or, in the case of widows or retirement pensions, over a certain number of years of a working life.35
As the Committee went on to observe “there is very little direct financial relation between what an individual puts into the Fund and what they get out”:
Most national insurance benefits are paid at a flat rate whereas contributions are earnings-related. The Government Actuary commented: “Over time the link between the benefit and the contribution of the individual has been loosened so that now it is very clearly on a pay as you go basis and contributions are set to meet the benefits in that year rather than the benefits of the individual in the future.”36
Writing on this issue in 1995 the then director of the Institute for Fiscal Studies, Andrew Dilnot, commented, “it would be hard to find much evidence of any persisting actuarial link between contributions paid and benefits received.”37
In his article Mr Dilnot cites an exchange back in June 1982 between an official at the Department of Health and Social Security, and Richard Wainwright MP, as part of an enquiry into the personal tax system being undertaken by the then Commons Treasury and Civil Service Select Committee. On this occasion Mr Wainright suggested that national insurance “seems to be an extraordinarily arbitrary system because in no way is a certain level of contribution paid for an average benefit.” He went on to ask Mr CM Regan, an under-secretary at the Department giving evidence to the Committee, “how on earth are the contribution requirements fixed and what relationship do they bear to the marvellous benefits they unlock?”
Mr Regan’s response to this question is illuminating:
They are not fixed on any particularly rational basis but on the basis that you want a reasonable test and do not want to make it too hard for people to get the benefits, because, after all, the contingencies are there and you do not want resort to means-tested benefits. But all the benefits in some sense are based on a pay as you go system, which is what the National Insurance system is. If you like, all the benefits are too easy. None of us has ever paid, or will ever pay, because even on the pension side it is not actuarially calculated, the full value of our benefits.
This is a function of the inter-generation apportionment process whereby the working generation today basically pays for the pensions of the generation which has now retired and we go forward in the hope that each successive generation will, in return for something which is much less than full value, go on doing so.
35 HC 56-I 1999-2000 para 14 36 HC 56-I 1999-2000 para 15. For a subsequent discussion of the contributory
principle see, Lewis Williams, “Fair rewards of just deserts? The present and future of the contributory principle in the UK”, Benefits vol.17 no.2 2009 pp159-69.
37 “Integrating income tax and social security”, in Cedric Sandford (ed.), More Key Issues in Tax Reform, 1995 p26
Number 4517, 17 July 2017 18
In answer to an earlier question from Mr Wainwright, Mr Regan observed, “the great majority of our fellow citizens believe that there is a direct relationship between what they pay and what eventually they get out of it at the end of the day as of right without the proof required for means-tested benefits, and that is something which people value.”38
On this theme, quite often constituents will raise the possibility of getting their ‘surplus’ contributions rebated, posing the question: once someone has met the contributory conditions to receive a full state pension, why should they continue to pay NICs on their earnings until they reach state pension age?
There are two answers to this question – the first focusing on the range of contributory benefits that exist, the second looking more widely at the wider principles which underpin National Insurance.
First, NICs do not only give entitlement to the State Pension. Other NI benefits, such as contributory Employment and Support Allowance and contribution-based Jobseeker’s Allowance use a contribution test which shows recent attachment to the labour market – namely that you must have contributed in each of the last two tax years before the benefit year in which you claim.39
Second, this type of complaint would carry more force if the National Insurance system was a classic insurance system, structured in the same way as a private pension, where the value of a person’s benefits relied wholly and exclusively on the size of their payments into the fund. In this sense one could talk of NICs which one ‘loses’, or do not ‘count’, if paid after the point of reaching the contributory conditions for a full state pension. But, as discussed, even from the time of Beveridge, the NI system has not been structured in this way. The ‘pay as you go’ principle was set out clearly as part of an answer to a PQ in 2013:
The National Insurance scheme operates on a ‘pay-as-you-go’ basis. This means that today’s contributors are paying for today’s social security entitlements and pensions, and those paying contributions previously were paying for the pensioners of that time. Contributors do not accumulate an individual pension fund of actual monies they have paid which is personal to them. Instead, payment of contributions entitles them or, in certain circumstances, their spouses or civil partners to a range of social security benefits which are available on the basis of the rules applicable at the time of the claim.40
As a system of social insurance, National Insurance then balances the ability of those of working age to pay against the entitlement of those whose working lives are over to be afforded protection by the State – in this transfer between generations. So, in the case of someone working now, while one will go on making payments which fund pensions for pensioners now, the system offers one the guarantee that the next
38 Treasury and Civil Service Select Committee: Structure of personal income taxation &
income support - Minutes of Evidence 23 June 1982, 11 May 1983 HC 331-viii 1981-82 Qs 839-841 pp 398-9
39 There is more detail on the contributory conditions for these benefits on Gov.uk, and on the Citizens Advice site.
19 National Insurance contributions (NICs): an introduction
generation of earners will do as much for oneself, when one comes to retirement.
Finally, as noted above, one part of all NICs paid do not go into the Fund to pay for contributory benefits, but go direct to the National Health Service. In this respect, paying NICs up until one reaches state pension age is a reflection of the communal responsibilities we have assumed, as a country, to prevent health care being means-tested, or prey to the vagaries of private insurance.41
One observation may be made here about the appeal of the contributory approach as a method for social security provision; as the authors of the standard text, The Law of Social Security, comment, “the popularity of [this approach] rests on its psychological appeal”:
People are prepared to subscribe more by way of contributions, which they see as offering returns in the form of personal and family security, than they would be willing to pay by taxation, which might be diverted to a wide variety of uses. They are led to believe that because of their contributions to the scheme they are participating in its administration and may thus exercise political control over its development.42
In a qualitative study of perceptions of the NI system published by the Department of Social Security in 1998, the author found that although the respondents lacked detailed knowledge of the benefits system, in their responses they were strongly committed to the contributory principle, believing that “contributors had a ‘right’ to insurance benefits, because the act of contributing legitimated claims for benefit.”
Nonetheless those interviewed usually saw no distinction between NI and taxes:
Generally, the respondents saw no real distinction between paying national insurance and tax. This was partly because they only looked at their net salaries, and not at the breakdown of any deductions. Indeed, some, typically employee earner respondents, said they did not know how much they paid in national insurance. It also partly reflected many respondents’ belief that the National Insurance Fund had only a notional existence. That whilst in practice there was a separate fund they saw national insurance contributions as part of the wider tax revenues collected by government. They believed that in practice there was just one ‘coffer’ or ‘main pot’ into which national insurance contributions and tax revenues were paid to fund all government expenditure.
A few respondents in one of the groups thought that the distinction between the two was merely for presentational reasons, in that it allowed governments to levy a lower rate of income tax than if there was no national insurance. At the same time … payment of national insurance contributions was seen as important in legitimating a person’s right to claim insurance benefits.
Generally, the respondents were unsure about which benefits were funded from national insurance. When asked ‘what do national insurance contributions pay for?’ respondents in all of the
41 This issue is explored in relation to the new State Pension in, Pensions 2015,
Commons Briefing Paper CBP7202, 27 May 2015 pp29-30. 42 Ogus, Barendt & Wikeley, The Law of Social Security, 5th edition 2002 p29
groups said hospitals or the health service. Respondents in most of the groups also identified state pensions and, what was usually called, ‘sickness pay’ as being funded by national insurance. Only one group mentioned, unprompted, unemployment as a risk covered by national insurance; it was also this group which was the only one to identify ‘maternity benefit’ as a contributory benefit.43
Many commentators have argued that NICs are poorly understood by the general public, despite the amount of money they raise:
John Whiting … a tax partner at PricewaterhouseCoopers … has a question that he tries out on people at parties when they talk to him about the tax system. “I ask them what the second biggest tax is, after income tax,” he says. “People flounder. They suggest value-added tax and you shake your head. They suggest corporation tax. Wrong again. Then they start the wilder guesses and suggest petrol duties. They rarely come up with the correct answer, which is national insurance contributions.” NICs are, in the words of Peter Bickley, technical manager at the Tax Faculty of the Institute of Chartered Accountants in England and Wales, “the Cinderella of taxes”. They are the unseen tax. They are a dream come true for Chancellors of the Exchequer. They are a tax that ordinary people, by and large, have not noticed.44
A standard guide to the tax notes that “very many people know little about [the tax]”, though the two increases in rates in 2003 & 2011 could have had an impact on public perceptions:
Just over a century ago, David Lloyd George stood before Parliament and introduced to the honourable members the novel concept of National Insurance. Anticipating a hostile response to the new levy, however, he described his contribution scheme as nothing more than a ‘temporary expedient’ and he hastened to assure the House that it was something which would ‘at no distant date’ become ‘unnecessary’. Ironically, Lloyd George’s ‘temporary expedient’ has now achieved a permanence even greater than that of income tax (another ‘temporary’ measure, but one which, unlike National Insurance, requires an annual Finance Act to revive it), and has established itself as, with some regulatory, the State’s second largest source of income ahead of Value Added Tax …
It is a curious fact … that despite the size and permanence of this levy, very many people know little about it. Even those who have the task of advising others of their financial responsibilities to the State – accountants, solicitors, business consultants and the like – have (until more recent times) treated it with a disregard that they would not dream of according to any other of Parliament’s taxation measures; and they have done so, it seems, in the belief that it cannot ‘bite’ in the way that other taxes can … The increase in the working population’s National Insurance contributions by 1% from 6 April 2003 made people far more aware of the existence of this form of taxation … The further universal increase of 1% … from 6 April 2011 should also have increased awareness.45
43 B.Stafford, National Insurance and the Contributory Principle: DSS In House Report
39, 1998 p40, pp18-19 44 “A vital contribution”, Financial Times, 11 April 2002 45 Tolley’s National Insurance contributions 2016/17 ed. paras 1.1-2.
21 National Insurance contributions (NICs): an introduction
In February 2014 Ben Gummer MP introduced a Ten Minute Rule Bill to rename NICs as ‘Earnings Tax’, on the grounds that “National Insurance is now a tax”, although this was not how it was “universally perceived”, because “the fiction of contributions consists.” Mr Gummer argued that the NI Fund could be merged “into general Government funds, which would save administration costs”, and that these changes would be “an important move in being clearer, simpler and more transparent about how our constituents are taxed, on what and where it is spent.” However, as with Ten Minute Rule Bills generally, Mr Gummer’s Bill made no further Parliamentary progress.46
4.1 The 1998 Taylor Report Following the 1997 General Election, the then Chancellor Gordon Brown set up a Task Force, chaired by Martin Taylor then chief executive of Barclays Bank, in line with the Labour party’s manifesto commitment to “examine the interaction of the tax and benefits systems so that they can be streamlined and modernised, so as to fulfil our objectives of promoting work incentives, reducing poverty and welfare dependency, and strengthening community and family life.”47
In his report, published alongside the March 1998 Budget, Mr Taylor made the general case for reforming the tax system to improve the benefits of work for those on low incomes.48 With respect to NI, the report led to changes in the rates and the base of NICs for employers and employees and in the rate of contributions paid by the self employed.
Mr Taylor argued that the schedule of rates for both primary and secondary Class 1 NICs seriously distorted the labour market. To illustrate this argument the report summarised the structure of Class 1 NICs in 1998/99:
If an employee earns over the lower earnings limit (£64 a week in 1998-99), he or she pays NICs at a rate of 2 per cent on earnings up to the lower earnings limit (LEL) [known as the ‘entry fee’] and 10 per cent on earnings over the LEL subject to a cap at the upper earnings limit (UEL) of £485 a week. Employees contracted out of the state earnings related pension scheme (SERPS) receive a rebate of 1.6 per cent on earnings between the LEL and UEL, ie a reduction in the rate of national insurance they pay …
Employers pay a uniform rate of NICs on all earnings for employees earning above the LEL. The rate paid depends on the earnings of the employee as set out below:
• £64 - £110 3% • £110 - £155 5% • £155 - £210 7% • £210 and over 10% • For those contracted out of SERPS, employers receive a 3
per cent rebate on earnings between the LEL and UEL.
With employer NICs, entry into each new band triggers the application of the higher rate to all earnings (unlike in income tax where the tax rate only applies to income in excess of any threshold). The result is that for employers there are steps not just at the LEL but at the three other thresholds.49
Mr Taylor argued that these steps in both primary and secondary Class 1 NICs had negative effects – especially in relation to employers’ administrative costs – and that the step at the LEL imposed high 47 HM Treasury press notice 47/97, 19 May 1997; Labour Party, New Labour: because
Britain deserves better, April 1997 pp12-13 48 HM Treasury, Work incentives: a report by Martin Taylor, March 1998 49 op.cit. pp11-12. The State Earnings Related Pension Scheme (SERPS) was the
23 National Insurance contributions (NICs): an introduction
marginal tax rates on those on low incomes, and he went on to recommended a number of changes to the structure of the tax:
• the introduction of a single flat rate of employer NICs • the abolition of the ‘entry fee’ for employer and employee NICs • aligning the lower earnings limit for employer and employee NICs
with the single person’s income tax allowance (provided that the rules on contributory benefits were amended to prevent significant loss of employees’ benefit entitlement).
In his March 1998 Budget speech Gordon Brown announced that he had accepted this programme for a “simpler, fairer and more employment-friendly national insurance system.”50
Over the following three years each of these proposals was implemented. The changes in employer NICs were made in April 1999, whereas the changes in employee NICs were made in two steps in April 2000 and April 2001. In his March 1999 Budget the Chancellor also announced that the UEL would be increased in two steps, in line with these increases in the LEL, to £535 per week from April 2000, and £575 per week from April 2001.51
In his report Martin Taylor had argued that the lack of alignment between NI and income tax was a cause for concern, particularly as employers were faced with separately recording and accounting for two sorts of NICs as well as income tax. He suggested that the NICs coverage of benefits in kind should be extended, although he did not advocate the much wider change supported by some employers – full integration of NICs and income tax:
At present, benefits in kind are not subject to NICs, other than the employer-only Class 1A charge on company cars and car fuel. This gives employers an advantage in offering benefits in kind, so reducing the NICs yield and distorting competition. However, it does not look straightforward to value benefits in kind, at least on anything like the income tax rules, on the current NICs pay period basis. So a full employee and employer NICs charge may not be easy for employers to handle. The pragmatic solution may be to extend, perhaps at a higher NICs rate, the Class 1A employer-only charge …
Some employers and representative bodies have in the past argued that NICs should be completely merged with income tax. This would save them the work of separately recording and accounting for two sorts of NICs as well as tax. This is an understandable suggestion, particularly for small employers who face relatively high unit costs for operating PAYE and NICs. However, full integration of employee NICs would require a substantially higher, basic rate of income tax. This could have very large redistributional effects, particularly if this higher rate were applied to other sources of income, such as pensions … Full integration would also mean a complete redefinition of the contributory principle for short term benefits and for pensions. It seems more worthwhile to focus on changes which would reduce
50 HC Deb 18 March 1998 c1104 51 Budget 99, HC 298, March 1999 p102. Historically the UEL for NICs has been
between 6½ and 7½ times the earnings point at which NICs first become payable.
Number 4517, 17 July 2017 24
the disincentives in the NICs system without raising such major policy questions.52
These conclusions were echoed in a study of employers’ tax compliance costs, published at this time by the Centre for Fiscal Studies at the University of Bath. It found that, “some employers found it frustrating and costly that treatment of benefits is not consistent across PAYE and NI” and recommended that, “the treatment of benefits in kind should be common across PAYE and NI Class 1A contributions.”53
In his March 1999 Budget speech the Chancellor confirmed that the Government would introduce legislation to extend Class 1A NICs to all taxable benefits in kind not already subject to NICs, such as private medical insurance, beneficial loans and assets transferred to the employee.54 The Government took the position that the revenue raised from this change facilitated the wider changes in NI mentioned above:
Not levying NICs on these benefits means NIC rates elsewhere in the system have to be higher. Since this Government’s major objective as far as national insurance is concerned is to make it fairer, and to structure it so that it does not discourage work, the revenue from NICs on benefits in kind has been put to very good use, cutting NIC rates for low earners and improving work incentives.55
Legislation was included in the Child Support, Pensions and Social Security Act 2000.56 Following the scrutiny of these provisions in Committee,57 the Government announced in Budget 2000 that an exception would be made for childcare benefits in kind: all forms of childcare provision would remain exempt from employers’ NICs.58
In addition, a new class of employer NICs – Class 1B contributions – was introduced in April 1999. This had been recommended by a working group set up under the Conservative Government’s deregulation initiative, to find changes to the definitions of income (for tax) and earnings (for NICs) which would cut employers’ costs and make it easier for them to meet their obligations in the administration of both.59
At the time the Conservative Government rejected the group’s recommendation for full integration,60 but it accepted the principle of closer alignment between the rules for each charge: in particular, the introduction of ‘annual voluntary settlements’ for NICs. Under these agreements employers have been able to settle the income tax liability on certain benefits in kind and for expenses in a single payment,
52 Work incentives: a report by Martin Taylor, March 1998 p14, p13 53 The Tax Compliance Costs for Employers of PAYE and National Insurance in
1995-96: Inland Revenue Economic Papers No.3, 1998 p87 54 HC Deb 9 March 1999 c187. Prior to this, a series of changes were made to the
coverage of employer NICs in relation to benefits in kind over the period 1991-96 (HC Deb 11 February 1997 c172W).
