Expanding the system of National Insurance in 1948 was the ingenious trump card played by the post-war Labour Government to help overcome Conservative Party and establishment opposition to its proposals for a British welfare state and National Health Service. National Insurance in 2023, however, is simply a disguised form of income tax which falls disproportionately heavily, and regressively, upon younger generations and working people, writes Carl Groves, retired further education college principal and IF supporter.
National Insurance – then and now
It was the Liberal Government’s reforms in the early years of the 20th century which first set up a system of UK National Insurance. Initially, it was a contributory form of state insurance offering modest financial support to workers in the event of their illness or unemployment; but it was hugely expanded by the post-war Labour government to include the cost of a new and improved Basic State Pension and a comprehensive National Health Service (NHS) – with health care made free to all at the point of delivery and based on need. National Insurance contributory benefits today are payable upon the circumstances of death, retirement (at state pension age), unemployment, sickness absence (from paid work), maternity, and disability.
Currently, people in paid work pay National Insurance Contributions (NICs) until the age they become eligible for the State Pension. NICs of 12% on gross earnings are due from those in employment and earning at or above the primary threshold of £12,570 per year (2023/24). Self-employed people contribute in two ways: through a small fixed monthly payment and on a percentage of their net profits above a threshold, in a comparable way to employees.
NICs are collected by His Majesty’s Revenue and Customs (HMRC) and raise over £176 billion a year (2022-23), representing 17.5% of all government tax revenue.
National Insurance and so-called “contributory benefits”
The post-war Labour Government demonstrated an impressive understanding of both political psychology and English culture in promoting their health reforms and the “Welfare State” as a self-funding, something for something, system of citizen support. A British subject paid into the scheme and got something back out of the scheme to cover a range of (usually) unfortunate personal circumstances. What could any reasonable person have against such a system of social security and family self-support?
However, the problem with the idea of contributory state benefits is what happens in the case of a person who, for whatever reason, has not, is not, or cannot make the required contributions? In the immediate post-war period there was an assumption that most people would live in a family household headed by a “working man” or, otherwise, live as a retired married person, widow, or widower. The changes in UK society in the second half of the 20th century would increasingly challenge notions of what constituted a family or indeed a household. In any case, would a British subject without sufficient NICs really be denied any form of state income support in retirement, or be denied any form of state income support if they couldn’t work for an extended period, or be denied the services of the NHS when they arrived in a hospital emergency department?
The answer had to be that both health care and some level of social support would be made available irrespective of a person’s NICs status. Yet the something for something “insurance” paradigm continues well into the 21st century, even though today there is no direct funding relationship between national insurance, health care and social security. National insurance is simply a form of income tax but one that most politicians dare not refer to as such for fear of exposing a highly effective income tax avoidance tool for an ever-larger affluent class of politically powerful pensioners.
National Insurance and the issue of “qualifying benefits”
While a useful residual connection between NICs and state pensions may remain, there is a better way to secure both a contributory link and a system of qualification for the UK State Pension. This could be achieved through an individual’s personal (combined income tax and national insurance) tax record, with qualifying years based on minimum levels of tax payments for each year and/or through compensation, with qualifying years based on factors such as caring for pre-school children, disabled family members, or elderly relatives. Similarly, an individual could qualify for the other National Insurance derived contributory benefits – those relating to death, unemployment, sickness absence, maternity, and disability – through the equivalent period/amount of contributions within their combined income tax record.
National Insurance, therefore, is not a necessary part of the UK tax system but its continuing existence has very real and negative consequences for our society and economy; and particularly within the context of the UK’s fast ageing population.
Nominal National Insurance is not merely an historic curiosity
The development of new medical treatments in the 21st century, combined with the larger than average post-WW2 birth bulge generation (called “Baby Boomers”) reaching retirement age, has resulted in a huge increase in the cost of health care. Research by the Nuffield Trust has found that there is a sharp rise in NHS spend per person after the age of 50, with over-85s requiring an annual average spend of £7,000. A further specific finding is that average spend for men in the over-85 age group is 7 times more than average spend for men in their late 30s. Yet, it is the older demographic which is much less likely to pay NICs due to its mostly retired composition. A similar point can be made about state pensions and the myriad of age-related universal benefits, the costs of which are falling disproportionately on younger generations of adult workers. This explains why intergenerational unfairness has increased and the social contract between the generations is under strain.
There is a partial solution to this problem that can address the intergenerational unfairness implicit in the current system and that is to merge income tax and NICs into one Common Personal Income Tax. Such action would widen the tax base of what we now call national insurance and, crucially, provide an opportunity to increase the combined income tax allowance, reduce its combined charge rate, and reduce intergenerational inequality; this would also greatly assist with the “optics” of the reform and the acceptability of these changes.
