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A truly bold chancellor would scrap national insurance

<span>Photograph: Renaissance Care/PA</span>
Photograph: Renaissance Care/PA

What’s the basic rate of tax? No, it’s not 20%. That’s just income tax. The true basic rate of tax is 32%, once national insurance is paid – and you can’t avoid it if you’re a PAYE employee earning above £8,632 a year. Every chancellor talks about making tax simpler and more transparent, yet in every budget they persist with the fictitious distinction between NI and income tax for purely presentational reasons. In other words, they take us for fools – and they’re probably right.

In 2000, the basic rate of income tax was 22%, and NI for employees was 10%. The basic rate has since been cut to 20%, but NI for employees has gone up to 12%. Yes, there have been valuable increases in the personal allowance, but true rates of tax have not shifted at all.

Why do we have these two separate tax regimes with income tax raising £196bn for the Treasury in 2019-20, and NI £143bn?

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It dates back to 1911, when David Lloyd George introduced the National Insurance Act to cover industrial sickness, which was subsequently greatly expanded by Beveridge after the second world war. At the core of NI is the contributory principle – the idea that when you pay, you are making a designated contribution, with entitlements such as a state pension, and unemployment payments should you lose your job. There is a sense that people are more willing to pay up if they see an actual return on their money, and that when they receive their state pension, it’s a right, not a gift from the government.

But in truth, there is little relation between what you put in and what you get out. Your money does not go into a pot with your name on it, held safely until you retire. It’s all notional – today’s workers pay NI, and that money goes straight out of the door to pay for those who have reached pension age.

It’s true that there is a ring-fenced National Insurance Fund, and by law the money that goes into the fund can only be paid out to finance a list of specified benefits. But not all the money from NI goes into the fund – of the £133bn raised from NICs in 2018-19, £107.4bn went into the fund (90% of which was then paid out as state pensions) while £25.4bn went to part-fund the NHS. In some years the government tops up the NI fund, in other years it uses a surplus to fund government expenditure elsewhere (by buying gilts, which is the government’s way of moving money from one pocket to the other).

In 1986 the then chancellor Nigel Lawson published a green paper on personal taxation which was supposed to look into the benefits and costs of integrating NICs with income tax. In 1998 the then chancellor Gordon Brown said he wanted a “simpler and fairer” NI system, not least because the lack of alignment between the starting rates for NI and income tax is incoherent and causes all sorts of anomalies. Twenty years on, those same anomalies persist. In 2014 there was an attempt in the Commons, via a 10-minute rule bill, to have NI renamed as “earnings tax” on the grounds that that is how it is “universally preceived”. It failed.

There will be winners and losers from merging NI with income tax. Well-off pensioners would be hit hardest. Currently, you stop paying NI when you reach state pension age, on the basis that you have already paid for it. Fair enough. Except that lots of people in their 50s have already made sufficient NI annual contributions to qualify for the full state pension. Yet they must continue to pay NI – exposing it for what it is, a general tax.

If NI were merged into income tax, pensioners on high incomes would continue to be liable for payments. The extra sum would probably be enough to solve the social care crisis. It’s a win-win.

Integrating the two taxes would also remove substantial administrative burdens from employers. More problematic, but not insurmountable, is that those earning over £50,000 currently see their NI rate drop to 2%. A merged NI/income tax system would have to recognise that.

Sweeping away NI and declaring the truth about tax would be the boldest and most honest reform a chancellor could make. Let’s see if the new man in the job, Rishi Sunak, is up to it.