55 HM Treasury Budget press notice HMT9, 9 March 1999 56 specifically s74 of the Child Support, Pensions and Social Security Act 2000, and the
Social Security (Contributions) (Amendment No.8) Regulations Order SI 2000/2207. 57 SC Deb (F) 29 February & 2 March 2000 cc658-690 58 Inland Revenue Budget press notice REV9, 21 March 2000 59 DSS, Deregulation Review: Report of the Tax/NICs working group, 1993 60 Deregulation Task Forces Proposals for Reform, January 1994 para 350; Business
Deregulation Task Forces Proposals for Reform: Update, November 1995 para 350
25 National Insurance contributions (NICs): an introduction
thereby avoiding having to reach a separate settlement for each individual employee. The rules for these payments were revised in 1996, and renamed PAYE Settlement Agreements (PSAs).61 Following consultation,62 the Labour Government introduced legislation as part of the Social Security Act 1998 to introduce a new class of NI contribution - Class 1B - payable in circumstances where a PSA has been agreed, from April 1999.63
Finally, in Budget 2000 the Labour Government announced that it intended simplifying some aspects of NICs “that create complexity and worry for employers and their payroll administrators.”64 Following a consultation exercise, a number of minor measures to improve the administration of NICs, as well as that of statutory sick pay and statutory maternity pay were introduced in 2004.65
4.2 The case for and against integration For some years it has been argued that with the erosion of the contributory principle, the NI system merely represents an administrative burden for employers and that NICs should be integrated with income tax. However, there are two significant obstacles to full integration: the redefinition of the contributory principle, and the implications for taxpayers for whom earnings form a relatively small or insignificant part of their taxable income (primarily pensioners, but also those with significant income from savings interest, rents or dividends).
In March 1986 the Conservative Government published a green paper on personal taxation. In publishing the paper, the then Chancellor Nigel Lawson sought to reinvigorate the debate about the tax treatment of marriage, and it lead to the introduction of independent taxation in 1990: the system under which all individuals are assessed for tax as separate persons. The green paper also looked at how the tax system might develop in the longer term, and as part of this, the benefits and costs of integrating NICs with income tax. It concluded that there were good grounds for a merger with regard to the administration costs of both charges, but that the costs were too great, particularly in terms of the contributory principle:
In the case of people solely or mainly dependent on investment income, they would be paying for benefits, such as unemployment benefit, which would not be relevant to their circumstances. Tax-paying pensioners would in a sense be asked to pay twice: after a lifetime of paying NICs, they would then have to pay contributions towards benefits which they thought they had earned as of right on the basis of their earlier contributions record. This kind of anomaly would tend to weaken the link between contributions and entitlement and thus undermine the contributory principle …
61 under s 110 of the Finance Act 1996 62 Inland Revenue, Proposed Changes to Align NICs with Inland Revenue Treatment of
Tax under PAYE, 1996 (DEP 3/2743) 63 specifically s 53 of the Social Security Act 1998 64 Inland Revenue Budget press notice REV10, Helping to get it right, 21 March 2000 65 under the National Insurance Contributions and Statutory Payments Act 2004
Number 4517, 17 July 2017 26
A combined charge replacing both income tax and employees’ NICs could lead to reductions in administrative costs. The size of these would depend on the precise scope and nature of the new charge, and on the form taken by any new qualifying entitlements test. To the extent that the new charge was not extended to all income and/or differentiation was introduced into it the benefits of administrative simplification would be reduced.
A combined charge could have benefits for employers, especially small employers. It would simplify the calculations which have to be made separately at present. The increasing use of computers and hand calculators for payroll work, however, and their declining cost may well mean that the complexity of the present arrangements will increasingly impose less and less of a burden even on small employers.
Against the benefits must be weighed the major distributional effects of such a change, the need to find a satisfactory way of upholding the contributory principle and the need for a new separate charge for employers’ NICs. The Government’s view is that the benefits of a combined charge would be unlikely to justify the ensuing upheaval.66
Nigel Lawson identified another downside to integration: the combined impact of income tax and NI rates had on marginal tax rates as incomes rose. To illustrate this, one can use the tax schedule as it operated in 2007/08. In that year, employees were charged NICs at 11% on earnings between the primary threshold – set at £100 a week – and the upper earnings limit (UEL) – set at £670 a week. NICs was charged at 1% on earnings above the UEL. The marginal rate of deduction faced by employees – combining income tax and NICs – was:67
Earnings (£ per week) Marginal rate
£100 - £143 21% £143 - £670 33% £670 - £766 23% Above £766 41% Eliminating this ‘kink’ by abolishing NICs would hit some taxpayers particularly hard – particularly those with incomes close to the top of the basic rate band.68 In his memoirs Lord Lawson, called this dilemma the ‘elephant trap’, citing it as the main reason why he left the UEL unchanged. Some years later, in 2009, the UEL was aligned with the higher rate threshold, removing this ‘kink’ - this is discussed below. However, the obstacles to full-scale integration remain considerable.
In his memoirs Lord Lawson also refers to the possibility – discussed at that time – of abolishing the UEL, but without allowing contributions above it to confer any additional benefit entitlement. “This somewhat bizarre arrangement,” Mr Lawson argues, “would have solved one
66 HM Treasury, The Reform of Personal Taxation, Cmnd 9756, March 1986 pp 39-40 67 Taking account of the basic personal allowance – which is £5,225 for 2007/08 –
employees are charged income tax at: 10% on earnings between £100 and £143 a week; 22% on earnings between £143 and £766 a week; and 40% on earnings above £766 a week. The figures ignore the impact of tax credits.
68 The distributional effects from raising or abolishing the UEL were discussed in The IFS Green Budget, January 2002 pp62-68.
27 National Insurance contributions (NICs): an introduction
problem only to create another. For ‘contributions’ above the [UEL] would become a straight-forward tax, risking undermining the contributory principle and leading to increased pressure to assimilate employees’ NICs into income tax altogether.”69
Abolishing the UEL could well have political costs as well. Many have suggested that a factor in the Labour Party’s defeat in the 1992 general election was their manifesto pledge to abolish the UEL.70 In that year the Institute for Fiscal Studies reviewed the case for integration, suggesting that if implemented, “the tax system would be more coherent, the scope for removing structural anomalies would be greater, and the scope for tax avoidance would be reduced” but that the political objections to this reform were considerable: specifically the impact on the contributory principle “and the prospect of large losses among middle-to-high earners.”71
One solution to the first of these obstacles would be “that NICs could simply be grafted on to the income tax system with no change in the relationship between contributions and benefits.” To prevent pensioners being adversely hit, the authorities would apply only the income tax component of a combined rate to the income of pensioners. On the second obstacle to reform – the ‘elephant trap’ – the noted that the numbers of taxpayers who benefited from the kink “has fluctuated greatly in recent years, from just under one million in 1981/82 to more than two-and-a-half million in 1989/90”:
This fluctuation has arisen from variations in the rate at which the UEL and the higher rate threshold have been uprated. The UEL, whose value is linked to that of the basic state pension, has been price indexed for most of the 1980s. Given that earnings typically grow faster than prices, the number with earnings in excess of the UEL would thus tend to increase. This phenomenon accounts for most of the rise in the numbers between 1981-82 and 1989-90. However, the threshold at which higher rate tax becomes payable has on some occasions been frozen or under-indexed. This has tended to increase the number of higher rate taxpayers, and thereby reduce the numbers in the ‘gap’ between the UEL and the higher rate threshold. This accounts for … falls [in this number seen] in 1981-82, 1991-92 and 1992-93.
The authors presented some estimates of the distributional impact of integrating NICs and income tax, noting that the losses faced by taxpayers from raising the UEL to the higher rate threshold could be mitigated by reductions in the basic rate of tax – an approach which, in their opinion, would “avoid a torrent of opposition of the sort which faced the opposition parties who in June 1992 proposed the immediate abolition of the UEL.”72
As noted above, in April 2003 the rates of NICs for employees, employers and the self-employed were all increased by 1 percentage
69 Nigel Lawson, The View From No 11, 1992 p827 70 David Butler & Dennis Kavanagh, The British general election of 1992, 1992
pp267-8; Anthony King et al., Britain at the polls 1992, 1993 pp205-7 71 “Income tax and national insurance: better together?” in Tax Reform for the Fourth
Term, October 1992 p124 72 Tax Reform for the Fourth Term, October 1992 pp113-4, p107, p124
point, to fund a substantial increase in public health spending – a change announced in the 2002 Budget. In their 2003 Green Budget the IFS noted that in its manifesto for the general election in June 2001 the Labour party had made a commitment not to raise the rates of income tax but no such commitment in respect of NICs, prompting the question, “why did Labour feel impelled to make a pledge in respect of one but not the other?”:
From a purely economic perspective, it makes little sense to be implacably opposed to a percentage point increase in the basic and higher rates of income tax, but at the same time to have no objection to a National Insurance increase with similar effects over most of the income distribution. The trend towards increased levels of NICs coupled with lower rates of income tax began almost thirty years ago and shows no sign of abating ...
On economic grounds, it would seem sensible in many ways to aim towards a complete integration of the income tax and NI systems. This would offer the advantages of transparency and administrative efficiency with few apparent drawbacks. The original rationale for separate systems – the ‘contributory principle’ underlying the NI system – is all but obsolete ... Nor do the other remaining differences between income tax and NI provide a strong justification for maintaining separate systems. Lower rates of taxation on unearned income and on self-employment income create a distortion in favour of these income sources, which is probably undesirable.
Yet even if the government wishes to retain either or both of these anomalies, it would still be possible to do so within the income tax system (to have a lower rate of tax on pension income, for example). If the government believes that payroll taxes have different effects depending on whether they are levied on the employer or the employee, another option would be to integrate employee NI with income tax, leaving NI as a pure employer tax.
Given these arguments, the barrier to full integration of the two systems seems primarily political. Governments appear to believe that raising NICs is likely to be less costly to them in votes than raising income tax. It will be interesting to see if the high-profile increases in NICs due to take effect in April change this political calculus. If they do not, full integration of NI and income tax remains much less likely than further gradual alignment, with equalisation of the UEL and higher-rate threshold perhaps the obvious next step.73
These observations proved prescient.
In the 2006 Budget the Government announced that it would consult a review of the case for further aligning the administration of income tax and NICs.74 This was published alongside the 2007 Pre Budget Report (PBR): its conclusion – that the benefits of aligning the two charges did not outweigh the costs. In the 2007 Budget the then Chancellor Gordon Brown had announced several significant changes to personal taxation: a cut in the basic rate of income tax from 22% to 20%, abolishing the 10% starting rate from April 2008, and equalizing the
73 Institute for Fiscal Studies, The 2003 Green Budget, January 2003 pp 62-63 74 Budget 2006, HC 968 March 2006 para 5.87
29 National Insurance contributions (NICs): an introduction
UEL with the higher rate threshold from April 2009.75 (The decision in May 2008 to increase the personal allowance for the 2008/09 tax year, as compensation for the withdrawal of the 10% rate, meant that NICs and income tax were no longer aligned at the point when individuals start to pay each tax. Subsequent changes to these thresholds have not resulted in their being realigned.) At the time the IFS welcomed these changes as “welcome simplifications” though noted that “they raise the question of whether a much greater simplification could be achieved by fully integrating income tax and National Insurance.”76
When the Treasury Committee took evidence on the 2007 Budget, John McFall, then Chairman, asked John Whiting at PricewaterhouseCoopers if the alignment of the UEL with the higher rate threshold meant that “the distinction between the National Insurance and the taxation system is now all but meaningless?” Mr Whiting replied:
In terms of the calculation of how much you should pay under each, no, it is not meaningless because the core figure on which you charge income tax and National Insurance is still different. The prime example of that is contributions to a pension fund which, of course, are deductible for income tax but not for National Insurance. What we do get is still differences in the base to which the two calculations are applied. Although employers have always argued and called for a combination of the two levies, that may be extremely difficult to achieve politically and structurally in terms of the contributory nature of National Insurance, although it should be achievable. There is still some bringing together possible of the exact base on which the two levies are charged.
When asked whether there was a case for integration, Mr Whiting said:
I would say that there is probably a lot to be said for combining the two … One accepts that there is probably a necessity for a payroll tax on employers, which is what employers' National Insurance is, but if one swept away the contributory principle and just had done there would be scope for simplification, but I realise I am straying into quite a minefield here.
Picking up on this last point Dr Martin Weale, at the National Institute of Economic & Social Research, said: “It seems to me the main reason for keeping National Insurance separate from income tax is that the Chancellor can say to people, "There is a standard 20p rate of tax" and forget about the employers' and employees' NICs ... Politically it follows the Colbertian principle of plucking as much as you can from the goose without it squawking.”77
75 Pre-Budget Report, Cm 7227 October 2007 paras 5.74-7; Budget 2007, HC 342
March 2007 paras 5.5-6. The National Insurance Contributions Act 2008 aligned the UEL with the basic rate threshold. Two Library papers give more details: RP 07/88, 11 December 2007 & RP 08/07, 24 January 2008.
76 IFS press notice, Analysis of the Budget 2007, 21 March 2007 77 Fifth report: The 2007 Budget, 23 April 2007 HC 389-II 2006-07 Ev10 Qs57-9. Mr
Weale is referring to Jean-Baptiste Colbert, the 17th century French finance minister, who said, "The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing."
4.3 The 2007 review on further alignment As mentioned, in the 2006 Budget the Labour Government announced that it would review the case for further alignment between NICs and income tax. This was completed in October 2007. The review focused on the proposal that NICs should operate more like tax, by being moved onto an annual basis and being collected cumulatively. It concluded that potential savings for employers would be lower than might have been expected, there would be mixed outcomes for lower-paid individuals, and alignment would come at a high Exchequer cost.
At the outset the authors underlined that they had taken “the current policy framework as a given, namely that each system serves a different purpose, with NICs providing entitlement to contributory benefits. Therefore [the review] has not looked at merging income tax and NICs into one charge.”78 One commentator in the Tax Journal commented that “the absence of any appetite for radical change is, one assumes, due to the feared political fallout if the voting population begins to equate NIC with being a real tax”:
The alignment of income tax and NIC would be a huge and complex undertaking for any Government and it would be unfair to single out this Government as not being willing to rewrite the appropriate legislation ‘from the ground up’; it is following precedent.79 A question that I would like to raise, though, is why the prospect of alignment continues to be held out when, in fact, occasional tinkering is all that is really intended. Whilst I do not dispute the findings of the latest paper, I suggest that it does not address the key matter that needs to be aired: whether an alignment of income tax and NIC is feasible.80
Another commentator writing in Taxation was more positive:
The … possibility of aligning National Insurance and PAYE for employers … has long been a favourite topic in Budget representations and … HMRC have done some very detailed work on exactly what such an alignment would entail. Perhaps surprisingly, the conclusion is that there would not in fact be many administrative savings from such an alignment and that in some cases the administrative burden would actually increase. So the recommendation is that there should be no such alignment.
I have not really had a chance to evaluate the evidence yet and want to reserve my judgment on the outcome, but I applaud the openness of HMRC in publishing the research. In the past I fear we would have been fobbed off by a statement to the effect that ‘we have looked at it and it would not work’. That would have satisfied nobody and would have led to all sorts of suspicions about what the research actually said. But now the evidence is there, laid out for all to see. This must be the way forward.81
The review estimated that, for employers, the maximum savings from making NICs annual and cumulative would be “around 4.5 per cent of 78 HM Treasury, Income tax and national insurance alignment: an evidence-based
assessment, October 2007 p3 Emphasis added. 79 [Earlier in his piece the author noted that the integration of tax and NICs had been
considered, and rejected, in both the 1986 green paper on personal taxation and the Taylor review of work incentives.]
80 “Much ado about nothing?”, Tax Journal, 19 November 2007 81 “Crushing the burden”, Taxation, 25 October 2007
31 National Insurance contributions (NICs): an introduction
the costs of operating the payroll taxes by 2012, which is the earliest year by which changes could be introduced”:
These savings would vary between different employers, and would be significantly greater for those employers using manual payroll processes rather than payroll software or outsourcing their payroll … The level of potential savings is also expected to fall further over coming years, as the number of those employers using manual payroll processes continues to decline: from perhaps 210,000 at present, it is estimated that this number will have fallen to between 25,000 and 100,000 by 2012.
