NICs: A tax, or a cost of welfare?

Donald-Drysdale By Donald Drysdale for ICAS

16 March 2017

Following uproar at the Budget proposals (since abandoned) to increase NIC rates for the self-employed, Donald Drysdale examines why we pay these contributions.

A pasty moment

In 2012 it took two months of hue and cry to persuade a beleaguered George Osborne to modify his plans to ‘simplify’ VAT by introducing his ‘pasty tax’.

The pace of political life has quickened.  Following widespread concerns that the Budget of 8 March would impact unfairly on the self-employed, of whom some are key wealth-creators in our economy and many earn very little, it took Prime Minister Theresa May only a day to put the brakes on Philip Hammond’s proposal to breach a Conservative manifesto pledge by increasing National Insurance contributions (NICs).

Hammond had wanted to increase the main rate of Class 4 NICs from 9% to 10% in April 2018 and 11% in April 2019, and initially he and May defended this approach.  However, within a week after the Budget he announced that he was abandoning the proposal – at least for the time being. There are to be no increases in NIC rates in this Parliament. Instead, he explained that the Government would carry out a wider review of differences in NIC treatment after publication of a review of modern employment practices and the introduction of better benefits for the self-employed.

The Taylor review

Last October the Prime Minister appointed Matthew Taylor (Chief Executive of the Royal Society of the Arts) to review how employment practices need to change to keep pace with modern business models.  The review is considering employee rights and responsibilities, employer freedoms and obligations, and our existing regulatory framework surrounding employment.

The Government is concerned about the large-scale shift of workers from employment to self-employment.  This is popularly attributed to workers seeking to avoid income tax and NICs, but there are more powerful pressures at work.  Those who engage workers want to reduce the cost of employers’ NICs and avoid granting their workers extensive (and expensive) employment rights.

An employment status review, commissioned by the Coalition Government and updated in December 2015, looked at the framework for determining employment status and provided a snapshot of the UK labour market at that time.

Under current law, a person’s entitlement to employment rights is determined by their employment status:

  • An employee is entitled to a full range of employment rights – the National Minimum and Living Wage, annual leave, rest breaks, maternity, paternity and adoption leave, the right not to be treated less favourably as a part-time worker, the right not to be treated less favourably as a fixed-term employee, the right to request flexible working, protection from discrimination at work, minimum notice periods, collective redundancy consultation, statutory redundancy pay, protection from unfair dismissal, and protection of employment on transfer of undertakings.
  • A self-employed person enjoys no entitlement to employment rights beyond basic health and safety and non-discrimination.
  • Between these two extremes are workers entitled to a limited range of employment rights – the National Minimum and Living Wage, annual leave, rest breaks, the right not to be treated less favourably as a part-time worker, and protection from discrimination at work.

The Taylor review seems a sensible, measured reaction to trends such as the shift towards self-employment, the growth of ‘gig’ working and disruptive business trends, and increasing use  by employers of zero-hour contracts. All these developments may justify changes to the existing laws on employment rights.

The same developments demand a review of the rules on income tax and NICs, to secure a fair and level playing field and ensure compliance. Strangely, these crucial aspects do not feature in Taylor’s terms of reference, although they have been raised elsewhere – for example, by the House of Commons Treasury Select Committee in its current inquiry into UK tax policy and the tax base, to which ICAS has responded.

The plumbers’ revolt

In recent weeks, the spotlight has fallen on the employment rights of workers engaged by Pimlico Plumbers, and others working for Uber, City Sprint and Deliveroo.  As a result, an increasing number of people are finding themselves classified as ‘workers’ falling between employment and self-employment.

This substantially confused those who were trying to assess the relative merits of Hammond’s Budget proposal to increase NICs on the self-employed.  It is no longer valid simply to compare the NICs payable by employees and employers on the one hand, and the self-employed on the other.  It is also necessary to consider the growing army of workers falling between those camps.

With NICs, as with any tax, the position is complicated by the fact that there are always those who seek to avoid paying – and this leads to convoluted anti-avoidance provisions. For examples, look no further than the controversial intermediaries legislation (IR35) or the complex provisions relating to disguised remuneration.

The trouble is, of course, that NICs are a tax that no-one fully understands.

What are NICs for?

When NICs were first introduced, back in 1911, their purpose was to insure against illness and unemployment.  Later, the Beveridge Report in 1942 set out proposals for social security, reflecting citizens’ preference for benefits in return for contributions – rather than free allowances from the State.

Based on Beveridge, the National Insurance Act 1946 created a wide-ranging system of sickness, unemployment, maternity and pension benefits – funded by contributions from employers, employees and the Government. Thus the welfare state was established on the basis that NICs were being paid in return for benefits.

Much has changed in the last 70 years.  NICs have risen from around 3% of GDP in the 1950s to some 6.5% of GDP now. In 2017/18, NICs (at £130bn) will constitute 17.5% of total Government revenues, surpassed only by income tax (£175bn) and VAT (£143bn).

Officially, NICs are still hypothecated: some 40% of NIC revenues go directly to fund the NHS, while the National Insurance Fund uses NIC receipts to fund contributory benefits including State pensions.  In practice, many taxpayers no longer see NICs as insurance contributions but regard them instead as part of general taxation.

There are fundamental flaws in the NIC regime and, to address these, there have been repeated calls to align NICs more closely with income tax – a subject considered by the Office of Tax Simplification (OTS) in two reports during 2016.  However, politicians fear that any solution might be seen as an increase in the rates of income tax – the more visible of the two levies.  For this reason no Chancellor has yet had the political courage to tackle the problem.

For employees, NICs are largely opaque and politicians use smoke and mirrors to preserve this lack of transparency.  For example, the increase in the higher rate income tax threshold from £43,000 to £45,000 for 2017/18 has been widely heralded, while little has been said about extra NICs payable as a result of the corresponding increases in the upper earnings and upper profits limits.

Not all governments necessarily want to paint the same picture.  For 2017/18, a Scottish employee faces a 52% marginal rate of income tax and NICs on earnings between £43,000 and £45,000.  Doubtless Westminster will attribute this to Scotland’s restricted higher rate threshold for devolved income tax, while Holyrood will ascribe it to increased NICs reserved to Westminster.

Conclusion

The Chancellor faces no easy task in determining what rates of NICs should be levied on employers, employees, the self-employed and the growing category of other workers in between.

As the Taylor review appears to be restricted to employment law, it is encouraging that the Chancellor now intends to look more widely at differences in treatment for NIC purposes. There is a pressing need for the appointment of an appropriate panel of tax specialists to carry out a fundamental review of NICs, including a re-assessment of relative contribution levels with regard to the respective benefit entitlements they provide.

Article supplied by Taxing Words Ltd

Topics

  • Tax

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