ICAEW briefing paper sets out the case for and against
The Institute of Chartered Accountants in England and Wales (ICAEW) has produced a briefing paper titled, ‘Income Tax and NIC – four options: a hard choice’ which discusses the difficulties of unifying income tax and NIC and also options to be considered.
The importance of income tax and NIC
Income tax receipts remain the single largest source of government revenue. According to the Summer Budget figures, total government receipts for 2015/16 are estimated to be £673 billion, of which around £629 billion comes from taxes and duties. Income tax and NIC are estimated to comprise £170 billion and £115 billion respectively. Compare these figures to other taxes – VAT £116 billion, corporation tax £42 billion and inheritance tax £4 billion, and it is noticeable that income tax and NIC account for nearly half of all tax revenues. Employers’ NIC will form about 10% of total tax receipts.
Any debate about a merger of income tax and NIC therefore needs to focus on their valuable contribution to government revenue.
Although NIC is more widely regarded as a form of taxation there are subtle but important differences. NIC origins are that of insurance for working people of working age and is therefore only payable on earned income of a cash or cash equivalent nature. It is not therefore payable by those who have reached state retirement age or those under 16. Furthermore, it is not payable on investment income such as dividends.
As income tax appeared to reduce back in the 1980’s, the scope and rates of NIC began to expand. This in turn has led to considerable tax and NIC planning and associated countermeasures. One of the simplest forms of this type of planning is the use of company dividends by SME’s to extract profits.
Previous merger attempts
The subject of unifying Income Tax and NIC is nothing new. In 1986, then Chancellor of the Exchequer, Nigel Lawson, considered it but decided that it would be too much of an upheaval.
In 2011, George Osborne made a Budget announcement that he wanted to start a discussion on the subject but this was only from an operational level rather than an outright unification.
NIF is the starting point
Before any discussion can take place, the ICAEW say that we need to decide what should be done with the National Insurance Fund (NIF). This is used to pay state pensions and certain benefits and funds part of the NHS. It was designed as a pay-as-you-go fund that tries to match revenues with current and future liabilities. This is important for an ageing population that puts a strain on state pensions, especially with fewer people making contributions.
According to the ICAEW there are four options:
- Full scale merger.
- Accept that merging is too difficult a problem to fix but consider improvements that are more than just sticking plasters.
- Demerge NIC and allow it to return to its roots as a separate insurance based system that buys benefits.
- Do nothing and make do with what we’ve got in the knowledge that the system may not be appropriate for the future.
Full scale merger
| Arguments For | Arguments Against |
|---|---|
| Simplification of administration and therefore reduced costs over the medium to longer term. | Headline rate of a merged tax would have to rise. |
| Reduced scope for avoidance and arbitrage. | A decision would need to be made about the extent to which payments earn a contribution record. |
| Improved taxpayer appreciation about how much they pay to government. | Social security legislation would need to be rewritten. |
| Inevitable winners and losers. | |
| Protection of former rights would be needed due to long contribution histories in existence, resulting in two sets of rules for the foreseeable future. | |
| Unpredictable fiscal and behavioural consequences would put government revenue flows at risk. | |
| How to replace employers’ NIC? | |
| HMRC and DWP software systems would need to be rewritten. | |
| Social security bilateral agreements with all EU and 17 other countries would need renegotiating. |
Improve the current position
One of the root problems of treating NIC as a tax but retaining its contributory status is the different treatment of unearned income. In the past ‘sticking plaster’ solutions have only added to the complexity. To address this the ICAEW suggest a number of options which would not go down to well with the contracting community:
- Reintroducing an investment income surcharge.
- Broadening the scope of NIC to include investment income.
- Taxing ‘close’ company dividends, e.g PSC’s, and/or unincorporated businesses under separate tax rules and rates, similar to the way savings and dividend income is treated nowadays.
- Taxing non-distributed company profits as income in the hands of shareholders.
- Increasing the rate of corporation tax.
- Reintroducing advance corporation tax for small companies, ie withholding tax from dividends and physically paying this over to HMRC.
Demerge NIC
This would allow NIC and NIF to be restored to a ring-fenced social fund where contributions would buy benefits and include an element of contributory pension provision. Examples in other countries suggest that for this to be acceptable, pension funds need to be individually ring-fenced and not subject to government control. It would effectively be a state sponsored pooled individual pension.
Do nothing
The UK’s ageing population will inevitably lead to an increase in pension and healthcare costs which, in turn, result in greater demands being placed on the NIF over the next few decades.
The current structure of National Insurance may not be broken but it is creaking to the point of breaking in the future. Simply patching up the system therefore is not going to lead to long term solutions.
As the ICAEW conclude, the debate about tax and NIC policy will not go away but there are no quick fixes or easy solutions. Significant reform requires difficult choices which may have profound consequences for both this country and its citizens.
The full document can be found HERE
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