This translates to a reduction in estimated savings from between £40 million and £56 million now, to between £4 million and £34 million in 2012, assuming current trends persist. In addition there would be one-off transitional costs of around £200 million but could range from between £150 million to £250 million.82
This reform would also have implications for individuals:
At present, individuals’ contributions and benefit entitlement are determined on the basis of their earnings in each pay period in each employment. Under an annual system, NICs would be calculated on the basis of an annual NICs-free allowance, equivalent to 52 times the current weekly Primary Threshold (PT). Similarly, the basis for calculating the earnings factor that determines benefit entitlement would be calculated differently. Earnings across employments would also be aggregated, meaning that individuals no longer received the benefit of a separate PT in each employment. The UEL would apply across annual pay, and not when pay reached the limit in individual earnings periods.83
The review looked at the impact on three groups of employees: those working for just part of the year, those with fluctuating earnings, and those with more than one job:
Working for part of the tax year
In an annual and cumulative system, employees would no longer have a PT for each pay period. Instead, there would be an annual NICs-free ‘allowance’, similar to the personal allowance for tax. This would mean that individuals working for part of the year would receive the full benefit of their annual allowance; such individuals would therefore pay less NICs under an annual system than at present. An estimated five million people would benefit from this each year, with an average annual saving per person of around £120.
Fluctuating earnings
The introduction of an annual UEL, rather than a UEL in each earnings period would also mean some individuals paying additional NICs. Those whose annual earnings are between the LEL and UEL, but who receive earnings in one or some earnings periods over the UEL (for example as a result of overtime or bonus payments) would no longer pay NICs at 1 per cent on those earnings above the UEL in certain pay periods. Instead, NICs would be charged upon these earnings at 11 per cent. It is estimated that around 400,000 individuals would pay an extra £200 on average each year in NICs as a result of this change.
82 Income tax and national insurance alignment, October 2007 p3, p44 83 op.cit. p45
Number 4517, 17 July 2017 32
At present, employees’ total pay in earnings periods in which earnings have met or exceeded the LEL contributes to their earnings factor. If NICs were made annual and cumulative, however, all earnings could count towards the earnings factor. This could allow around 250,000 individuals each year to improve their earnings factors sufficiently for them to reach the qualifying earnings factor, so accruing a year of entitlement to basic State Pension, when they would not have done so under the current system. However, the White Paper on pensions: Security in Retirement includes proposals to make it easier for people with incomplete NICs records to obtain a full State Pension. It is expected that around 90 per cent of people in the UK reaching pension age in 2025 will receive a full State Pension. This means that it is less likely that particular individuals would gain from all of their earnings counting towards the earnings factor.
More than one job
Annualising the PT would, as set out above, reduce the amount of NICs paid by those employees who work for part of the year. However, while these individuals would gain from receiving an allowance for the full year, those with more than one job would no longer be able to receive several allowances, as they can at present. This is because NICs are currently calculated in each job, with no aggregation of earnings across jobs.84 It is estimated that around 600,000 individuals who work in more than one job would pay more NICs as a result of this change. The average increase in NICs would be £300 per year, but some individuals could pay up to £550 per year extra, with no change in their benefit entitlement position. Of the 600,000 people who work in more than one job, the majority already build up entitlement to contributory benefits because they earn above the Lower Earnings Limit in one of their jobs. If all earnings from each job counted towards benefit entitlement, around 20,000 employees would be brought into the benefit system and would start to build up benefit entitlement.85
Taking these together, the review estimated that approximately 5 million people would save an average of £120 per year in NICs but 1 million individuals, including some low earners, would pay up to £550 more NICs per year.
Finally there would be an Exchequer cost to this reform:
A significant number of individuals would gain from the introduction of an annual NICs ‘allowance’, in place of the PT for each pay period. These gains would have a substantial cost to the Exchequer, estimated at around £600 million. While there would be some yield from those individuals who would pay increased levels of NICs, the net effect on the Exchequer of making NICs annual and cumulative would be a cost to the public purse of £340 million.86
Although the Labour Government ruled out formal integration, the review identified a number of areas “to reduce administrative burdens by between £14 million and £21 million through changing the way
84 Unless jobs are with the same employer or employers who carry on business in
association with each other – in which case the jobs are treated as one and earnings are aggregated.
85 Income tax and national insurance alignment, October 2007 pp 45-6 86 op.cit. p47
33 National Insurance contributions (NICs): an introduction
benefits in kind and expenses are reported, removing the end of year reporting process and dealing with all payments of earnings, expenses or benefits in kind in a single payroll process.” In October 2007 HMRC confirmed it would:
• consult with business, in the autumn, on how best to improve guidance on tax and NICs to ensure it more closely meets business needs;
• issue a consultation document in November 2007 on how best to introduce a system to tax benefits in kind and expenses through the payroll; and
• consult, in the autumn, on ways of improving the processes for collecting Classes 2 and 4 NICs from the self-employed.87
There have been some developments in each of these areas. Following consultation, HMRC completed a survey in mid-2009 of the small number of businesses who chose to collect benefits and expenses through the payroll, to inform any wider change in the rules.88 In March 2008 HMRC reviewed the way the self-employed paid NICs, and from April 2011 the payment dates for Class 2 NICs were aligned with income tax self-assessment (ie, 31 January & 31 July each year).89 In 2013 the Coalition Government consulted on using self assessment to collect Class 2 NICs alongside income tax and Class 4 NICs,90 and provision to this effect was made with effect from April 2016.91
4.4 The 2010 Mirrlees Review In November 2010 the Institute for Fiscal Studies published the conclusions of a review of the UK’s tax system chaired by the Nobel laureate Sir James Mirrlees.92 Among its many recommendations the review argued that income tax and NICs should be merged, and some of its analysis is reproduced below. It should be emphasized that one of the review’s central arguments was that the tax system should be considered as a whole, and that policymakers should consider how individual taxes interacted with each other and with the benefits system.
The review rehearsed many of the criticisms that have been made of the system of NI in recent years – such as the administrative burden and compliance costs created by having two separate taxes on earnings – but it went on to make a wider criticism about transparency: “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.” As the authors observed, this lack of
87 op.cit. p52. See also, Pre-Budget Report, Cm 7227 October 2007 pp 62-3, p68 88 Including Benefits in Kind and Expense Payments in the Payroll - A Fresh Approach,
13 December 2007 89 Under SI 2011/797 – see also, HMRC, Impact assessment: improved collection of
NICs from the self-employed, February 2011. 90 Budget 2013, HC 1033, March 2013 para 2.42. Details of the consultation are
collated on Gov.uk. 91 Budget 2014, HC 1104, March 2014 para 2.212. Provision for this was made by
ss2-3 of the National Insurance Contributions Act 2015. 92 IFS press notice, Mirrlees Review of tax system recommends radical changes, 10
November 2010. A final version of the report was published in 2011.
transparency could be seen in nearly all public debate over the rates of tax individuals pay on their income:
The tax schedule that people actually face on their earnings reflects the combination of income tax and National Insurance contributions (NICs). Transparency requires that it is the combined schedule that should be described and debated. When politicians debate whether the current 20% basic rate, 40% higher rate, and 50% additional rate of income tax are appropriate, people should not have to remind themselves (or be reminded) that the true rate schedule includes NICs on top of that, nor should they have to do the calculations.
It is rare in popular discourse to hear discussion of the 31%, 41%, and 51% rates that (in 2010-11) apply once employee NICs are taken into account, let alone consideration of the effect of employer NICs (or the different rate schedule that applies to the self-employed). Because attention is often restricted to headline income tax rates (which rise from 20% to 40% and then 50% at higher incomes), ignoring NIC rates (which fall from 11% to 1% for employees), the degree of progression towards the top of the distribution is easily overstated.93
Further than this, “governments may see the lack of transparency in the current system as a positive rather than a negative”, and the authors cited the case of the General Election in 2001 which preceded the increase in NI rates announced by the Labour Government in its first Budget after being returned to office:
Just one example of the way in which the separation of the systems can lead to confusion (to put it generously) was the Labour Party’s 2001 general election manifesto. This included a pledge not to increase rates of income tax, but contained no such pledge on NICs. Labour was re-elected and, in its first Budget after the election, promptly announced an across-the-board increase in NIC rates.
It is hard to believe that the government had decided after careful deliberation that tax rates on earnings (subject to NICs as well as income tax) should increase but that the tax rate on other income (subject only to income tax) should not, and that the manifesto pledge had been intended to guarantee the latter while leaving open the former.
Such an intention was certainly not made clear to the public during the election campaign. Whether the shortcoming was duplicity, incoherence, or merely poor communication, we should strive to make such episodes unrepeatable.94
The authors acknowledged that one serious obstacle to integration would be reforming employer NICs. The choice would be between merging employer NICs into employee NICs and income tax, or levying an equivalent tax on non-employment income. Neither reform would be politically easy:
There is … a strong case for phasing out the employer contribution altogether … [but] given where we start, such a transition would be painful. The immediate effect of an overnight shift from employer to employee taxes is that take-home pay would fall and employers’ profits increase. Earnings would
93 Tax by Design, September 2011 p482, pp127-8 94 op.cit. pp 128-9
35 National Insurance contributions (NICs): an introduction
eventually rise to return take-home pay and employer cost to their previous levels, but this could take a long time …
Income tax and employee NICs could be merged while leaving a separate employer tax in place. But retaining an employer tax has a price beyond simply forgoing part of the benefits of integration. Since it is necessarily confined to employment income, it has consequences for the tax system as a whole.
For example, suppose we wanted to apply the same overall tax schedule to all forms of income, not just employment income—something we will argue for [elsewhere in this review] … Employment income is currently taxed more heavily than self-employment and capital income (and capital gains), largely because NICs apply only to earnings. For all forms of income to be subject to the same overall rate schedule, NICs or something equivalent to them would have to be extended to other forms of income. It is easy to see how this could be achieved for employee NICs, the scope of which could simply be extended.
The same would apply to employer NICs if they too were brought within a merged tax. But if employer NICs were kept as a separate tax, it could apply only to employment income; so to achieve equal treatment, additional tax equivalent to employer NICs would have to be levied on capital income, self-employment income, and so on. This would add further complexity to the system, and it hardly seems politically appealing either. Whether it is a more attractive prospect than phasing out employer NICs and raising income tax instead is a moot point.95
In its analysis of small business taxation, the report mentioned two other arguments for integration: first, the relative burden of NICs on the self-employed, compared with employees …
Self employed individuals pay significantly lower NICs than employed individuals, particularly when both employer and employee NICs are taken into consideration. This advantage is partially offset by lower entitlements to some state benefits for self-employed individuals. Nevertheless, actuarial estimates suggest that the value of additional social security benefits for a typical employee is substantially lower than the additional cost imposed by these higher NICs.96
The absence of employer NICs results in slightly higher taxable income and hence personal income tax for the self-employed individual, but the net effect remains a significant inducement for individuals to choose self-employment over employment, in situations where they would otherwise be indifferent.
… and second, the ability of owner-managers of small companies to make considerable tax savings, by avoiding NICs:
The absence of National Insurance contributions on both company profits and company dividends provides opportunities for even greater savings for owner-managers of small companies. By paying themselves a wage below the earnings threshold for National Insurance (and also below the personal allowance for income tax), they can avoid any income tax or NICs on this component of their remuneration. By taking the rest of their
95 op.cit. pp131-2 96 [HMRC’s latest estimate of the Exchequer cost of reduced NICs for the self-employed
not attributable to reduced pensions eligibility is £5.1 billion for 2016/17. HMRC, Principal tax reliefs, December 2016.]
remuneration in the form of dividend income paid out of company profits, the only tax paid is corporation tax on these profits …
Moreover, no NICs are charged on dividend income. By taking a substantial share of his remuneration in the form of dividends paid out of company profits, rather than in the form of wages or salary, the owner-manager of a small company can thus enjoy a substantial saving in combined direct tax and National Insurance contributions, relative to both a self-employed individual with an unincorporated business and, still more, relative to an employee.97
The authors acknowledged that in some respects this over-simplifies the picture – “for example, company dividends will generally be paid out less frequently than wages and salaries, which may limit the extent to which some small company proprietors can take advantage of this tax saving” – but, nevertheless “there remains a substantial tax advantage”, and one that has been recognised in the development of anti-avoidance legislation, to prevent this advantage being aggressively exploited:
Whatever one thinks about the economic case for subsidizing particular kinds of small businesses—for example, those that are highly innovative or that have considerable growth potential—it is difficult to rationalize tax advantages on this scale for all small businesses. Evidently, this view underpins the growth of anti-avoidance legislation in the UK.98 However, by tackling symptoms of the problem, rather than addressing the difference in the rates at which labour income and capital income are taxed, the result has been a dramatic increase in the complexity of the legislation covering these aspects of small business taxation, rather than a coherent solution …
Closer alignment of the taxation of income from employment and self-employment could be achieved by increasing the National Insurance contributions paid by self-employed individuals towards the combined level paid by both employers and employees in respect of income from employment. Any difference should reflect only the actuarial value of differences in entitlements to state social security benefits, and these entitlement differences should be limited to benefits where it would be administratively difficult to extend full coverage to the self-employed.99
Alternatively, NICs could be integrated with the personal income tax in one of the ways discussed [earlier in this report], and residual elements of the ‘contributory principle’ for state social security benefits be replaced by different entitlement rules, with equal treatments of employed and self-employed individuals in so far as this is administratively feasible.100
97 op.cit. pp456-8 98 Crawford and Freedman [“Small Business Taxation” in, Dimensions of Tax Design:
The Mirrlees Review, 2010] provide a detailed discussion of various special measures that have been introduced in the UK to limit the extent to which particular types of small companies can exploit these savings.
99 For example, this may be difficult where the level of a benefit payment is related to past earnings.
37 National Insurance contributions (NICs): an introduction
5. The Coalition Government’s approach
5.1 Assessing the case for integration In its first Budget in June 2010 the Coalition Government announced that it would set up an independent body to review the tax system and make recommendations for its simplification.101 The following month Treasury Minister David Gauke announced the establishment of the Office of Tax Simplification. The OTS would undertake two reviews in its first year, looking at the existing structure of tax reliefs and at small business taxation and the specific question of finding a simpler alternative to IR35.102 Michael Jack and John Whiting were appointed as the chair and tax director respectively.103
Just prior to the 2011 Budget the OTS published reports on both of these issues. In its paper on simplifying the tax system for small business, the OTS argued that combining income tax and NICs would remove a series of anomalies in the tax system which distorted taxpayers’ behaviour, and would result in significant administrative simplification. The report acknowledged that there were serious obstacles to full integration, but went on to suggest a number of septs that could be taken to bring the base of each tax into closer alignment:
Consistency in the definition of earnings: e.g. tax and NICs on benefits in kind and reimbursed expenses;
Consistency in the required calculations: this includes aligning thresholds, calculating NICs based on annual and cumulative earnings, and assessing NICs liability on a per person basis rather than per employment;
Reliefs and exemptions on either income tax or NICs: some of these discrepancies have been highlighted in the final report of the OTS review of tax reliefs104;
Treatment of pensioners: one of the major issues identified is with the taxation of pensioners, as noted [earlier in the report]. We also believe that any review would also need to cover issues such as the married couples allowances and the age related allowance;
Treatment of self-employment: including examining current differences in NICs between employees and self-employed and recommending potential, costed, methods to align the rates. As noted in Chapter 4, a potential initial step could be to combine Class 2 and Class 4 NICs; and
101 Budget 2010, HC 61 June 2010 para 1.64 102 IR35 refers to anti-avoidance legislation introduced in 2000 to counter the
exploitation of one-person companies, channelling income from clients through a company to be taxed on this remuneration as dividends rather than earnings, avoiding NICs. The rules have long been criticised by stakeholders, though governments have maintained that they are important to prevent erosion of the tax base. For details see, Personal service companies: recent debate, Commons Briefing paper CBP5976, 9 June 2017.
103 HC Deb 20 July 2010 c8WS; HC Deb 20 July 2010 cc175-84; HM Treasury press notice 29/10 20 July 2010. Details of the OTS’s work is collated on Gov.uk
104 OTS, Review of tax reliefs; final report, 3 March 2011
Treatment of savings and dividend income: these are currently exempt from NIC and the OTS view is that the difference in the treatment to earnings is central to the tax motivation for incorporation and is a major incentive to operate a personal service company. This should be examined in more detail to see whether this income should be taxed at a lower or higher rate than earnings (this should be looked at in conjunction with the treatment of the self-employed, and employer NIC).105
Although the Coalition Government did not publish a formal response to Mirrlees, Treasury Minister David Gauke was not enthusiastic when asked about integration in December 2010:
John Stevenson: To ask the Chancellor of the Exchequer whether he has plans to merge income tax and national insurance as a means of tax simplification.
