Aligning income tax and national insurance in a partially-devolved world
Donald Drysdale explains why hopes of aligning income tax and NICs are thwarted where one is devolved and the other is not.
Recommendations on alignment
Differences between income tax and national insurance contributions (NICs) are a major source of complexity in the UK’s tax system. In March the Office of Tax Simplification (OTS) addressed this in a report on the closer alignment of income tax and national insurance.
The report focuses on the differing rules governing these two taxes and, in particular, the complexities inherent in NICs. The OTS sets out a seven-stage programme for bringing the two taxes closer together:
- Moving to an annual, cumulative and aggregated basis for employees’ NICs;
- Basing employers’ NICs on total payroll costs, renamed as a Payroll Levy;
- Aligning self-employed NICs more closely with employees’ NICs, and their benefit entitlements;
- Improving transparency for NICs and the contributory principle;
- Aligning the definition of both earnings and expenses for income tax and NICs;
- Bringing taxable benefits in kind into Class 1 NICs;
- Having a joined up approach for income tax and NICs laws and practice.
Levying NICs on each individual based on an annual, cumulative and aggregate basis would require a new approach to administration, necessitating NICs codes for individuals similar to tax codes. This could result in a fairer imposition of NICs on workers – particularly on the increasing number of people with more than one job.
Tax changes can create winners and losers. If the OTS recommendations were adopted, some six million individuals would pay more NICs (some of them gaining contributory benefits) while seven million (including many lower earners) would pay less. The path towards closer alignment would not be easy, and the OTS has called for a full debate on the issues.
Currently, different sets of thresholds apply to overall income (in determining the rates at which income tax is payable) and to each employment or self-employment (in calculating NICs).
One common factor is the basic rate threshold for income tax (£43,000 for 2016/17), which coincides with the job-specific upper earnings limit for NICs and is likely to be kept aligned with it in future. Immediately below this point, earners pay income tax at 20% and NICs at either 12% (employed) or 9% (self-employed) – a combined marginal tax rate of 32% or 29%. Immediately above it they pay income tax at 40% and NICs at 2% - a combined rate of 42%.
According to the OTS, a fully joined up approach to the two taxes would require, where possible, alignment of the matrix of rates and thresholds. However, this becomes impracticable as soon as devolved administrations have powers to set income tax rates and thresholds on earnings, and the Scottish Parliament will have such powers from 6 April 2017. The OTS report pre-dates the passing of the Scotland Act 2016 by only a few weeks, and (surprisingly) sidesteps this issue.
On 5 May, while local elections take place across England, general elections will be held for the Scottish Parliament, the National Assembly for Wales and the Northern Ireland Assembly. Campaigns are in full swing and tax features widely in manifestos.
Scots voters are concerned with what will happen from 6 April, 2017, when Holyrood will have much wider powers over the income tax rates and thresholds applied to the non-savings non-dividend income of Scottish taxpayers. In Wales the devolution of income tax powers is not so far advanced but still a topic at the hustings. In Northern Ireland the focus is on corporation tax – there are no current plans to devolve income tax.
Among diverse political party aspirations for Scottish income tax are proposals to
- Raise the personal allowance to £12,750 by 2020/21(instead of the £12,500 proposed for the rest of the UK) by introducing an intermediate zero rate;
- Maintain the basic rate threshold at its current level in real terms (£43,387 for 2017/18 rather than the £45,000 proposed for the rest of the UK);
- Increase existing income tax rates by 1p; and
- Raise the additional rate to 50p or 60p.
Impact of the new income tax powers
A nil rate band introduced to extend the personal allowance would apply for income tax on earnings but not for NICs; the usual NICs would be payable on this band of income at 12% (by employees) or 9% (by the self-employed).
If the Scottish basic rate was 20% and the basic rate threshold was lower than in the rest of the UK, then immediately below that point Scottish earners would pay income tax at 20% and NICs at either 12% (if employed) or 9% (if self-employed) – a combined marginal rate of 32% or 29%. Immediately above that point they would pay income tax at 40% and NICs at 12% or 9% – a combined rate of 52% or 49%. Then immediately above the UK basic rate threshold (equal to the upper earnings limit for NICs), their combined rate would fall to 42%.
In such circumstances, the effective tax rates on employment earnings in excess of the personal allowance in the rest of the UK might progress through 32%, then 42%, and then 47%. The equivalent pattern in Scotland might be 12%, 32%, 52%, then 42%, and then 47% or 52% or 62%.
Some Scots with a marginal tax rate of 52% might remain unaware of this, while others could resent paying tax at a much higher marginal rate than some of their compatriots with larger earnings. One possible remedy would be for Scotland to introduce a narrow intermediate 30% income tax band – but not without adding further complexity.
Simplification of the rules for income tax and NICs has long been required but is unlikely to happen soon. Given the progress of devolution, we cannot hope for full alignment. It seems inevitable that the rates and thresholds applicable to these two taxes – one devolved and the other reserved – will remain a frustrating muddle.
Article supplied by Taxing Words Ltd
Has there ever been a greater time of change in the world of tax? Secure your place at this year’s conference as we look to bring insight and clarity to the changes in the fiscal landscape. Find out more and book now.