There has been speculation that the Conservative manifesto at the next election may include a commitment to merge income tax and NICs. But what if we went further and abolished employers' national insurance contributions too; employers could have a massive financial boost and the holy grail of "full employment" could be well within reach. James Davies of Lewis Silkin makes his case for this radical reform.
Tax on income
If you were deciding afresh how best to tax income, it’s extremely unlikely you would want to start from the current position in the UK. And almost certainly you would not set up a system of social security akin to our National Insurance contributions (“NICs”).
NICs were introduced in 1911 as a health insurance scheme and then extended after the Second World War as a contributions model to fund entitlement to the NHS and social security. As the NHS has been funded more and more out of general taxation, the distinction between NICs and income tax has become increasingly blurred.
NICs for employees combine employee and employer contributions. The former are deducted from the employee’s headline salary or wages, in reality representing a second income tax nowadays, whereas the latter constitute more of a payroll tax.
There has been speculation that the Conservative manifesto at the next election may include a commitment to merge income tax and NICs. There is much to commend this idea. In relation to employees’ NICs, the result would be a simpler, more progressive and more transparent approach to taxing income, creating long-term administrative efficiencies. The net impact on the Exchequer need not change. The idea has been floated periodically over the years but presumably has ended up filed under “too difficult” or “too vulnerable to unhelpful media headlines”. It has, however, now received support from such unnatural bedfellows as the Taxpayers’ Alliance and Labour Uncut.
As far as employers’ NICs are concerned, it seems absurd to impose a tax on employing people when job creation and the UK’s competitiveness in the global economy are today’s political priorities. Why tax a behaviour you want to encourage? Imagine the boost to UK employers if approximately 11% of payroll paid to the Exchequer was removed (i.e. the employer NICs rate of 13.8%, less a corporation tax deduction). The incentive to move work abroad or replace people with technology would diminish and the UK would become an even more attractive base for overseas businesses.
It should be acknowledged that most other countries do have something akin to employers’ NICs, in many cases at significantly higher rates. However, some competitor economies have substantially lower or negligible rates. In Hong Kong, for example, employers are required to contribute just 5% of an employee’s monthly salary (up to a maximum of HK$1,500 (£113) per month) to an approved mandatory provident fund scheme.
Abolishing national insurance
Abolishing employers’ NICs would also remove one of the incentives for moving from traditional employment to some of the increasingly common forms of casual working arrangements. The Coalition has already made small moves in this direction. From April 2014, all businesses and charities are able to offset an allowance of £2,000 each year against their employer NIC bill. And from next April, there will be no employer’s NICs on the wages of young people under 21 up to the upper earnings limit (currently £41,865 pa).
The obvious challenge in abolishing employers’ NICs would be the revenue which would be lost. Around £60 billion each year is raised through employers’ NICs, representing approximately 12.5% of the Exchequer’s revenue. Putting aside arguments as to whether the overall tax burden is too big, too small or about right, there would clearly be a problem in replacing the lost revenue. Some radical suggestions for reforming tax have, however, been floated in recent months. Ideas for raising additional revenue might, for instance, include:
- Raising the top rate of income tax back to 50%.
- Adopting the US approach of taxing all UK citizens on worldwide income, irrespective of residence and domicile, and abolishing the favourable tax regime for UK residents who are not domiciled here.
- Taking further steps to reduce tax avoidance, such as introducing an Australian-style anti-avoidance rule providing that lawful schemes with the dominant purpose of avoiding income tax do not work.
- Following Thomas Piketty’s ideas about a wealth tax.
- Taxing capital gains on the same basis as income.
- Taxing gains on people’s primary residence.
- Expanding the range of services on which VAT is charged (e.g. certain financial services).
No doubt any of these will result is gasps of horror from some quarters, but perhaps the overall benefits might outweigh the negative impact?
There is much debate about how much a rise in the top rate of income tax to 50% would raise, but even the most optimistic projections suggest it would only be around £3.5 billion - less than 1% of the UK’s tax revenue. (Of course, bearing in mind NICs, the current top rate is in reality 47%, so this would only be an additional 3%.)
If you were starting from scratch in deciding how to tax income, would you use the basis of residence alone or impose some tax based on citizenship? The obvious argument for taxing only residence is that residents use the public services that tax pays for. But with increased global mobility, would it not be fair to levy some tax on citizens who maintain their British passports? And if you are looking to the tax regime to encourage behaviours which benefit the economy, surely discouraging citizens from moving to tax havens would be beneficial.
Joining the US (and Eritrea) as the only countries to tax all non-resident citizens on foreign income would represent a radical step for the UK and one there seems to have been a trend away from in recent years. It might also lead to non-resident Brits relinquishing citizenship. If the UK were to adopted this approach, consideration should be given to setting a lower rate for non-residents (as in Eritrea) - perhaps 50% of the rate for residents. That would seem more equitable in the circumstances - and with double-tax treaties would capture only those based in tax havens or countries with a lower rate of tax. Another further potential revenue raising idea would be to abolish the favourable tax regime for long-term UK residents who are not domiciled here.
Wealth tax
Taxing wealth has also received attention recently, particularly in the context of the mansion tax favoured by the Labour and Liberal Democrat parties. But if you are going to tax wealth, why tax property and not other assets? It seems somewhat arbitrary. The argument against taxing wealth is that, in effect, it would often amount to taxing income twice. In addition, enforcing and collecting a wealth tax against assets other than property may in practice be difficult. The Institute for Public Policy Research has modelled the introduction of a 1% wealth tax on non-pension assets held by individuals in the UK and estimated that this would raise around £7 billion per year - less than 2% of the country’s tax revenue.
Capital gains tax (CGT) only accounts for around £4 billion - less than 1% of tax revenue - so it would seem unlikely changes here would raise much of the shortfall. Yet there seems no logical reason why earned income should be tax differently from increased wealth derived from other sources. It would be important to retain entrepreneurs’ relief and, if CGT was extended to primary homes, an equivalent relief where the proceeds of sale were reinvested in another primary home. Such measures would continue to encourage investment and mitigate the obvious downside of extending CGT to primary residences – namely, that it would deter people from moving home.
It would also seem right that any removal of employer NICs should result in at least part of the benefit to employers being reflected in a rise in tax on their profits. If you were starting again, would it not make more sense to tax business on profit rather than employing people? Here, the popular way forward would be address some of the well publicised loopholes being exploited by some household-name multinationals, while maintaining a globally competitive rate of corporation tax. The main problem is that this is beyond the powers of the UK alone and would require international collaboration. Further, passing on some of the savings to improve the lot of the least well paid by increasing the national minimum wage would seem just.
VAT
There has been considerable debate about extending VAT to certain financial services which are not currently subject to VAT, but there is little precedent for this (although China has been considering doing it for some time). Co-operation from the other EU member states would also be needed.
While abolishing NICs might make sense if we were beginning afresh and integrating employees’ NICs with income tax is logical, the Exchequer’s revenue from employers’ NICs would not easily be replaced even with some of the more radical ideas mentioned above. In addition, the consequences of “moving the goalposts” with some of the possible changes would be much more contentious than if we were starting with a clean sheet of paper.
Nonetheless, the potential gain to the UK economy would be immense and could truly help create an obvious home for international business and employment. Perhaps a long-term plan gradually to reduce employers’ NICs with the ultimate aim of abolishing them entirely is more realistic.
By James Davies, Joint Head of Employment at Lewis Silkin LLP
Is the £60bn cost of abolishing employers' NICs an investment worth making? Share your thoughts on this "jobs tax" using the comments section below.
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