Mr Gauke: The Government aim for a tax system which is more competitive, simpler, greener and fairer, and keeps the system under continual review with a view to meeting these objectives. While national insurance shares some of the characteristics of income tax, it is a system of social insurance which determines entitlement to state pensions and other benefits. Therefore the two cannot easily be merged.106
In the weeks before the 2011 Budget there was some speculation that the Government had changed its position on this issue.107 In his Budget speech on 23 March the then Chancellor, George Osborne, announced a consultation on merging the operation of income tax and NICs; the Chancellor went on to make clear that any reforms would not result in NICs being extended to other forms of income, or the end of the contributory principle:
For decades, we have operated income tax and national insurance as two fundamentally different taxes and forced businesses large and small to operate two completely different systems of administration, with two different periods and bases of charge. The resulting anomalies are legion, and it imposes totally unnecessary costs and complexity on employers and costs the taxpayer in the extra burden that it places on Her Majesty's Revenue and Customs. So I am announcing today that the Government will consult on merging the operation of national insurance and income tax.
I am not proposing that we extend national insurance to pensioners, or to other forms of income, or that we abolish the contributory principle. Our purpose is not to increase taxes; it is to simplify them, and this huge task will therefore require a great deal of consultation and take a number of years to complete, but it is time we took this historic step to simplify dramatically our tax system and make it fit for the modern age.108
105 Small business tax review, March 2011 paras 3.12-4. The authors noted that the IFS
had explored this in more detail: Integrating Income Tax and National Insurance: an interim report, December 2007.
106 HC Deb 21 November 2010 c1144W 107 “Tax and national insurance merger is mooted”, Financial Times, 18 March 2011;
“Income tax to be merged with National Insurance”, Sunday Times, 20 March 2011 108 HC Deb 23 March 2011 cc954-5
39 National Insurance contributions (NICs): an introduction
The Budget report simply stated the Government would consult later in 2011 “on the options, stages and timing of reform.”109
Several commentators pointed out that the Chancellor’s choice of words indicated that any reform would stop well short of a full merger.110 At the IFS post-Budget briefing James Browne noted that it was not clear exactly what was meant by integrating “the operation” of the two taxes, though the decision to keep savings and dividend income outside NICs would meant the system would continue to create perverse incentives for individuals to convert labour income to capital income to avoid tax.111
The Chartered Institute of Taxation congratulated the Chancellor “on finally grasping a nettle that successive administrations have shied away from” but expressed disappointment on the fact Mr Osborne had ruled out abolishing the contributory principle: “with the announcement elsewhere in his speech of moves toward a flat rate pension, the burden of running the contributory aspects of the system may outweigh the benefits.”112 Writing in Taxation, one practitioner suggested that “the end result will probably be a mere tinkering around the edges, which could reduce administration but is unlikely to be notice by the majority of those currently in employment.”113
When the Chancellor appeared before the Treasury Committee he was asked if the retention of the contributory principle would nullify most of the potential benefits to any merger:
I think there are very substantial operational benefits. I think there are two issues with running National Insurance and income tax alongside each other. The first is for the taxpayer, which is you basically have two taxes on income that are levied in different ways and at different rates and so on, and you could, if you were being completely idealistic about it, you would say the whole thing is a fantasy, let’s get rid of it all, let’s have a single rate of income tax. I don’t think that is realistic …
There is a separate problem with National Insurance and income that I am trying to address, which is companies, small businesses and others, have to run two completely separate payroll systems. Now, if we can merge the operation of that so there is a single payroll but there is still a separate National Insurance and income tax, then we should be able to save for business very substantial sums of money and save for the taxpayer very substantial sums of money because we have to run two different systems in the Inland Revenue as well.
Mr Osborne went on to argue why, in his view, the contributory principle still mattered:
I think [the contributory principle] … is quite an important principle of our pension system, and there are other contributory benefits as well, there is a contributory job seekers allowance and
109 Budget 2011, HC 836, March 2011 para 1.77 110 “Fiercely complex reform to stop short of a radical merger”, Financial Times, 24
March 2011 111 Personal tax and benefit changes: IFS 2011 post Budget briefing, 24 March 2011 112 CIOT press notice, Income tax and NICs reform a nettle that needed grasping, 23
March 2011 113 “Cancel the wedding””, Taxation, 7 April 2011
employment support allowance, but particularly for our state pension I think there is a long established principle in Britain that if you work and you make contributions or indeed now if you are a mother and you look after children, you are making a contribution to your future pension and I think a Government should think long and hard before it abolished that.114
For its part the Committee noted that, while it understood the Chancellor’s “desire to move cautiously” given the complexities to reform, “the change appears to have been anticipated as a radical measure but turned out, at second glance, to be a modest one.”115
In July 2011 the Treasury issued a ‘call for evidence’ on the greater integration of income tax and NICs, with a view to “build a strong evidence base on the burdens to employers of having to operate two different systems.” Responses were invited on a series of questions, most of which are focused “on the burdens employers and payroll professionals face in paying income tax and NICs through the PAYE system. For example, how much staff time and other resource is required to manage the systems, which aspects of the process currently work well and how often problems are encountered when calculating payments.”116 The department’s consultation paper suggested that “closer integration of the operation of income tax and NICs has the potential to deliver benefits in four areas”:
Reducing burdens on employers. … Employers are required to understand and comply with two different systems and two different sets of rules. Integration has the potential to make compliance simpler and cheaper.
Removing distortions in the economy and improving transparency. As the OTS noted, maintaining two systems leads to a number of anomalies that provide incentives to distort behaviour.117
Fairness. The current systems deliver different outcomes depending on the nature of a person’s employment. In short, individuals with similar circumstances and income may pay different amounts and receive different benefit entitlements. Greater integration may be able to improve the fairness of outcomes by making it more likely that individuals with similar circumstances pay similar amounts and gain similar contributory benefit entitlements. More generally, many individuals may find it hard to understand how much they will pay under the two systems. A more integrated system may be more transparent, helping individuals make better decisions regarding their employment.
Cutting administrative costs for government. Each year operating PAYE costs private sector employers and pension providers £0.7 billion and HMRC spends around £1 billion on PAYE administration. Any changes to the current system will entail up-front costs. But if closer integration can reduce complexity (for employers and for government), it may be able to reduce the
114 Tenth report: Budget 2011, 9 April 2011, HC 897 of 2010-11, Ev82-83 Qs 521-2 115 op.cit. para 136 116 HM Treasury press notice 77/11, 11 July 2011 117 Small Business Tax Review (Office of Tax Simplification, March 2011)
41 National Insurance contributions (NICs): an introduction
likelihood of error and HMRC’s overall costs of collection in the longer term.118
Responses were invited by 19 September 2011 – and in November the Government published a document describing the next phase of work on this project.119 One issue raised by many respondents had been the fact that tax and NICs are assessed in different ways. So, income tax is assessed on total annual income, and the deductions employers make through PAYE are based on pay to date (cumulative). Liability is then finalised following the end of the tax year. By contrast, NICs is assessed on earnings in each earnings period (non-cumulative); liability is finalised at the point that the earnings are paid. There is also a key difference in liability across employments. For tax earnings from separate employments are aggregated, whereas for NICs liability is calculated on each employment in isolation.120
As the paper stated, “the Government sees the main path to integration as bringing NICs closer to income tax, rather than vice versa … reform in this direction would be a continuation of changes that have gradually made NICs more like income tax over recent decades. The alternative – moving income tax closer to NICs – would imply changing the annual assessment of income tax to a pay period basis, which could be unworkable given the need to cover non-earnings forms of income.” Given this, a “priority for further work would be to look at:
• Annual NICs. Whether assessment for NICs should be based on the tax year as it is for income tax.
• Cumulative NICs. Whether liability for NICs should be based on earnings over the year-to-date, rather than assessed independently in each pay period.
• Aggregated NICs. Whether earnings should be considered across employments when determining NICs liability, rather than per each employment.121
The paper set out some of the challenges to any reform, including the implications for individual earners in terms of the tax and NICs they pay as well as their access to contributory benefits:
Any reform of NICs to an annual, cumulative and aggregated basis to match the income tax structure could mean a significant number of individuals would end up with a different NICs liability – some could pay more and others less. On the one hand, there are around nine million individuals in the UK who currently work less than a full year. Many of these individuals would pay less NICs if only one NICs threshold was applied each year. Some of these individuals might find their contributions record is affected, though they would be able to compensate by paying voluntary NICs.
On the other hand, there are nearly three million individuals who work more than one job simultaneously. They would be likely to pay more NICs if only one NICs threshold were applied across
118 Integrating the operation of income tax and National Insurance contributions : a call
for evidence, July 2011 pp7-8 119 HC Deb 14 November 2011 c27WS 120 HM Treasury, Integrating the operation of income tax and national insurance
contributions: next steps, November 2011 p9 (Table 2.C) 121 op.cit. p23
multiple employments. Some of these individuals would find themselves eligible for contributory benefits for the first time. And there are over seven million individuals who have earnings that fluctuate across NICs thresholds within the year (e.g. through periods of overtime or irregular bonus payments). This final group could pay either less or more depending on the level and pattern of their earnings.122
In his foreword to the paper, Treasury Minister David Gauke argued that “in this area, as with many aspects of tax reform, a consultative and deliberate approach is desirable.” The paper gave a possible timetable for reform:123
It is the Government’s view that any significant reform of the operation of income tax and NICs will take two Parliaments to deliver. This will give sufficient time for issues of design to be resolved, legislation to be passed, and systems used by government and employers to be redesigned …
[The timetable shown in the table below] should be considered indicative only, as there may be a number of options as to how to introduce reform in phases. The timetable will be confirmed at Budget 2012, following further work.
As one commentator noted, “mindful of the number of people it would affect (and, no doubt, the … 10% rate debacle) the timetable for further consultation and eventual implementation is slow.”124 Another practitioner writing in Taxation was more critical, arguing that the Government’s consultation on merging the operation of the two taxes “is like announcing the re-invention of the wheel, provided it is square, and has no axle, and consulting on what the colour should be.”125
As it transpired the Budget report simply stated that the Government would “consult on integrating the operation of income tax and NICs after Budget 2012.”126 In a speech on tax reform in October 2012 Treasury Minister David Gauke underlined the Government’s view that it
122 op.cit. p25 123 op.cit. p27. Details of the consultation are collated on the National Archives site. 124 “Digitally transparent”, Taxation, 17 November 2011. The reference to the ‘10%
rate debacle’ is to The Labour Government’s decision in 2007 to abolish the 10% starting rate of income tax from April 2008. For more details see, Income tax: the 10p starting rate, Commons Briefing Paper CBP4685, 5 March 2013.
125 “No convergence”, Taxation, 17 May 2012 126 Budget 2012, HC 1853, March 2012 para 2.41
43 National Insurance contributions (NICs): an introduction
would be “crucial that major reforms are well thought through rather than rushed”:
Any reforms that make NICs match income tax structure could mean a significant number of individuals would end up with a different NICs liability. Some could pay more and others less. Therefore before proceeding with any reform, it is our responsibility to ensure we have a clear understanding of the number of individuals likely to be affected and how they will be affected. I encourage businesses and representative bodies … to continue to engage with us on this and other reforms … [and] I hope to be in a position to provide an update on this detailed programme of work shortly.127
However, in the 2012 Autumn Statement the Government stated that it would “wait for further progress on planned operational changes to the tax system before formally consulting on the operational integration of income tax and NICs.”128 No further details were published for the remainder of the 2010-15 Parliament.
5.2 Reforms to NICs (2010-2015) Arguably the most important change to NICs during this period was a policy that had been announced by the previous Labour Government. From April 2011 the rates of NICs paid by employees, employers and the self-employed rose by 1%. This tax increase had been announced in two stages by the Labour Government in its Pre-Budget reports in December 2008 & 2009. It was confirmed by the Coalition Government in its first Budget on 22 June 2010, and legislation to this effect was introduced in autumn 2010. To mitigate the impact on individuals on lower incomes, and on the incentives for employers to take on new staff, both the primary and secondary threshold were increased substantially above inflation.129
In their assessment of the Coalition Government’s tax policy, published in March 2015, the IFS noted that this was the Government’s second biggest single tax increase, raising an estimated £11.8 billion in 2015/16. The Government’s decision in the first Budget to raise the standard rate of VAT to 20% is estimated to raise £14 billion in the same year. The increases made to NI thresholds at this time were of a considerable cost, though, as the authors note, these were a ‘one-off’. NI thresholds were not raised in line with the personal tax allowance, which was increased each year in real terms over the 2010-15 period. (The personal allowance was increased to £10,600 in 2015/16, £2,835 higher than the £7,765 it would have been if the 2010/11 allowance had simply been increased in line with RPI inflation (used by default for uprating at the time):
127 HM Treasury press notice, Speech by the Exchequer Secretary, David Gauke MP:
taxation for the 21st century, 5 October 2012 128 Autumn Statement, Cm 8480, December 2012 para 2.52. see also, HC Deb 10
March 2014 cc2-3W 129 For a summary see, National Insurance contributions: changes from April 2011,
In April 2011 the rates of NICs paid by employees, employers and the self-employed all increased by 1 percentage point, raising £11.8 billion. These increases had been announced, but not implemented, by the previous Labour government; the coalition chose to go ahead with them. At the same time, the thresholds at which NICs become payable were increased. The increase in thresholds for employees and the self-employed (costing £3.6 billion) had also been planned by Labour; the increase in the threshold for employers (costing £3.9 billion) was a new announcement. These threshold increases reduced the impact of the NICs rate rise on low earners.
However, the NICs thresholds have not increased in line with the income tax personal allowance. It is hard to think of a good economic reason for wanting to increase the income tax allowance but not the NICs thresholds. The emphasis on income tax and neglect of NICs highlights the absurdity of continuing to have two similar but separate taxes given that National Insurance is not a true social insurance scheme.130
As an aside, the Conservative Government made a commitment to increasing the personal allowance over the 2015-20 Parliament to £12,500 – and by April 2017 the allowance had reached £11,500.131 In a speech at this time to the CIOT the tax barrister and commentator Jolyon Maugham noted that the gap that had been opened up between the primary threshold and the personal allowance represented a major political obstacle to integrating the two taxes, whatever the merits of a merger might be in terms of transparency, efficiency or fairness.132
In his Budget on 20 March 2013 the then Chancellor, Mr Osborne, announced a new ‘Employment Allowance’ – to reduce employers’ NIC costs:
The cost of employing people is a burden on small firms. It is a real barrier to taking an extra person on. To help create jobs and back small businesses in this country, I am today creating the employment allowance. The employment allowance will work by taking the first £2,000 off the employer national insurance bill of every company. It is a tax off jobs. It is worth up to £2,000 to every business in the country. It will mean that 450,000 small businesses—one third of all employers in the country—will pay no jobs tax at all.
For the person who has set up their own business and is thinking about taking on their first employee, a huge barrier will be removed. They can hire someone on £22,000, or four people on the minimum wage, and pay no jobs tax. Ninety-eight per cent. of the benefit of this employment allowance will go to small and medium-sized enterprises. It will become available in April next year, once the legislation has passed. We will also make it available to charities and community sports clubs. The previous Government’s answer to Britain’s economic problems was to
130 The Coalition Government’s Record on Tax: IFS Briefing Note BN167, March 2015
p6, p9, pp12-13. For more details see, Income tax : increases in the personal allowance (2010-2015), Commons Briefing paper CBP6569, 17 June 2015.
131 Spring Budget 2017, HC 1025, March 2017 para 3.4 132 “Raising the NICs floor so it matches the income tax floor would be another hugely
expensive commitment. Will Government tackle it? It’s not impossible to imagine it might – but certainly not in order to deliver the technical win of unifying the two taxes.” The speech is published on Mr Maugham’s blog: “My address to the Chartered Institute of Tax”, Waiting on Godot: musings on tax, 12 June 2015.
45 National Insurance contributions (NICs): an introduction
propose a tax on jobs. We stopped that and today this Government are taking tax off jobs.133
The cost of the allowance was projected to be £1.26 billion in 2014/15, rising to £1.73 billion by 2017/18.134
Mr Osborne announced a second employer NI relief in the 2013 Autumn Statement, for employers taking on employees under 21. This relief took effect from April 2015.135 Provision for these reliefs was made by National Insurance Contributions Act 2014.136
As noted above, in April 2011 the procedure for paying NICs was simplified for self-employed persons, when the dates for paying Class 2 were aligned with the dates for tax under self assessment. Payments of Class 2 NICs & Class 4 NICs continued to be made separately, though in its report on small business published in March 2011, the OTS argued that this created difficulties for many taxpayers, who were obliged to recover over-paid NI after the end of the tax year:
From 6 April 2011, payment of Class 2 NICs will be collected on 31 July and 31 January in the year of liability. From that date quarterly billing will be superseded by biannual or monthly direct debit payments, but this is not being collected through the self assessment system.
