Government could merge income tax and national insurance

Taxes cubes

The government is reviewing the possibility of merging income tax and national insurance (NI) into a single tax to make things simpler for taxpayers.

Following July's summer Budget, David Gauke, financial secretary to HM Treasury, said in a letter to the Office of Tax Simplification (OTS) that he wanted it to review the potential for 'closer alignment' of income tax and national insurance.

“This is an area often cited as a major source of complexity for taxpayers,” he writes.

“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.”

According to press reports, chancellor George Osborne has previously considered merging the two taxes in his 2014 Budget but refrained from doing so due to complexities linking the respective IT systems.

In a document outlining the review - which the OTS hopes to complete in time for next year's Budget - the office says: “Differences in the rules and procedures between the income tax and [national insurance contributions] systems were found to be the second highest source of complexity for small businesses.”

The idea was also mooted in 2011, but kicked into the tall grass until progress was made on other tax changes being worked on at the time.

Expert view

Gary Smith, financial planner at Tilney Bestinvest, outlines four potential implications of the merge:

1. Potential reduction in tax liability - the starting rates at which you pay income tax (£10,600) and national insurance (£8,060) are different.

Logic would dictate that, given the Conservative pledge to increase the personal allowance to £12,500, this would also have to be the starting rate for any combined income tax/NI rate. This would mean that everyone could earn £4,500 more before paying any NI equivalent.

2. It would enable the government to increase the rate at which people pay higher rate tax to £50,000, while reducing the potential loss to the Exchequer.

This is quite devious, as under the current system an individual pays 40% income tax and only 2% NI above the basic rate band. So, if they leave the system as it is, the exchequer will be giving up 20% income tax on circa £8,000 of income if they do increase the basic rate band to say £50,000 (including personal allowance).

However, if the government merge income tax and NI, the effective basic rate tax would be 32% and the higher rate 42%. Therefore, if they increase the basic rate band they are only giving up 10% on £8,000.

3. The death of pension tax relief?

At present, a basic rate taxpayer gets 20% tax relief on pension payments, but surely this would increase to 32% under a combined system. It seems illogical to increase tax relief at a time when they are actually trying to reduce the cost to the Exchequer.

An equal tax treatment of Isas and pensions could be a prelude to merging the two, potentially drawing Isas into some form of lifetime allowance.

4. Would any new rate apply to dividends?

We have already seen the introduction of tax on dividends of 7.5% for basic rate taxpayers from April 2016. At present NI isn't payable on dividends, and one could suspect that the government will also seek to increase this rate to reflect the merged rate.

While probably below the 32% rate for people with earned income, the additional tax generated could cover the cost of increasing the basic rate band to £50,000.


Your Comments

5. Would the new rate apply to pensioners?
Currently pensioners pay income tax but not NI. Increasing the income tax rate from 20% to 32% would not be popular with Conservative voters. Exempting pensioners would counteract any simplification.

5. Would the new rate apply to pensioners?
Currently pensioners pay income tax but not NI. Increasing the income tax rate from 20% to 32% would not be popular with Conservative voters. Exempting pensioners would counteract any simplification.

I logged in to make a similar point re NI and pensioners -would be a very sneaky way out of all those pledges! 

Having already paid N.I. contributions on my earnings before contributing to my SIPP, I am somewhat reluctant to pay them again when I draw a pension from my SIPP!
In fact isn't double taxation illegal?

I agree- my main issue is what rate I would pay now that I am over the age to pay NI and what rate would I pay on my savings. I do not disagree with merging the two- but it needs to be made that we are not paying anymore in tax than we do now- and the govt saving is on the one collection

What no-one seems to be considering is that people earning less than £12,500 (the personal allowance) will no longer be entitled to Jobseekers Allowance or State Pension because they won't be contributing to NI.  There are plenty of jobs and areas of the country where this is a fairly standard wage. Forget the £25k plus that is widely mooted as an average wage.  That is skewed big time by some really extortionate wages in the City etc.  There are, of course, people who would rather have "the jam" today especially if they are struggling to pay big rents but long term it may not be to their benefit.

One more pensioner's protest!  If combining these taxes comes to fruition then we'll all be contributing to our State Pension until the day we die.

It is all speculation. The problem is far more complex than it looks. The article starts for a particualr perspective about covert redistribution and that clouds the issues discussed. Important factors have been ignored.
The reason this propsal was put off in 2011 was the problem of pensioners not being liable for a full integrated tax. Lloyd George is responsible for this mess. He conned the voters (all men) into paying for what was billed as state controlled insurance, and a into a non existent "pension fund" (aka contibutions record) that was designed to pay out for only a year or two in over half the cases. Like a lot of what he did it was cynical with a longterm sting in the tail.
Successive governements have stretched that term beyond any acceptable meaning under the Trades Descriptions Act. Brown nakedly used it as a substitute for income tax because it actually raises so much for a very small headline increase as everyone in work has to pay it, unlike income tax which has a host of valuable reliefs. 
Another problem is that many people in the bottom half of the income distribution in the population get more back in benefits than they pay in tax and NI's. Effectively the top 10% pay a hugely disproprtionate amount of income tax. The only reason it is tolerated is because of the existence of a highly regressive flat tax (NI) operating over the lower two thirds of the distribution.
Take that away and the problem becomes much more obvious. As with France the top third can often walk away and go somewhere else.