06 June 2023
The political appeal of a 2p cut to income tax or national insurance contributions (NICs) before the next general election is pretty clear. It is an easy measure for voters to understand and it would benefit a broad cross-section of society. However, what might be considered good politics does not necessarily make good tax policy.
Such a move would be costly to the exchequer, with the latest statistics from HMRC indicating that a reduction in the basic rate of tax by 2% could cost £13.7bn if it was introduced from 6 April 2024. By comparison, a 2% reduction to the main rate of NICs for employees and the self-employed from 6 April 2024 is estimated to cost £9.6bn. A cut to employees and self-employed NICs costs less as NICs are generally only charged on earnings, ie employment income and self-employment profits, whereas income tax is charged on various other income sources, such as rental income and savings income. Additionally, those who are under 16 or over state pension age are not personally subject to NICs on any earnings.
A reduction to the main rate of NICs would be more focused on workers which might prove more attractive to the chancellor at a time when he is trying to encourage the economically inactive back into employment.
The problem with this strategy is whether an NIC giveaway would be well understood. In the past, some chancellors have sought to balance the books by increasing NIC revenues, with critics labelling NICs as a ‘stealth tax’. Perhaps the most blatant example of this was in 2001 when Labour pledged in its election manifesto that it would not increase the basic and higher rates of income tax but then promptly announced an increase in the rate applicable to NICs instead in 2002.
If increases to NICs haven’t been fully appreciated by taxpayers, the opposite may also be true for a cut to it and act as a political deterrent. Taxpayers could gleefully unwrap their gift of reduced NICs but remain perplexed at what they’ve actually received.
This lack of understanding by taxpayers points to a wider question that could be looked at instead – should we scrap NICs and merge them with income tax?
The very fact that the prime minister is undecided on whether to cut income tax or national insurance highlights the lack of distinction between the two and the potential barrier faced by politicians when considering a cut. Merging income tax and NICs would certainly make the system simpler for taxpayers to understand. The headline rates of income tax are often talked about. However, we have two taxes on earned income and it’s rare for the combined income tax and NICs rates to be referred to.
It should also capture people’s attention as such a simplification would bring with it some complex issues that would need to be thrashed out. In particular, pensioners who do not suffer NICs on their earnings and savings income could be left worse off. There are solutions to such issues that could be explored but it may be a minefield that politicians are wary to tread.
Looking just at the cost to the Treasury and the wider economic objective of incentivising workers, a cut to NICs rather than income tax appears more attractive. The bolder move would be to scrap NICs entirely and revamp the income tax system.