Problems can arise after the tax year end. HMRC has to calculate and refund any NICs paid by an individual which is in excess of the annual maximum NICs for the tax year. A self-employed person who has employment income will be liable to national insurance Classes 1, 2 and 4 and may pay more than the effective annual maximum. Such individuals can apply in advance to defer paying their Class 2 and Class 4 NICs until after total income for a tax year is known. The deferment process is paper based and has several stages.
Further, where business profits are below a ‘small earnings’ threshold, the individual may apply for a ‘small earnings exception’ (“SEE”) from paying Class 2 NICs (Class 4 NICs would not be due) but cannot apply for deferment. This separate form and process, with different time limits, is confusing and frustrating for those whose earnings fluctuate above and below the threshold.137
In July 2013 HMRC published a consultation document, which looked at the problems for businesses applying for an SEE certificate, and for deferring payment of Class 2 NICs. The paper illustrated the difficulties created by basing the SEE process on anticipated profit levels:
John anticipates profits above the SEE limit and pays Class 2 NICs throughout the year. At the end of the tax year John finds that he has made profits below the SEE limit and decides to apply to
133 HC Deb 20 March 2013 c944 134 Budget 2013, HC 1033, March 2013 p64 (Table 2.1 – item 25). See also, Treasury
Committee, Budget 2013, 20 April 2013, HC 1063 of 2012-13 paras 117-121. General guidance on the Allowance is on Gov.uk.
135 Autumn Statement, Cm 8747, December 2013 para 1.195. The relief was projected to cost £440m in 2015/16, rising to £505m by 2017/18: Budget 2014, HC 1104, March 2014 p58, Table 2.2 – item d
136 For details see Library Research paper RP13/60 1 November 2013 & Commons Briefing paper CBP6761, 26 February 2014.
137 Small business tax review, March 2011 para 4.12-14
HMRC for a refund of the Class 2 NICs he has paid. He has to provide evidence of his profits. John applies for a refund within the time-limits, HMRC approves his application and John gets a refund of the Class 2 NICs that he has paid.
Jake on the other hand expected low profits and applied to HMRC for a SEE. HMRC approves Jake’s SEE application and issues Jake with a SEE certificate. Jake doesn’t pay any Class 2 NICs. At the end of the tax year Jake finds that he has made profits above the SEE limit. Because Jake had a SEE in place he is not required to pay any Class 2 NICs for the past periods. However Jake is required to inform HMRC who will cancel his SEE certificate going forward and Jake commences Class 2 NICs payments.138
Similarly the process for deferring payment of Class 2 NICs until the end of the tax year was quite complex:
There is a maximum amount of NICs an individual is liable to pay across Class 1, Class 2 and Class 4 NICs. Individuals who think they might exceed this maximum can choose to defer payment of NICs until the end of the year. The individual can request deferring Class 2 payment from HMRC via a paper application form. However individuals who expect to have profits below the SEE limit are requested not to apply for Class 2 deferment and instead apply to HMRC for a SEE certificate …
Deferment of NICs can only be made for one year at a time. If an individual expects to exceed the annual maximum in subsequent years, then they currently need to apply to HMRC and renew their deferral to pay Class 2 NICs each year. Where deferment has previously been granted, HMRC automatically issues a renewal application to the individual.139
Taken together, these processes “drive significant administrative burdens on small business … Class 2 account for less than 0.3% of the £102bn NICs collected by HMRC in 2012/13 and yet accounted for around 40% of NI related telephone calls to HMRC and associated processing work.”140
As an alternative, the paper proposed that liability to Class 2 NICs could be calculated as part of the process for completing an annual return, and to someone’s liability for income tax and Class 4 NICs:
When an individual completes their SA Return, they will be asked for a start date and an end date of their self-employment (if these are not completed the system will assume that the individual has been self-employed for the full tax year). They could also be asked on the return whether they want to apply for the small earnings exception if their profits are below the SEE limit. The SA system could calculate the amount of Class 2 NICs due based on the number of weeks the individual has been self-employed.
The Class 2 NICs liability will be added to the individual’s total SA liability and will be due by the SA final payment deadline. Once the SA Return is filed, payments against the final liability could be made at any time from the point of filing the SA Return to the 31st January following the end of the relevant tax year … When the individual makes their SA payment, the Class 2 element would
138 Simplifying the National Insurance Processes for the Self-Employed, July 2013 p12.
Details of the consultation were collated on Gov.uk 139 op.cit. p14 140 op.cit. p15
47 National Insurance contributions (NICs): an introduction
still be accounted for separately to enable HMRC to update the individual’s contribution record to show that Class 2 NICs has been paid for the relevant tax year.
If an individual reports profits below the SEE limit, they could opt-out of paying Class 2 NICs. This could be prompted through the SA calculation process … As occurs today the individual would need to be alerted to the potential impact on benefit entitlement if they opt out … Additionally because the Class 2 NICs liability will be calculated after the end of the tax year when the self-employed person files their SA Return, the timing means that the total amount of any Class 1 contributions made during that year will be known. This could offer the opportunity to explore how the annual maximum calculation could form part of the SA calculation allowing the Class 2 deferment process to be removed.141
The consultation also asked whether the SEE process should be scrapped, removing the liability to pay Class 2 NICs for those on profits below the SEE limit.142 As responses were generally positive, in the 2014 Budget the Government confirmed it would bring forward legislation to effect this reform.143 While the Bill to give effect to this reform was being scrutinised by the House, the Chancellor, in his Autumn Statement in December 2014, proposed that the NI relief for employers taking on young people would be extended: from April 2016, employers would not be liable to pay NICs, up to the UEL, on earnings for apprentices under 25.144 Subsequently the Government amended this legislation to make provision for the new relief.145
5.3 The OTS report on employment status In March 2015 the Office for Tax Simplification published its last report of the 2010-15 Parliament on ‘employment status’ – the ways employment and self-employment are categorised for tax, as well as for employment law.146 The report made the case that this was a real problem, one that, due to changing work patterns, “was getting worse”:
The tax system is still in many ways stuck in an out-of-date mindset: of categorising workers as either employees, firmly on the payroll, or self-employed, with the traditional jobbing plumber in mind. This made sense in the 1950s and 1960s but the huge growth in freelancing as a way of life (and work) doesn’t fit readily into this traditional model. That growth stems from the IT industry, but has spread far beyond it, facilitated by the internet
141 op.cit. pp18-19 142 Individuals operating property or investment businesses can find their earnings fall
under the statutory scope of Class 2 but not Class 4 NICs (for more detail see Annex B to the consultation document).
143 Budget 2014, HC 1104, March 2014 para 2.212. For more details see Library Research paper RP14/45, 21 August 2014.
144 Autumn Statement, Cm 8961, December 2014 para 2.53. This was projected to cost £105m to £120m from 2016/17 to 2019/20: Budget 2015, HC1093, March 2015 p66, Table 2.2 – item d.
145 For more details see Commons Briefing Paper CBP6975, 11 February 2015. 146 The difficulties in establishing employment status are long-standing, particularly in
the construction industry. The issue is examined in more detail in, Self-employment in the construction industry, Commons Briefing paper CBP196, 9 June 2017.
and (nowadays) ‘apps’. Some people may be forced into this form of working but more choose it and value the flexibility it brings. All of this leads some to suggest that the tax system needs to recognise a ‘third way’ of working.147
The authors noted that, in developing their ideas, they “kept coming back to three key points”:
1 The tax (mainly NICs) differential between employees and self-employed is significant; as long as it exists there will be pressures on the employment status boundary from those who wish to gain an advantage or manage the risk of getting it wrong.
2 Often of greater significance to business is the issue of employee rights.
3 Because the dividing line for employment status is blurred rather than clear, it brings a lack of certainty and invites attempts to ‘game’ the rules.148
The report made 28 recommendations on matters of administration, legal definition and tax incidence. Among these recommendations the authors suggested that the Government should consider two options to simplify the determination of employment status:
• Setting a ‘de minimis’ level of payment or period of time for any contract, where the person providing their services would definitely not be classified as their client’s employee.
• Establishing a statutory employment test.149
The report also argued that the Government should initiative a joint review involving the Revenue and HM Treasury, as well as DWP and BIS, to look “at the possibility of developing an agreed code of principles on employment status”:
Ideally there would be an agreed, coherent set of principles developed from case law to guide and govern decisions on employment status. In an ideal world that set of principles would apply to all relevant areas: tax, National Minimum Wage, benefits and employment law.
However desirable, that goal seems unlikely to be achieved, not least because of constantly changing circumstances and the tendency of cases to be taken that seek to distinguish previous decisions. It would, though, be the basis of a statutory test if it is decided to introduce one.
One advantage of an agreed set of principles would be that where decisions are taken to introduce statutory rules, there would be clear bases for the changes. Whether or not the set of principles can be developed, any statutory changes that are made need to assess the impact on the general principles that do exist as part of the process of consultation.150
In the report’s discussion of longer-term options to simplify employment status, one point is worth highlighting; as the authors put it, “if progress is to be made in ‘solving’ employment status as an issue, it is
147 Employment Status report, March 2015 pp1-2 148 op.cit. p6 149 For details see paras 6.15 and 9.53 respectively. 150 op.cit. p45
49 National Insurance contributions (NICs): an introduction
difficult to see how this can really be made without tackling NICs” – particularly in respect of the contributions paid by employers:
Longer term ideas to explore
The main onus [for proving an individual’s employment status] is currently on the business (hence the tendency to ‘solve’ the situation by hiring only through an intermediary) … We think there is a need to put more of the onus/responsibility on the individual … Something that would help many businesses would be a set ‘de minimis’ level in the employment status (ES) area. The principle would be that someone who is paid under a set amount or works for less than a defined period would never be regarded as an employee …
We think that a statutory employment test needs to be explored further … There are two approaches possible:
• a detailed, complex exposition that would aim to reflect all relevant case law
• a simple or pragmatic set of rules that would have rough edges
There was a lot of support for exploring the idea, though much of that support was predicated on the statutory employment test applying ‘across the board’ – so to employment rights in particular and areas such as benefits and auto-enrolment. This is a key point that needs to be explored: whether or not we end up with a statutory rule, there is an almost universal call for rules to apply to both tax and employment rights …
If progress is to be made in ‘solving’ employment status as an issue, it is difficult to see how this can really be made without tackling NICs: the differences between NICs and income tax and, of course, the differing NICs rates. The OTS has recommended the integration of income tax and NICs in the past in a number of our reports and we do so again in [this report] … There is a strong case for evening up NICs (and consequent benefits entitlement) between employment and self-employment (ignoring employers’ NICs at this stage).
But employers’ NICs is the real ‘elephant in the room’. It is not an easy thing to tackle, given the money it raises, but it is key to ‘solving’ the employment status issue. If it could be tackled, many of the problems go away – though differences around employment rights would remain. We have some ideas for making progress here but the starting point is more honesty and transparency about the levy: if more people realise how much it costs/raises, would there be more support for looking afresh at how to raise the money involved?151
In his March 2015 Budget the then Chancellor, George Osborne, announced two measures to simplify personal taxation, to be introduced in the next Parliament: the abolition of Class 2 NICs, and the introduction of digital tax accounts, replacing the annual tax return:
Businesses, like people, want their taxes to be low. They also want them to be simple to pay. We set up the Office of Tax Simplification at the start of this Parliament, and I want to thank Michael Jack and John Whiting for their fantastic work in this regard. To support 5 million people who are self-employed and to make their tax affairs simpler, we will, in the next Parliament,
151 op.cit. pp9-10
Number 4517, 17 July 2017 50
abolish entirely class 2 national insurance contributions for the self-employed.
Today, we can bring simpler taxes to many more people. Some 12 million people and small businesses are forced to complete a self-assessment tax return every year. It is complex, costly and time-consuming. So, today I am announcing that we will abolish the annual tax return all together. Millions of individuals will have the information the Revenue needs automatically uploaded into new digital tax accounts. A minority with the most complex tax affairs will be able to manage their account online. Businesses will feel like they are paying a simple, single business tax, and again, for most, the information needed will be automatically received.
This revolutionary simplification of tax collection will start next year, because we believe that people should be working for themselves, and not for the tax man. Tax really does not have to be taxing, and this measure spells the death of the annual tax return.152
The Budget report gave details of how the Government would proceed with replacing the annual return:
As a first step, the government will:
• publish a roadmap later this year setting out the policy and administrative changes needed to implement this reform
• introduce digital tax accounts for all 5 million small businesses and the first 10 million individuals by early 2016
• abolish Class 2 NICs in the next Parliament and consult on reforming Class 4 NICs to include a contributory benefit test.153
Treasury Minister David Gauke referred to both of these proposals in his initial response to the OTS’ report on employment status, and a report on partnership taxation published earlier in the year:
Before I address your recent reports, I want to highlight a major announcement in the Budget on our plans to modernise tax administration. This sets out our intention to transform how individuals and small businesses engage with the tax system over the next parliament, with every taxpayer able to manage their tax affairs through their digital account.
It will mean the end of the tax return for millions of individuals (including many pensioners, as you have championed). Small businesses will only have to provide information once, be able to link their accounting software to their digital account, and if they wish they will be able to pay as they go so that it will feel like paying one tax. It also means that those who use the cash basis introduced following your small business review will not have to do an end-of year tax return at all (around a million small businesses used the cash basis in its first year of operation in 2013-14).
Building on another of your recommendations, the Chancellor also announced that we will abolish Class 2 NICs in the next Parliament and consult on reforming Class 4 NICs to include a contributory benefit test. This will simplify NICs for five million self-employed people.
152 HC Deb 18 March 2015 c777 153 Budget 2015, HC 1093, March 2015 para 1.109. For more details on the first of
these see, Making Tax Digital, Commons Briefing paper CBP7949, 26 April 2017.
51 National Insurance contributions (NICs): an introduction
Mr Gauke went on to say the Government would consider the OTS’ recommendations regarding employment status in the next Parliament:
I welcome your report and think you have effectively highlighted the challenges of ensuring the tax system reflects the reality of the modern day labour market, and of providing certainty for individuals and employers. As you note, there are no 'quick wins' here, but I believe there is considerable merit in some of your more ambitious and longer term recommendations.
There are trade-offs between which of these to pursue and we will need to work through the broader implications of any change, including the impact on employment law. The government will therefore consider the recommendations carefully in shaping its programme of tax reform and administration for the next parliament.154
In November 2015 the Government announced that it would take forward the majority of the OTS’s recommendations.155 In a letter to the OTS Treasury Minister David Gauke confirmed that the Government would set up a cross-government working group for employment status, and that it would consider looking at a statutory employment test, although he rejected the idea of a ‘de minimis’ test, on the grounds that this would increase the risk of tax avoidance:
As your review found, the dividing line between employment and self-employment can differ depending on whether status is being decided for the purposes of employment law or tax. This is a complicated situation which can cause confusion for both workers and employers.
To help to address this, I have asked officials to establish a Cross Government Working Group for Employment Status. The intention is for this group to include representatives from HM Revenue and Customs (HMRC), HM Treasury, the Department for Work and Pensions (DWP) and the Department for Business, Innovation and Skills (BIS). The Working Group will consider the benefits of and barriers to an agreed set of employment status principles and a statutory employment status test.
Since the publication of your report, BIS have asked Julie Deane OBE to carry out a review of self-employment in the UK. DWP have also launched a review of business start-ups and entrepreneurship in disadvantaged communities, which will be led by Baroness Mone. I believe it would be premature to establish a separate review of employment status while these two reviews are taking place, though I expect that the Working Group will consider any relevant findings. I have written to DWP and BIS ministers and intend for the group's first meeting to take place in early 2016.156
Both of the reviews mentioned by the Minister were completed in early 2016 – the first by Julie Dean, the founder and CEO of the Cambridge Satchel Company,157 the second by Baroness Mone.158 Following this in 154 Letter from the Financial Secretary to the OTS on Budget 2015, 19 March 2015. See
also, OTS, Employment Status Report – follow up summary of responses, July 2015. 155 Spending Review & Autumn Statement, Cm 9162, November 2015 para 3.97. 156 Letter from the Financial Secretary to the Treasury to OTS on Autumn Statement
2015, 26 November 2015. An appendix listed 17 recommendations the Government accepted, and 6 that it would further consider.
157 Self-Employment Review: an independent report, BIS February 2016 158 DWP press notice, Baroness Mone publishes ‘Be the boss’ review, 1 March 2016
March 2016 the Government confirmed that the Departmental internal review of employment status had been concluded, and that, “Ministers are carefully considering whether further steps are required to improve clarity and transparency for employers and individuals alike.”159
Subsequently in October 2016 the Prime Minister Theresa May appointed Mr Matthew Taylor (Chief Executive of the Royal Society of the Arts) to lead a review “to consider how employment practices need to change in order to keep pace with modern business models.”160 Mr Taylor published his final report in July 2017, making a series of recommendations covering a variety of issues in relation to the ‘gig economy’.161 With regard to employment status, the review argued that there should be a clearer outline of the tests for employment status, with key principles set out in primary legislation, and more detail in both secondary legislation and guidance. Though the report focused on employment status for the purposes of employment law, it also recommended that it should be better aligned with the test for tax law.162 To date the Government has simply stated that it will publish a full response to the review by the end of the year.163
Turning back to the OTS’s report on employment status, the authors had floated the idea of increasing the transparency around employers’ NIC, on the grounds that this might provoke a better-informed debate on how best to reform the tax. This proved to be one of its recommendations that the Government rejected, arguing that “including employer’s NICs on payslips will decrease simplicity for individuals.” The report had also raised the much wider question of merging NICs with income tax, which, as noted above, the OTS had recommended in its 2011 report on small business taxation. In this case, the Minister’s letter simply stated that the Government would ‘consider’ this suggestion, with no further comment.