Replacement for Employer National Insurance Contributions
In the place of Employers’ National Insurance, a new “Employers’ Pension Contributions System (EPCS)” could be introduced. Under the terms of the EPCS, Employer Pension Contributions (EPCs) would be set at a level to fully fund the UK State Pension (£113bn in 2022/23) for all qualifying people from 65 years of age. All employers would pay a set fixed percentage of the value of each employee’s monthly gross pay – and upon their own previous year’s profits in the case of the self-employed – and submit this to the HMRC monthly. Going further there could be no upper earnings limit and no zero band in the EPCS, irrespective of the type of staff contract and the number of weekly hours worked by individual employees. This will avoid employers making employment decisions which are influenced by considerations of EPCS tax avoidance. Data from the EPCS could also provide HMRC with a useful source of verification to assist the DWP in assessing an individual’s qualification for the State Pension.
But if the costs to most employers of these changes are neutral, why then change the nomenclature for this type of business tax?
Firstly, replacing NICs with EPCs will remove the anomaly whereby employers are asked to pay towards the cost of their employees’ use of the NHS, Statutory Sick Pay benefit, out-of-work benefits and so forth, and for which the employer does not see themselves as a co-beneficiary. However it is much easier to make the case that employers are co-beneficiaries of the proposed Employer Pension Contributions Scheme (EPCS) for all the following reasons:
- The EPCs should be defined in terms of “deferred income for employees” and are a necessary recognition that – in the era of a fast-ageing population – the employer is a major beneficiary of the “prime working years” in the lives of their employees.
- Under the current arrangements employers will increasingly face government and labour market pressures to offer more generous auto-enrolment pension benefits than at present, or significantly higher wages/salaries to cover the cost to their employees of ever more expensive private pension schemes.
- In the absence of the proposed EPCS, and its related guaranteed state retirement age of 65 years, employees will feel forced to better “pace themselves” through an indefinite working life with all the negative consequences for worker commitment and productivity which are already becoming evident in the UK.
Secondly, there are wider social and economic benefits to the UK of the EPCS. The EPCS has the potential, at a suitable time in the future, to be extended to become a more substantial source of pensioner income. As the economy grows there could be a case for increasing the role of the EPCS and eventually replacing auto-enrolment pension schemes. The EPCS also provides a useful measure of the cost of the State Pension at any one time and carries an in-built index-linking characteristic. If worker incomes increase so does the EPCS income pool, facilitating an uplift in the state pension itself. There is also the “opportunity” to link falling real incomes and falling real state pensions! In short, if both working-age and pensioner-aged people benefit from a stronger economy and suffer from a weaker economy, the UK economy would be stronger for much more of the time!
Replacement for Employee National Insurance Contributions
If Employee NICs are absorbed within general income tax administration costs will be reduced for most employers and for the HMRC. The newly Combined Income Tax rates would show an apparent increase but, interestingly, not by as much as you would expect. This is because the new combined income tax would be paid by everyone; everyone, that is, whose income was above the annual income thresholds, irrespective of age. In short, this proposal spreads the personal income tax load and addresses the current issue of NICs having to be paid by younger hard-up workers yet not having to be paid by older well-off non-workers.
The argument that some older, wealthier people will move overseas to more favourable tax jurisdictions is not a serious threat given the experience of European countries who have introduced wealth taxes in recent years. In such cases, however, there are both economic gains as well as losses for the UK. A better argument is that by spreading the income tax base there is an opportunity to reduce the overall income tax burden on the working population, thereby reducing intergenerational unfairness, incentivising participation, skills development, and ambition within the workforce. There is also an opportunity under these proposals to reduce the overall tax burden on a group of poorer pensioners by increasing the level of income tax allowance to a level which would take them out of income tax altogether.
National Insurance is an intergenerational fairness issue
In the immediate post-war era when life expectancy for most people was only a little above retirement age, and when the source of income in retirement was almost exclusively the state pension, it was widely accepted that National Insurance payments should cease at retirement. But in an era that boasts millions of multiple pension, asset rich, older people with retirement spans of 15, 20, 25, and even 30+ years – largely due to NHS life-extending treatments – it is no longer tenable or acceptable on intergenerational fairness grounds to excuse these millions of older people from the income taxes imposed on hard-pressed younger people and the working population in general.
The persistently high number of job vacancies in both the public and private sectors of the economy is currently hindering the UK’s return to economic growth. It is also compelling evidence that rewards for employment (wages and salaries) are too low and that rewards for asset ownership (rent and profits) are too high. Far from addressing this imbalance in the economy, the UK tax system only serves to exacerbate the problem. The case for intergenerational fairness therefore is not only socially desirable but also economically essential, and the reforms to UK National Insurance proposed here could make an important contribution.
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