National Insurance: Simplification of system carries risks

George Osborne portrayed himself as a reformer by announcing that he wants to merge the operation of the tax and national insurance systems.

As part of a drive to simplify the tax system and cut costs for businesses, the Chancellor raised the prospect of the most radical reform to national insurance since his Liberal predecessor introduced it 100 years ago.

He admitted that his move, revealed by The Independent last week, would take several years to complete and would need extensive consultation.

Critics of the tax system have long pointed out the anomalies caused by separate tax and national insurance payments. Recent changes have introduced a bizarre marginal rate structure, as shown in the graphic above. National insurance is simply another form of income tax, as is, in a way, the withdrawal of child tax credits and child benefit as earnings rise. Also factored into the graphic is the way tax thresholds and personal allowances kick in.

Once all these factors are considered, we see that those earning, say, £10,000 a year lose about 70p in the pound in NI and tax on every extra pound they earn; yet someone on £150,000 pays only 52p on each extra pound.

While most of us know whether the top slice of our annual earnings is taxed at the rate of 20 per cent, 40 per cent or 50 per cent, few know that we pay a further 12 per cent or 2 per cent in NI, or nothing, on our weekly income.

Mr Osborne promised he would not extend national insurance to pensioners or other forms of income, such as savings or dividends. He insisted that the Government would not abolish the contributory principle behind national insurance.

Treasury officials played down the chances of tax and national insurance being merged into a single payment with one set of rates and allowances. This would carry huge political risks as it would effectively raise the basic rate of tax from 20p to 32p in the pound. But allies say Mr Osborne hopes to encourage voters to support parties offering low taxes by highlighting how much of their income is swallowed up by the state.

"Our purposes is not to increase taxes, it is to simplify them," the Chancellor said. "For decades, we have operated income tax and national insurance as two fundamentally different taxes and forced businesses large and small to operate completely different systems of administration, with two different periods and bases of charge."

Taxes are assessed annually and national insurance weekly. Treasury advisers estimate that aligning the earnings periods would cut employers' administrative costs by between £40m and £56m a year. It could also bring big savings for HM Revenue & Customs.

Ed Balls, the shadow Chancellor, said Labour had repeatedly looked at the idea but had decided it was "not worth the candle". The Confederation of British Industry called the move "a significant improvement, increasing the transparency of the tax system".