159 PQ29005, 4 March 2016 160 Details on the Review are on Gov.uk. 161 Department for Business, Energy & Industrial Strategy press notice, Government
employment practices reviewer outlines “7 principles for good quality work for all”, 11 July 2017
162 Good work: the Taylor Review of Modern Working Practices, July 2017 (see pp33-8) 163 As set out by BEIS Minister Margot James in a statement to the House on the
publication of the review: HC Deb 11 July 2017 cc157-8.
53 National Insurance contributions (NICs): an introduction
6. The Conservative Government’s approach
6.1 Summer Budget 2015: the Tax Lock In its 2015 General Election manifesto the Conservative Party stated that, in government, it would “not increase the rates of VAT, Income Tax or National Insurance in the next Parliament.”164 In a speech the Conservative leader David Cameron confirmed that this ‘tax lock’ also meant that there would not be any extension to the scope of VAT, or an increase in the ceiling to NICs.165 In its manifesto the Labour Party stated in government it would “not increase the basic or higher rates of Income Tax or National Insurance. Nor will we raise VAT”, though it would reverse the Coalition Government’s decision to cut the additional rate of income tax from 50p to 45p.166
In its analysis of the parties’ tax and spending proposals the IFS noted that these commitments did not discount increases in these taxes through other measures. In government each party “could, for example, change income tax or National Insurance thresholds, or implement further restrictions to income tax relief on pension contributions. These could affect many of the same people, via the same tax, as the hypothetical tax rises that they have ruled out.”167 Despite this, the Financial Times’ economics editor, Chris Giles, argued that such pledges were “positively dangerous”:
Britain’s income tax already bears the hallmarks of commitments not to increase the main rates. Labour and Tory-led governments since 2000 have complicated the levy, introducing higher rates over large slices of income, necessary to remove the financial benefits of child benefit and the personal allowance from richer people. Income taxation is further complicated by national insurance, an income tax in all but name, from which pensioners are exempt and which uses a different definition of income: all of which encourages the tax avoidance industry that politicians say they abhor. When individuals arrange their affairs quite legitimately to avoid taxation, it is no surprise productivity suffers as they waste time minimising tax bills rather than doing something more productive.168
Following the Conservative Party’s election victory, the new Government announced that the Chancellor would present his first Budget on 8 July 2015.169 At the time some commentators argued that, as this represented the first Budget of the Parliament, it presented a good opportunity for tax reform – as debates over ‘winners and losers’ from
164 Conservative Party, 2015 General Election Manifesto, April 2015 p27 165 “Cameron pledges to ban tax rises until 2020”, Financial Times, 29 April 2015. Mr
Cameron also publicised this commitment on Twitter. 166 Labour Party, 2015 General Election Manifesto, April 2015 p18, p27 167 Taxes and Benefits: The Parties’ Plans - IFS Briefing Note BN172, April 2015 p12, p29.
See also, “Triple tax lock puts other revenue sources in spotlight”, Financial Times, 28 May 2015.
168 “The battle for Britain’s most reckless tax pledge”, Financial Times, 8 April 2015; see also, “Cameron’s pledges unwise or costly or both, says Lawson”, Financial Times, 29 April 2015
any controversial changes were likely to have faded from view by the time of the next General Election. For his part Paul Johnson, director of the IFS, argued that the Government should set out a long-term plan, so that the Chancellor could set out “how he means to address the growing challenges created by increased dependence on a few very well off taxpayers, by international mobility of people and of profits, and by the growth of e-commerce.” Mr Johnson explicitly mentioned a number of possible initiatives, “including [setting] us on a course toward the real integration of income tax and NICs”:
The latter serves purely as an additional tax on earnings and exists only to attempt to fool the electorate into believing that they pay less tax than they do and into believing there is a meaningful link between what each individual pays in and what they get out. There is not.170
In the Financial Times, Chris Giles suggested the Chancellor should follow this advice, and, in particular, supported the case for a merger:
Almost 30 years after the last serious attempt to simplify tax on incomes, the complications and contradictions of the system are again crying out for reform. Bringing the rates and thresholds of income tax and national insurance into line could be the first step to a merger of the base and the rate structures, ensuring over time that, unlike today, everyone faces the same income tax bills if they have the same income, regardless of age or source of income. Whether such a radical move would help families on middle incomes, the poor or the rich is entirely a political choice.171
However, as recent history has illustrated, consensus among academics, journalists and tax practitioners is no guarantee of change. In his 2015 speech to the CIOT, quoted above, Jolyon Maugham suggested that the goals of transparency and simplification did not, by themselves, remove the major political obstacles to integration. Certainly, a merger would “demonstrate that we pay really quite high rates of income tax”, but what of the costs of that demonstration?:
People might be shocked to hear that employment income above £10,600 [the personal tax allowance in 2015/16] bears an effective tax rate of over 40%. One can see that shock as being enormously politically helpful to a party that believes in a smaller state. So there is an argument in favour of merging the two taxes. It would absolutely be a helpful stepping stone on that path. But, gosh, this Government has some rather uncomfortable shoes to don before it takes that first step.172
In his Budget speech on 8 July George Osborne confirmed that “in the coming weeks” the Government would legislate to “prohibit any increase in the main rates of income tax, national insurance and VAT for the next five years.”173 On 14 July the Government published Finance Bill 2015-16, including provision to set this ‘tax lock’ for income tax and
170 “Time for tax reform”, IFS Observations, 2 July 2015 171 “George Osborne’s brief chance to seal his reputation as a reformer”, Financial
Times, 1 July 2015 172 “My address to the Chartered Institute of Tax”, Waiting on Godot: musings on tax,
12 June 2015. 173 HC Deb 8 July 2015 c336. see Summer Budget 2015, HC 264, July 2015 para 2.53
& Tax lock: Income Tax, NICs and VAT: tax information & impact note, 8 July 2015.
55 National Insurance contributions (NICs): an introduction
VAT.174 At the same time the Government published a separate Bill to bar any increase in the current rates of Class 1 NICs, and any increase in the UEL above the higher rate threshold.175 The lock applied to a tax year which came after the date of the Bill’s Royal Assent, and before the first parliamentary general election after that date. In the case of the UEL, the lock was set by reference to the ‘proposed’ higher rate threshold set in the Government’s “pre-budget proposals”, that is, the Chancellor’s Autumn Statement before the tax year in question.176
The Government was obliged to make statutory provision for the tax lock this way because provisions regarding NI cannot be included in the annual Finance Bill. The Finance Bill’s remit – as set out in its long title – specifically excludes any tax that does not raise money for financing central government as a whole. Given this, the Bill cannot include provisions relating to NICs as receipts are collated in the NI Fund to meet the costs of contributory benefits exclusively. Similarly the Finance Bill cannot impose a charge to finance other bodies in the public sector (such as local authorities), or to authorise borrowing.177
As noted, in the March 2015 Budget the Government had proposed the abolition of Class 2 NICs, and introducing a new contributory benefit test tied to the payment of Class 4. The new Government confirmed it would take this measure forward,178 and a consultation to this effect was launched in December 2015.179
Finally, in the Summer Budget 2015 the Conservative Government also confirmed that it would establish the Office of Tax Simplification as “a permanent office of HM Treasury.”180 Treasury Minister David Gauke gave more details in a letter to the OTS, announcing that the OTS would be commissioned to carry out two new reviews in the coming year: the taxation of small companies, and, notably, the closer alignment of tax and NICs; a short extract is given below:
The closer alignment of income tax and NICs … is an area often cited as a major source of complexity for taxpayers. I would like the OTS to look at what the impacts, costs and benefits of closer alignment would be and to set out what the necessary steps would be to achieve closer alignment. This is a new type of review for the OTS, focusing on the issues and impacts rather than on making specific recommendations.181
174 The Bill, explanatory notes and details of its scrutiny are on its Parliament page.
These provisions now form ss1-2 of Finance (No.2) Act 2015. 175 The National Insurance Contributions (Rate Ceilings) Act 2015 made no other
provisions. Full details are on the Bill’s Parliament page. 176 Bill 54-EN, July 2015 para 15. See also, Commons Briefing Paper CBP7260, 2
November 2015. 177 For more details on these procedures see, The Budget and the annual Finance Bill,
Commons Briefing paper CBP813, 13 April 2017. 178 Summer Budget 2015, HC 264, July 2015 para 2.163 179 The abolition of Class 2 National Insurance: Introducing a benefit test into Class 4
National Insurance for the self-employed, December 2015 180 Summer Budget 2015, HC 264, July 2015 para 2.157. see also, HMRC, OTS:
permanent establishment – tax information & impact note, December 2015 181 HM Treasury, Summer Budget 2015: Office of Tax Simplification – correspondence,
6.2 The OTS report on aligning tax and NICs One of the key differences between income tax and NICs is that NICs is assessed on a weekly, not an annual basis, and earnings from separate jobs are taxed separately. One common suggestion has been that earnings from multiple jobs should be aggregated for NICs, to ensure individuals with more than one job, whose earnings from each job might fall below the lower earnings limit, can still be in a position to build entitlement to contributory benefits.
As discussed in earlier sections of this paper, over the last decade governments have considered the case for aligning income tax and NICs,182 but have taken the view that aggregating earnings would impose an unfair compliance burden on employers – as noted in two written answers, reproduced below – the first in October 2005 …
Mr. Laws: To ask the Chancellor of the Exchequer if he will take steps to aggregate earnings where people are more than one job and earning less than the lower earnings limit for national insurance contribution purposes; and if he will make a statement.
Dawn Primarolo: Each employment is treated separately for national insurance contributions purposes. The aggregation of the earnings of people doing more than one job who are earning below the lower earnings limit, would therefore be administratively extremely complex for employers.183
… and the second in June 2009:
Dr. Cable: To ask the Secretary of State for Work and Pensions if he will estimate the change in the number of people who would accrue contributory years of national insurance contributions as a result of charging employee national insurance contributions on aggregate income from all employments; and if he will make a statement.
Ms Rosie Winterton: Evidence from the Labour Force Survey 2006-08 shows that there are around 40,000 people who have two jobs each paying below the lower earnings limit but when aggregated their earnings are at least equal to the lower earnings limit. Around half of these people are estimated to already be accruing entitlement to contributory benefits through other interactions with the system and represent less than 0.1 per cent. of all people accruing entitlement to state pension in those years.
These are point-in-time data and people are unlikely to remain in this position for lengthy periods and may well have other opportunities to build up qualifying years during their working lives.
Reforms in the Pensions Act 2007, including the reduction in the number of qualifying years to 30 for a basic state pension, mean that from 2010 people reaching state pension age will have far greater opportunity to build up a full basic state pension entitlement. The aggregation of the earnings of people doing
182 by the Labour Government in 2007, and the Coalition Government in 2011; for
details see, HM Treasury, Income tax and national insurance alignment: an evidence-based assessment, October 2007 & Integrating the operation of income tax and national insurance contributions: next steps, November 2011).
57 National Insurance contributions (NICs): an introduction
more than one job would add an increased burden for employers to comply with.184
More recently the issue has come up again in relation to the growing importance of the ‘gig economy’ and concerns over the prevalence of zero hour contracts in the labour market.185
In March 2014 the Low Incomes Tax Reform Group raised concerns that individuals on low-paid zero-hour contracts (ZHCs) might, unwittingly, fail to build up their NI record, and argued that the Government should consider reforms to the NI system to prevent this – such as allowing for earnings from multiple jobs to be aggregated for NI purposes:
The general move towards flexible labour means that people could have irregular earnings patterns for many years. They could be unwittingly heading towards an uncertain retirement, as well as an uncertain working life. We therefore would urge the Government to seriously consider extending the system of credits, as exists for those on Job Seeker’s Allowance for example, to casual workers, as a person in work arguably deserves to have their contributions record protected to the same extent as an unemployed person.
Alternatively, the option to buy their way cheaply in to the system would be potentially useful, as exists in the form of Class 2 NIC for the self-employed. Another thought is that the ability to aggregate earnings in the event of more than one ‘mini’ job could help them meet the Low Earnings Limit more easily.186
In early 2015 Baroness Hollis – a Labour Member and former DWP Minister who has a long-standing interest in this issue – raised the position of those on ZHCs failing to build up an NI record, during the proceedings of the Small Business, Enterprise and Employment Act 2015 – as this legislation made provision to render unenforceable exclusivity terms in ZHCs.
At the Committee stage of the Bill, Baroness Hollis moved an amendment to reduce the earnings threshold at which workers on ZHCs become covered by the NI system, so that a person would be covered if their annual earnings exceeded £3,000.187 On this occasion Lady Hollis outlined some of the problems with the present system including:
• The inability of people with two or more part-time jobs to have their earnings amalgamated for NI purposes; and
• The fact that people can be credited into the NI system if they are unemployed or on ESA, if they have children under 12, or are carers; but not others “bravely patching together” an income from two or even three jobs.
She explained that she had discussed various solutions with Ministers - allowing people to amalgamate two or more “mini-jobs” for NI
184 HC Deb 1 June 2009 c100W. The 2010 State Pension reforms referred to in the
second of these PQs are discussed in more detail in State Pension reform, Commons Briefing paper CBP5787, 22 January 2013 (see section 2.3).
185 For more background on this see, Zero-hours contracts, Commons Briefing Paper CBP6553, 11 July 2017.
186 LITRG, Zero Hours Employment Contracts, March 2014 para 6.4 187 HL Deb 26 January 2015 cc44-52GC
purposes, treating all people with zero-hours contracts as though they were self-employed, letting older workers “revisit” their NI record to make good shortfalls due to periods when they had mini-jobs – but “the Coalition Government have, wrongly, refused all such possibilities.” She suggested either the LEL should simply be scrapped, or that it should be substantially reduced:
With this amendment, I am trying another path to again get people on ZHCs into the national insurance system. Revisit the lower earnings limit, the point at which you come into national insurance. It is currently £5,700 but you do not pay it until £7,500. You could abolish the LEL altogether. After all, if you are on JSA, ESA or UC you come into the national insurance system as of right, without paying a penny and, at that point, without working. It is therefore arguable that there is no point in the LEL anymore. However, if that is too radical, I make a more modest suggestion that anyone earning £3,000 a year in any one job—that is £60 a week, or around 10 hours per week at minimum wage—should be credited into NI …
We know that the best predictor of anyone in a full-time job is that they held a mini-job the year before, and that a zero-hours contract job of around 10 hours may be a stepping stone back into the labour market for older women. It may, over time, add to our tax and NI receipts. However, the real case for the amendment is a moral one. We are—some of us—happy to have a flexible labour market in which all the risk passes to the worker, who is then exposed to an exploitative labour market and a rigid and inflexible social security system.188
In response the Minister, Lord Newby said the Government were “actively considering this matter” but “it remains a work in progress and we believe that we do not yet know enough to make a sensible legislative change at this point. There are many complex issues regarding the scale of the problem and how to address it.” He went on to point out that individuals whose annual earnings for a given year fell below the LEL “are not without some protections already”:
At the highest level, individuals have to reach the lower earnings limit in only 30 years of a 49-year working life to qualify for a full state pension. Those who reach state pension age from 6 April 2016 will require an additional five years. That means that the individual can fall below this limit for a significant number of years—up to 14—and not be penalised in retirement …
[In addition] not only income that is above the lower earnings limit counts towards eligibility for a full state pension. Many national insurance credits also count towards that entitlement. For instance, NI contributions can be credited where a person is unable to work full-time due to ill health or because of caring responsibilities. These can be awarded to those receiving certain benefits, such as child benefit or working tax credits, to help build entitlement to a state pension. While we cannot be certain, it is highly likely that many individuals whom the noble Baroness is seeking to benefit are getting national insurance credits during those years in their working life where their earnings fall below the lower earnings limit.189
188 op.cit. c46GC 189 op.cit. c49GC, cc50-51GC
59 National Insurance contributions (NICs): an introduction
Lady Hollis returned to the issue at the Report stage put down a further amendment, to cut the LEL to the cash value of Job Seekers Allowance.190 On this occasion Lady Hollis argued that if receipt of JSA triggered someone’s entitlement to NI credits, then making an equivalent amount from a part-time job should have the same effect. In response the Minister Lord Newby reiterated that none of the solutions that had been proposed “is at all straightforward and there is a danger that they could all, to a greater or lesser extent, involve unnecessary administrative expenditure, perverse outcomes and possible new inequalities in the national insurance system.“ The Minister went on to explain that the Department were continuing to gather data to determine the severity of the problem.191
As noted, in July 2015 the Conservative Government asked the Office for Tax Simplification to look at possible options to align income tax and NICs – and the OTS completed a report in March 2016.192
The report set out a series of steps that could be taken to bring the two taxes closer together, though the authors argued that a lot more work should be done on the impact of reform “so that informed choices on how to proceed can in due course be made.”193 More specifically, the OTS proposed undertaking two more reviews: one on the impact of putting NICs on an annual, cumulative and aggregated basis, and another on the reform of employer NICs – a recommendation that the Government agreed to.194
The report’s executive summary set out the case for each of these reforms, and the obstacles they might pose:
Moving to an annual, cumulative and aggregated (ACA) assessment period for employees’ NICs on employment income, similar to PAYE IT, would achieve a simpler and more inclusive system. This would address the headline finding that the current structure of NICs is no longer fit for purpose for a modern flexible workforce, and creates distortions … It would necessitate a NICs code for individuals, similar to that of a tax code.
