National insurance (NI) is a regressive tax that hits the poor hardest. It’s opaque and a relic of a bygone era. It needs to either go or be seriously reassessed. While more obscure and less talked about than its big brother, income tax, NI has a much larger impact on low earners, and it currently does not seem to be a good one.
NI was introduced in 1911 and became a version of its current form in 1948 under the post-war Labour government. It was designed to provide for cradle-to-grave protection for workers.
Initially, it was essentially a nationalised insurance scheme based on actuarial science, with everyone paying a fixed amount. But it was changed significantly in 1977 to become earnings-based under the pay as you earn scheme (PAYE). And that’s is why NI is largely a relic, because it is the shell of an insurance scheme that has been repackaged into a regressive income tax.
Unlike income tax, NI contributions are still paid by the lowest earners. If you earn between £166 and £962 a week then you pay the same rate of 12 per cent. This essentially means someone earning £8,630 a year and someone earning £50,000 a year are paying the same rate of contribution.
It’s also important to remember that employers pay 13.8 per cent of your salary in employer contributions too. The result of this is that you receive just 77.3 per cent of the amount it costs for the employer to employ you. So NI has the effect of a 22.7 per cent tax on even the lowest wage earners in our economy.
It is surprising that this has not generated a wider and more notable reaction. The complexity of the PAYE system has helped prevent people from truly understanding the cost of NI contributions to their wages. As if that was not bad enough, you only pay 2 per cent on income earned above £50,000. Again, it’s plain as day that NI is a regressive tax system that hurts the poorest the most.
The reason why it has been able to survive is probably because it’s well branded and it’s perceived well by the public on the whole. Indeed, in a YouGov poll from 2017, 53 per cent of people support raising the NI basic rate to 13 per cent to increase NHS funding, with only 26 per cent opposing such a move. Meanwhile, only 42 per cent support raising the basic rate of income tax to 21 per cent, with 37 per cent opposing. So raising the basic rate of NI is more popular than raising income tax even though such a policy would hurt the poorest the most.
Most of us imagine that our NI contributions go off to fund hospitals and pensions. However, the reality is rather different. NI contributions go into the NI fund which, since the mid-1990s, has had a surplus which has been invested in gilts (government debt), allowing the government to essentially lend itself money from the fund to pay for other things. That means that the money from NI contributions is, in effect, going into the central treasury pot. Only about 20 per cent of NI money goes to the NHS.
Should we therefore simply scrap NI and integrate it with income tax? Sadly, that would prove far more complicated than it sounds. Paying NI is what qualifies you for your pension, as well as a number of other benefits, such as maternity allowance, bereavement support payment, and at least four other schemes not covered by universal credit.
Our other options are to return it to its original form (and rely on income tax for modest redistribution) or accept that it has become an income tax in all but name and reform it to lessen its burden on low earners.
The first option would see it become a nationalised insurance scheme once again with a flat rate, preferably a low one. This would be paid by everyone and would qualifies you for the benefits you enjoy. This maintains the principle that you must contribute to the system in order to take out from it. Income tax – and possibly even a negative income tax – would then step in to ensure that low earners are supported.
The other option would allow NI’s regressive effects to be mitigated through reform. For example, those earning less than the living wage might be exempted from paying it through the creation of a new lower band. This could be financed by raising the current two per cent rate on income earned above £50,000.
Admittedly, this would complicate the system, but if it’s politically possible, it would be markedly preferable to the status quo. Nonetheless, there is no doubt that there needs to be more awareness of how the current system is structured and how it hurts the poorest.
Areas such as national insurance are talked about less than income tax even though they have a much larger impact on low earners. Sensible reform in this area could quite easily put more money in the pockets of the lowest earners and score a win for the government during its never-ending Brexit woes.