Positive impact: This would create a straightforward system that is clear, harmonious and, once bedded down, simpler to understand and to administer. Employees will need to have the implications clearly explained and phased in: some of those with more than one job below the NICs threshold would pay NICs but would get access to work related benefits for the first time. There would be some administrative benefits for employers and HMRC, once established.
190 HL Deb 11 March 2015 cc721-30 191 op.cit. cc726-7. In written answers on this topic, Ministers have cited DWP estimates
that at any one time around 10,000 men and 40,000 women have multiple jobs below the lower earnings limit (LEL) with combined earnings above it, but are not receiving any qualifying years towards the State Pension on those earnings (PQ16334, 24 November 2015; and, PQ HL1835, 27 September 2016).
192 Closer alignment of income tax and national insurance contributions, March 2016 193 OTS press notice, Aligning national insurance and income tax, 7 March 2016 194 Letter from the Financial Secretary to the Office of Tax Simplification following
Budget 2016, 24 March 2016; OTS, OTS review of income tax and national insurance alignment (phase 2) – terms of reference, May 2016
Concerns and challenges: the change would create ‘losers’ as well as ‘gainers’. HMRC estimates195 are that 6.3 million would pay more NICs but 7.1 million would pay less (and these tend to be lower earners196 … Any change will require timetables sufficient for the changes to be seamlessly absorbed; employers will be required to implement the new arrangements, HMRC will need to be able to administer the process smoothly and employees time to adjust to the change ...
Basing employers’ NICs on whole payroll costs would make it easier to understand and reduce distortions created by the current system, such as any incentive for fragmented hours. The consultation found that, in principle, this would be welcomed by employers, creating a system that is simpler to understand and a tax that is easier to calculate. In addition, the name should be changed to more closely reflect its role and purpose. This proposal could go ahead in isolation from ACA above but complements it.
Positive impact: a simpler system, easier to understand and administer; we assume that the overall receipts raised from employers’ NICs would remain the same although some would pay more and some less; the new tax could be set at a lower rate (perhaps 10%, or higher with an allowance) than the existing 13.8% rate in order to achieve this.
Concerns and challenges: this essentially replaces an existing tax and so is not necessarily an obvious simplification. The impact in certain sectors would need careful consideration, and it potentially does not address the incentives for engaging self-employed workers through a variety of structures. The consequential impact on the labour market around part time employment (recognising that some employees choose to work part time) needs to be understood.197
One striking finding in the report was amount that the public knew about what the contributory principle actually did, and didn’t do. Survey evidence gathered as part of its work found that a significant number of people believed NICs paid for the NHS, and that individuals had to have a full contributions record to qualify for NHS treatment.198
The report also commented on the wider issue of the growth in numbers of individuals working as self-employed persons or as company owner-managers, and the tax and legal drivers to this trend. Very briefly, from the perspective of the employer, engaging someone as a freelancer, possibly through an agency, or through their own limited company, allows them to have the benefits of a flexible workforce without the need to consider employment rights and employer’s NICs. From the perspective of the individual, considerable tax savings may be made by working as self-employed, charged Class 2 & Class 4 NICs, or
195 An explanation of these figures is given in Chapter 9. These are estimates for a
single year and figures and circumstances are naturally subject to change 196 Low earners whose NICs change may well have consequent benefits changes.
Someone paying more, is likely to receive more in universal credit and other means-tested benefits as their entitlement will rise in proportion to the decrease in their net income (though the same is not true of tax credits).
197 Closer alignment of income tax and NICs, March 2016 pp8-9 198 “Appendix C: Online Survey Results”, op.cit., pp133-6
61 National Insurance contributions (NICs): an introduction
as an owner-manager, charged corporation tax on one’s profits, and income tax on salary taken as dividends.199
In November 2016 the OTS published a second detailed report, making the case for an ‘ACA’ assessment period for employee NICs, and setting out some options for an employers’ payroll levy.200 Three extracts from the report’s executive summary are reproduced below: first, the authors gave a precis of the distortions created by the current system …
Currently, an individual’s sources of employment income are treated separately for NICs, so that someone with two part-time jobs can pay less NICs than someone earning the same from one full time job. PAYE income tax combines sources of income, so this difference doesn’t arise …
These different outcomes are also reflected in the benefits people are entitled to, so some do not build up pension rights. The OTS’s proposal is that all employment income in the year would be combined when calculating the employee's annual NICs liability and their potential entitlement to some benefits. This annual, cumulative and aggregated (‘ACA’) approach would be simpler for employers to operate. It would work in the same way as income tax, be easier to understand and fairer for taxpayers.
… second, the report provided some analysis of the potential winners and losers in a move to ACA NICs …
The chart below indicates the gainers and losers on a move to ‘ACA’ NICs, showing the number of people affected at different total income levels and the average annual gain or losses involved:
199 “Chapter 12 - Discussion: employed and self-employed”, op.cit., pp 103-18; see in
particular, para 12.7-10 & Table 12.A. For a detailed discussion of this issue see, Institute for Fiscal Studies, Tax, legal form and the gig economy, 2 February 2017.
200 Office for Tax Simplification press notice, OTS calls for simpler and fairer national insurance, 14 November 2016; Closer alignment of income tax and national insurance: a further review, Cm 9354 November 2016
• About 40% of those employees paying NICs could see some change (people with more than one job, with fluctuating income or working for only part of a year).
• Generally, those affected and who would pay less NICs would be part-time employees, women, those under 35 years old and those in lower paid service industries. About 7.6 million people could pay an average of £169 less national insurance. These tend to be lower income households
• Generally, those affected and who would pay more NICs would be multi jobbers earning above £20,000. About 5.5 million people could pay an average of £242 more national insurance. The interplay with social security could mitigate the effect for some taxpayers in lower income households. Some may have increased entitlement to contributory benefits.
• For some, these amounts would be a ’one off’. For others, the difference would repeat each year. Broadly, the Exchequer would not benefit: the changes would balance each other out.
• There will be transitional costs for employers, but it should be cheaper in the long run.
• Employees will be able to review their NICs and state pension entitlement through their on-line Personal Tax Account, to help them understand the changes. There will be an inevitable focus on who will pay more and who will pay less (the ‘gainers and losers’), simply by comparing pre- and post-change NICs bills. However, another way of looking at it is that ‘ACA’ NICs would ensure that individuals earning the same amount overall will pay the same NICs, regardless of how their income is earned through the year, which is not the case now.
… and third the report looked at the possible options for moving to a payroll levy:
At present, employers’ NICs are calculated at 13.8% of employees’ weekly or monthly pay, generally over a threshold of £156 per week / £676 per month.
The OTS is clear that, instead, a simple percentage charge applied to total payroll costs (following the approach of the Apprenticeship Levy) but including the cash value of workplace benefits, would be less complicated. It need not affect the National Insurance Fund’s operation. However, the simplest approach to this (a 10% levy on total payroll without any thresholds or allowances) would have a major impact on those employing low paid or part-time workers, due to the loss of the £156 weekly / £676 monthly threshold, and could affect particular industries and regions disproportionately.
The OTS therefore explored 7 other options to reform employers’ NICs, keeping the overall outcome revenue neutral to the Exchequer. We consider the best of these would be to replace the employee threshold with a cumulative annual employee allowance per employer. There is no clear cut solution because each option has significant impacts. However, the OTS still recommends
63 National Insurance contributions (NICs): an introduction
reforming the current process, especially if employees’ NICs are changed as we propose.201
Some days after the OTS published its report, the Chancellor Philip Hammond presented his Autumn Statement to the House. The Chancellor did not mention the report in his speech, although he announced that the NICs primary and secondary thresholds would both be set at £157 per week from April 2017.202 In its earlier report published in March the OTS had noted the variety of NI thresholds, and suggested that, at the least, the Class 1 primary and secondary thresholds should be aligned:
Taxpayers and employers are faced with a mass of rates and thresholds … The two examples cited to us most often vary widely in impact - while the value to the exchequer of the difference in 2015-16 between the IT personal allowance (£10,600 pa) and the NICs primary threshold (£8,060 pa) is around £6.5 billion, the value to the exchequer of the difference between the NICs primary threshold and the NICs secondary threshold (£8,112 pa) is around £130 million. It is not long since both these pairs of thresholds were aligned.
New thresholds continue to be introduced, rather than use existing thresholds. For example an Apprentice Upper Secondary Threshold (AUST) will apply from 6 April 2016. While initially this will be at the same level as the long established Upper Earnings Limit (UEL) it has ‘been deliberately framed to keep the definitions separate so that the AUST, and UEL and the age-related secondary rate may be changed independently in future.’203
While recognising that setting each threshold is a policy issue, we recommend that:
• new thresholds are not introduced in circumstances where existing ones can serve the same purpose
• existing thresholds are reviewed to establish which may be aligned (and then remain linked) in a given timeframe. Aligning the NICs primary and secondary thresholds is a good place to start.204
To align these thresholds from April 2017, the secondary threshold would rise by £2 a week, double the rate rise of the primary threshold - a change estimated to raise £170m in 2017/18.205 Mr Hammond set out his response to the OTS’ report in a letter published alongside the Autumn Statement,206 and in this the Chancellor ruled out the introduction of an ACA NICs:
I am writing to thank you for your two reports on the alignment of income tax and National Insurance contributions. The reports provide a thorough analysis of these important issues, and I am grateful to you and your team for your work …
201 OTS, Closer alignment of income tax and national insurance: report summary, 14
November 2016 202 HC Deb 23 November 2016 c907 203 Tolley’s National Insurance Contributions 2015-2016. Emphasis added. 204 Closer alignment of income tax and NICs, March 2016 para 6.17-9 205 Autumn Statement, Cm 9362, November 2016 para 4.7, Table 2.1 – item 19 206 Correspondence between the Chancellor, Financial Secretary to the Treasury and the
Office of Tax Simplification regarding recent OTS publications, 23 November 2016
I am particularly grateful for your work on aligning the calculation of income tax and NICs by moving the calculation of NICs to an annual, cumulative and aggregated basis. I am aware that this is an area of significant interest and your reports have made a valuable contribution to the debate on this important issue …
As the report sets out, there are potential gains from moving NICs onto an annual basis – including making the interaction between income tax and NICs easier to understand. However, the reform would also be a major upheaval, with consequences for the labour market and a large number of individuals and businesses. On the basis of the scale of change required, I do not consider now to be the right time to make this major reform but I am grateful to you for bringing these issues to light.
In his letter Mr Hammond was non-committal as to the case for reforming employer NICs, although he went on to say that the Government would be looking at the wider issue of the tax losses sustained by the growth in the numbers of self-employed persons and those providing their services through their own company, an issue that had also been flagged up by the Office for Budget Responsibility:
Lastly, you set out some options for reform of employer National Insurance. I have asked officials to consider the details of the options that you have set out and to keep this under review …
There are also wider issues with the different tax treatment of different forms of labour, highlighted by the growth in self-employment and the number of single person incorporations. This not only causes complexity but also - as the OBR has highlighted (in relation to the growth in incorporations207) – is resulting in increased fiscal costs to the Exchequer. The Government will therefore also look at how it can ensure that the taxation of different ways of working and different forms of employee remuneration is fair, sustainable and efficient.208
6.3 Budget 2017: NICs and the self-employed As noted, in December 2015 the Government had proposed abolishing Class 2 NICs from April 2018, and in the 2016 Autumn Statement the Government confirmed it would proceed with this reform.209 Further details were published in December 2016.210
From April 2018 the self-employed would gain access to contributory benefits based on a profits test in Class 4 NICs. A new zero-rate band would be introduced into Class 4 NICs on profits between the Small Profits Limit (replacing the Class 2 Small Profits Threshold) and the Lower Profits Limit:
In April 2018, Class 4 will be reformed to confer entitlement to the new State Pension and other contributory benefits.
207 see, OBR, Economic & Fiscal Outlook, Cm 9346, November 2016 pp121-3, Box 4.1;
and, more recently, Fiscal Risks Report, July 2017 paras 5.54-80 208 Letter from the Chancellor to the OTS, 23 November 2016. Mr Hammond also
flagged this in his Autumn Statement (HC Deb 23 November 2016 c907). 209 Autumn Statement, Cm 9362, November 2016 para 4.8 210 HM Revenue & Customs, Abolition of Class 2 National Insurance contributions: tax
65 National Insurance contributions (NICs): an introduction
• The contribution conditions attached to the new State Pension and other contributory benefits will be changed to enable Class 4 NICs to count towards benefit entitlement.
• A new zero-rate band of Class 4 NICs will apply on annual profits between a threshold to be known as the Small Profits Limit (SPL) and the Lower Profits Limit (LPL, the point beyond which Class 4 NICs become payable).
• This means that self-employed individuals with annual profits at or over the SPL will be able to gain qualifying years (QYs) for benefit entitlement.
• The SPL will be aligned with the annual equivalent of the Lower Earnings Limit (LEL) in Class 1 employee NICs.
The existing and proposed systems are shown in Figures 2.A and 2.B.
This reform means that self-employed individuals will gain access to benefits if their profits are over the SPL, even though Class 4 NICs are only paid on profits over the LPL. This is consistent with the rules in place for employees, who are treated as having paid Class 1 NICs with earnings between the LEL and the Primary Threshold in an earnings period. By aligning the way in which employees and the self-employed gain access to benefits based on their earnings or profits, this reform also makes the NICs system simpler and more equitable for all.211
211 Abolishing Class 2 and reforming Class 4 National Insurance contributions: response
Individuals whose profits fall below the Small Profits Limit would be able to protect their entitlement to the State Pension by taking up the option of paying Class 3 NICs. As noted above, employees whose earnings are too low to be liable for NICs may protect their benefit entitlement by paying Class 3 NICs, though at present the rate of Class 3 is considerably higher than the rate of Class 2.
Many respondents to the Government’s consultation paper raised concerns that people who were paying Class 2 NICs voluntarily would have to pay considerably more in tax if they wish to protect their entitlement to the State Pension. In its response the Government argued that relatively few individuals in this position would have to pay Class 3 NICs …
The government wants to ensure that self-employed individuals who have profits below the SPL can continue to gain access to the new State Pension. There is already protection in the NICs system for these individuals to do this:
• government analysis suggests that in 2018-19, around 77%212 of all self-employed individuals expected to have profits below the SPL will see their State Pension record protected by NI contributions from employment alongside self-employment, by NI credits or will already have a full State Pension record213
• the remainder will be still be able to pay Class 3 voluntary NICs to gain access to the new State Pension for those years in which their profits were below the SPL. Class 3 NICs can usually be paid for up to six years after the year in which an individual did not achieve a qualifying year. Individuals are able to check their National Insurance record on their Personal Tax Account (via GOV.UK) before deciding whether to pay Class 3 voluntary NICs214
• an individual needs 35 years of NICs and/or NI credits to qualify for the full rate of the new State Pension. NICs are currently payable by those aged between 16 and State Pension age, which means that an individual could have up to 15 years of gaps in their National Insurance record without their State Pension award being affected
• the median duration of self-employment is between six and ten years (Department for Work and Pensions analysis). This means that those with profits below the SPL are unlikely to rely solely on their profits for their entire working lives
Analysis suggests that those expected to pay Class 3 NICs in any one year following the abolition of Class 2 would represent only 5% of those with profits below the SPL in 2018-19, and around 2% of all self-employed individuals who may have self-employment profits.215
212 This is based on HMRC forecasts. This figure also includes those who have already
achieved the maximum number of qualifying years towards the State Pension. 213 NI credits are available to individuals in certain circumstances and help to protect
their future entitlement to contributory benefits. More information is available here: https://www.gov.uk/national-insurance-credits/overview.
214 More information is available on how to check your National Insurance record is available here: https://www.gov.uk/check-national-insurance-record
215 This is based on HMRC forecasts showing that there will be over 5 million self-employed individuals who may be liable to NICs in 2018-19.
67 National Insurance contributions (NICs): an introduction
… and that the introduction of the new State Pension will mean that the self-employed will be able to gain a greater amount of pension than they had in the past:
Box 2.A: The self-employed and the new State Pension
The new State Pension allows self-employed individuals to gain a greater amount of State Pension than they were able to in the past. Under the old system, Class 2 NICs counted towards the basic State Pension (a maximum of £119.30 a week in 2016-17, for 30 years of contributions). However, Class 2 NICs did not count for the earnings-related additional State Pension. This meant that in general, each qualifying year based on Class 2 NICs in the ‘old’ system would only have been worth £3.98 of State Pension per week every year.
Under the new State Pension, all contribution years after 6 April 2016 will add a year of new State Pension in the same way for all classes of NICs and credits. That is 1/35 of the full amount for each post-2016 year. The full new State Pension is £155.65 a week in 2016-17, for 35 years of contributions.
Therefore, a qualifying year gained under the new system, including those by self-employed individuals, is worth £4.45 of State Pension per week. As a result, it will be possible for self-employed individuals to gain a much higher State Pension (with 35 years of any NI contributions) under the new State Pension system, than they could in the previous system (with 30 years of Class 2 NICs).216
On 8 March 2017 the Chancellor presented his Spring Budget, and as part of this, announced two reforms to personal taxation: the main rate of Class 4 NICs, paid by the self-employed, would increase from 9% to 10% from April 2018, and from 10% to 11% from April 2019; and, the dividend allowance – the annual amount of dividend income that individuals may receive tax free – would be reduced from £5,000 to £2,000 from April 2018.217
In his Budget speech Mr Hammond set out the case for increasing the rate of Class 4 NICs, noting the “dramatic increase in the number of people working as self-employed or through their own companies” while arguing that “people should have choices about how they work, but those choices should not be driven primarily by differences in tax treatment.” Mr Hammond acknowledged that, historically, the lower rate of NICs paid by the self-employed reflected their limited access to social security benefits, but suggested the size of this disparity was no longer justified:
An employee earning £32,000 will incur, between him and his employer, £6,170 of national insurance contributions. A self-employed person earning the equivalent amount will pay just £2,300—significantly less than half as much. Historically, the differences in NICs between those in employment and the self-employed reflected differences in state pension entitlement and contributory welfare benefits, but with the introduction of the
216 Abolishing Class 2 and reforming Class 4 National Insurance contributions: response
to the consultation, December 2016 pp 9-10 217 For more details on the Budget as a whole see, Spring Budget 2017: a summary,
new state pension last year, these differences have been very substantially reduced …
The most significant remaining area of difference is in relation to parental benefits, and I can announce today that we will consult in the summer on options to address the disparities in this area…
Such dramatically different treatment of two people earning essentially the same undermines the fairness of the tax system. Employed and self-employed alike use our public services in the same way, but they are not paying for them in the same way. The lower national insurance paid by the self-employed is forecast to cost our public finances over £5 billion this year alone. This is not fair to the 85% of workers who are employees.218
Mr Hammond noted that the size of this disparity would increase with the abolition of Class 2 NICs, and announced that in the light of this, the rate of Class 4 NICs would be increased to 11% by April 2019:
The abolition of class 2 NICs for self-employed people … due to take effect in 2018 would further increase the gap between employment and self-employment. To be able to support our public services in this Budget, and to improve the fairness of the tax system, I will act to reduce the gap to better reflect the current differences in state benefits.
I have considered the possibility of simply reversing the decision to abolish class 2 contributions, but the class 2 NIC is regressive and outdated—it is absolutely right that it should go—so, instead, from April 2018, when the class 2 NIC is abolished, the main rate of class 4 NICs for the self-employed will increase by 1% to 10%, with a further 1% increase in April 2019.
The combination of the abolition of class 2 and the class 4 increases I have announced today raises a net £145 million a year for our public services by 2021-22. That is an average of around 60p a week per self-employed person in this country. Since class 2 contributions are payable at a flat rate while class 4 is chargeable as a proportion of profits, all self-employed people earning less than £16,250 will still see a reduction in their total NICs bill.219
The rise in the rate of Class 4 NICs was forecast to raise £325m in 2018/19, rising to £645m in 2019/20,220 while the abolition of Class 2 NICs was forecast to cost £405m in 2018/19, rising to £430m in 2019/20.221 The Budget report observed that, taken together, individuals would only pay more in NICs if their annual profits exceed £16,250 in 2019/20.222
Alongside the Budget report the Treasury published a number of examples of how these reforms would affect individuals on different profit levels, taking into account the projected increases in both the
218 HC Deb 8 March 2017 cc813-4 219 HC Deb 8 March 2017 c814 220 Spring Budget 2017, HC 1025, March 2017 p 26 (Table 2.1 – item 15). Receipts
were forecast to fall in later years: £595m in 2020/21, and £495m in 2021/22. 221 Spring Budget 2017, HC 1025, March 2017 p 29 (Table 2.2 – item am). The cost of
this measure is forecast to fall in later years: £380m in 2020/21, and £350m in 2021/22.
222 Spring Budget 2017, HC 1025, March 2017 para 3.5. see also, HM Treasury, NI and the self-employed factsheet, March 2017 para 1.23-4
69 National Insurance contributions (NICs): an introduction
personal allowance and the higher rate threshold; an extract is reproduced below:223
Note : Rates and thresholds are based on OBR projections for 2018-19 onwards. The government
has committed to increase the income tax personal allowance to £12,500 and higher rate threshold
to £50,000 by the end of the Parliament. All case studies apply to England, Scotland and Northern
Ireland only, as the main rates and thresholds are devolved to Scotland.
However, on 15 March the Chancellor announced that the Government would not proceed with the proposed increase in Class 4 NICs, first in a letter to the Chair of the Treasury Select Committee,224 and later that day in a statement to the House – part of which is reproduced below:
The measures I announced in the Budget sought to reflect more fairly the differences in entitlement in the contributions made by the self-employed. The Government continue to believe that addressing this unfairness is the right approach. However, since the Budget, parliamentary colleagues and others have questioned whether the proposed increase in class 4 contributions is compatible with the tax lock commitments made in our 2015 manifesto.
Ahead of last year’s autumn statement, the Prime Minister and I decided that however difficult the fiscal challenges we face, the tax lock and spending ring fence commitments we have made for this Parliament should be honoured in full ... As far as national insurance contributions are concerned, the locks were legislated for in the National Insurance Contributions (Rate Ceilings) Act 2015. When the Bill was introduced, it was made clear by Ministers that the lock would apply only to class 1 contributions … However, it is clear from discussions with colleagues over the last few days that this legislative test of the manifesto
223 HM Treasury, NI and the self-employed factsheet, March 2017 p6 224 HM Treasury, Letter from the Chancellor to the Chair of the Treasury Select
commitment does not meet a wider understanding of the spirit of that commitment.
It is very important both to me and to my right hon. Friend the Prime Minister that we comply with not just the letter but the spirit of the commitments that were made. Therefore … I have decided not to proceed with the class 4 NICs measures set out in the Budget. There will be no increases in NIC rates in this Parliament. For the avoidance of doubt, and as I set out in the Budget, we will go ahead with the abolition of class 2 national insurance contributions from April 2018. Class 2 is an outdated and regressive tax, and it remains right that it should go. I will set out in the autumn Budget further measures to fund, in full, today’s decision.
I undertook in the Budget speech to consult over the summer on options to address the principal outstanding area of difference in benefit entitlement between the employed and the self-employed: parental benefits. We will go ahead with that review, but we now intend to widen the exercise to look at the other areas of difference in treatment, alongside the Government’s consideration of the forthcoming report by Matthew Taylor … on the implications for employment rights of different ways of working in a rapidly changing economy. Once we have completed these pieces of work, the Government will set out how we intend to take forward and fund reforms in this area.225
On this occasion Andrew Tyrie, Chair of the Treasury Committee, welcomed the decision but went on to ask if the Chancellor agreed that “a differential should, none the less, remain in the long run to reflect the additional risk taken by the self-employed when they are doing their job?” In response Mr Hammond said,
In the Budget speech last week, I made very clear that we were seeking to close the gap a little. We were not seeking to equalise the contributions treatment of the employed and self-employed, as there are very good reasons why there may well need to be a gap. That is why we will look at this in the round—contributions, entitlements and the way the whole package works for the self-employed. Let us come back to this once we have completed the review, have the Matthew Taylor work and can look at the problem in the round.226
While Members who spoke on this occasion generally supported the Chancellor’s decision,227 reactions in the press were more varied,228 while an editorial in the Financial Times argued “the UK government’s climb-down on national insurance puts politics over good policy”:
Mr Hammond’s mistake was not raising contributions, but rather failing to include the change in a wider package of reforms for self-employment … Mrs May has announced there will be no further changes to NICs until after the next general election, due in 2020. A serious problem has in effect been put on indefinite
225 HC Deb 15 March 2017 cc420-1 226 HC Deb 15 March 2017 c423 227 HC Deb 15 March 2017 c423 228 “Tory U-turn as Philip Hammond scraps tax rise on self-employed“ & “Self-employed
relieved but wary after Hammond’s Budget U-turn”, Financial Times, 15 March 2017
71 National Insurance contributions (NICs): an introduction
hold. The danger now is that the Taylor Review into self-employment due this summer will suffer the same fate.229
Among stakeholder groups and commentators, the FSB strongly endorsed the Chancellor’s decision,230 while the Chartered Institute of Taxation suggested “the Government’s U-turn over the National Insurance increase for the self-employed shows what can happen when Chancellors pull ‘rabbits’ out of the hat on Budget day without consulting or preparing the ground in advance.”231 Torsten Bell, director of the Resolution Foundation, argued that “the Chancellor’s U-turn on his Budget plan to raise National Insurance for the self-employed is a very unusual one, combining as it does a very firm defence of the need for the policy with the decision to scrap it”:
That we have ended up in that place reflects the undeniable fact that the politics of the increase in self-employed National Insurance contributions (NICs) has been a disaster, while the policy rational remains absolutely undeniable. To put it another way, whatever the rights and wrongs of breaking the spirit of Manifesto commitments – be it tax rises, migration targets or membership of the single market – the substance of the Chancellor’s U-turn on (NICs) means the government has missed an opportunity to correct a big structural flaw in our tax system.232
In a letter to the Times IFS director Paul Johnson expressed the view that “some long-term planning and strategy would not go amiss”:
We should learn some lessons. First, it is a mistake to commit in a manifesto to not raising the three most important taxes — that ties the chancellor’s hands to an absurd degree. Second, some long-term planning and strategy would not go amiss. The self-employed have been handed two big bonuses in recent years: access to a much enhanced state pension and the abolition of class 2 national insurance contributions. Announcing an increase in the class 4 rate at the same time, rather than as an apparent afterthought, might have made more sense.
And finally, we need a more sensible debate about tax and spend. If we really can’t raise taxes, then even more (and even deeper) public spending cuts are the only alternative.233
Subsequently in the Queen’s Speech on 21 June the Government confirmed it would introduce legislation to provide for the abolition of Class 2 NICs, although it stated at this time “this legislation does not relate to the discussion of Class 4 contributions at the time of the Spring Budget 2017.”234
In his Budget speech the Chancellor had referred to the ongoing review of working practices led by Matthew Taylor. Mr Taylor published his report in July 2017, making a series of recommendations covering a
229 “Editorial: Philip Hammond has made the wrong U-turn for the wrong reasons”,
Financial Times, 16 March 2017 230 FSB press notice, NIC’s U-turn is a great victory for FSB’s self-employed members, 15
March 2017 231 CIOT press notice, National Insurance U-turn shows why Budget ‘rabbits’ are a bad
idea, 15 March 2017 232 “U-turn if you don’t want to”, Resolution Foundation blog, 15 March 2017 233 “Letters: Hammond’s U-turn over national insurance”, Times, 16 March 2017 234 Cabinet Office, Queens Speech 2017 : background briefing notes, June 2017 p34
variety of issues in relation to the ‘gig economy’.235 Though the review’s remit did not extend to making proposals for tax changes, it discussed the distortions created by the different ways that employment and self-employed were taxed, such as the bogus claiming of self-employed status by both individuals and businesses, and argued that “the principles underlying the proposed NI reforms in the 2017 Spring Budget are correct”:
The level of NI contribution paid by employees and self- employed people should be moved closer to parity while the Government should also address those remaining areas of entitlement – parental leave in particular – where self-employed people lose out.236
The Government has stated that it will publish a full response to the review by the end of the year, although when BEIS Minister Margot James made a statement to the House on the publication of the review, she explicitly ruled out revisiting the question of reforming Class 4 NICs:
Rachel Reeves (Leeds West) (Lab) : Matthew Taylor said today that he wants employers to pay national insurance for people with whom they have a controlling and supervisory relationship. Do the Government plan to implement that aspect of the Taylor review, and can the Minister reassure workers that the Government do not plan to U-turn on their U-turn and increase national insurance for the genuinely self-employed?
Margot James : I can assure the hon. Lady that … Parliament has spoken on the issue of national insurance class 4 contributions. That matter is now settled, and will not be revisited. I agree with her that we should pay close attention to ensure that people who are genuinely contracted to provide an ongoing service are given the protections that workers enjoy, and are not falsely labelled as self-employed. 237
235 Department for Business, Energy & Industrial Strategy press notice, Government
employment practices reviewer outlines “7 principles for good quality work for all”, 11 July 2017
236 Good work: the Taylor Review of Modern Working Practices, July 2017 p72 237 HC Deb 11 July 2017 cc162-3. See also, PQ901, 28 June 2017
73 National Insurance contributions (NICs): an introduction
Appendix: main features of NICs Rate in Rate from 2016/17 April 2017 Class 1 Lower earnings limit (LEL) £112 a week £113 a week Upper earnings limit (UEL) £827 a week £866 a week Primary threshold £155 a week £157 a week Secondary threshold £156 a week £157 a week Upper secondary threshold for under age 21 group £827 a week £866 a week Upper secondary threshold for relevant apprentices £827 a week £866 a week Upper secondary threshold £827 a week £866 a week Contribution rates (NI Fund and NHS combined) Primary (employee) On earnings between the primary threshold and UEL 12.0% 12.0% On earrings above the UEL 2.0% 2.0% Reduced rate for married women and widow optants, on earnings between the primary threshold and UEL 5.85% 5.85% NHS allocation included in above - percentage of earnings between the primary threshold and UEL) 2.05% 2.05% - percentage of earnings above the UEL 1.0% 1.0% Secondary (employer) On all earnings above the secondary threshold 13.8% 13.8% NHS allocation included in above (percentage of all earnings for employees earning above the secondary threshold) 1 1.9% 1.9% Class 1A and Class 1B Contribution rate (employer only) 13.8% 13.8% NHS allocation included in above 1.9% 1.9% Class 2 Flat rate contribution £2.80 a week £2.85 a week Small profits threshold £5,965 a year £6,025 a year NHS allocation included in above (percentage of contribution) 15.5% 15.5% Class 3 Flat rate contribution £14.10 a week £14.25 a week NHS allocation included in above (percentage of contribution) 15.5% 15.5%
Class 3A2 Contribution Varies N/A NHS allocation included in above (percentage of contribution) 15.5% 15.5%
Number 4517, 17 July 2017 74
Rate in Rate from 2016/17 April 2017
Class 4 Lower profits limit (LPL) £8,060 a year £8,164 a year Upper profits limit (UPL) £43,000 a year £45,000 a year Contribution rate
On profits between the LPL and UPL 9.0% 9.0% On profits above the UPL 2.0% 2.0%
NHS allocation included in above
On profits between the LPL and UPL 2.15% 2.15% On profits above the UPL 1.0% 1.0%
Notes : (1) The amount of the secondary Class 1 NICs apportioned to the NHS is calculated as the relevant percentage (currently 1.9%) of the total earnings of those employees who earn above the primary threshold. This is in line with the interpretation of subsections (5) and (5A) of section 162 of the Social Security Administration Act 1992 provided to GAD by HMRC. (2) Class 3A voluntary contributions are distinct from the Class 3 voluntary contributions. They were introduced from 2015-16, under the Social Security Class 3A Contributions (Units of Additional Pension) Regulations 2014. Class 3A contributions differ by age, sex and amount of State Pension top up to be purchased (up to a maximum). Class 3A voluntary contributions will not be available after 5 April 2017. For more details see, State pension top up, Commons Briefing paper CBP7067, 6 January 2015. Adapted from, Government Actuary’s Department, Report on draft of the social security benefits up-rating Order 2017, January 2017 (Appendix B: pp22-3)
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