Is an NI/income tax merger likely?

MAKERS OF BLACK beer might not be happy, but the Office of Tax Simplification report on tax reliefs has been unexpectedly and welcomingly bold.

The abolition of certain reliefs grabbed the national headlines, yet John Whiting’s review hinted that these were tinkering around the edges compared with the real change that would simplify the system – principally a merger of income tax and National Insurance.

Despite overwhelming support from the profession, there is far more riding on this for the chancellor than a simplification of the system – a botched merger would likely bring down a government. So what are the chances that George Osborne will tackle the elephant in the room?

Winners and losers

The government claims it is serious about simplifying the system. And a huge percentage of the anomalies that complicate the system come from the separation of income tax and NI, according to Whiting.

Certain benefits, shares and cash are subject to one of the two, with discrepancies in areas as diverse as payments to mariners, welfare counselling and divers’ allowances. “That sort of points you to stage one of any review – which is to get rid of all those anomalies.”

Although the review stops short of outright support for the merger, it does recommend a further review. In an area as sensitive as overhauling the tax system, that is as bold as could be imagined within the terms of the office’s remit.

graph-tax-simplification-who-contributesThere are, of course, plenty of significant pragmatic details that could derail any overhaul: pensioners and savers do not pay NI, so their tax bills will increase immediately; the thresholds are different for the two, as is the upper limit of NI contributions; and, most importantly, an individual’s state pension depends on their NI contributions.

The latter, most important point, is perhaps the easiest to deal with. As Whiting said, any talk of a merger is only possible because of the increasing likelihood of a flat-rate state pension.

The other practical issues need ironing out, and it will not be easy. In even the smallest change to tax reliefs, there will be winners and losers, and the losers are invariably and understandably more vocal.

Political ramifications

Any changes will need to come with extra benefits for elderly people and those that live on savings will need to be reimbursed or ignored – both of which are problematic.  Furthermore, employment status determines what NI contributions you make and what entitlements they bring (see box).

But the one big hurdle that will prevent a merger happening are the political ramifications. It is a decision that Sir Humphrey would describe as “courageous” – in that it is a likely government-destroyer.

For example, Gordon Brown’s premiership was ­troubled for many reasons but he never recovered from his decision to abolish the 10p tax rate.

As Deloitte tax partner Bill Dodwell said, even this simple tweak left five million lower earners worse off, and “we ended up giving money to 15 million people”. A structural change as big as a merger would affect the majority of the population.

This would most likely be in terms of presentation. A merger of income tax and NI would immediately increase the rate of income tax. Even the most optimistic analysis of any merger puts the required base rate at 28% – an immediate increase of 8% – said Richard Mannion, tax partner at Smith & Williamson.

Significant funds

The better implemented it is, the less people would see a change in their pay packets. But these nuances tend to be lost on headline writers, and an 8% increase will always make for good newspaper copy.

It does work both ways – the political establishment has used the situation for its own benefit in the past. Mike Warburton, tax partner at Grant Thornton, pointed out: “Successive governments have used NI as a means of generating receipts at the same time they have reduced the headline rate of income tax.”

If a merger ever does happen, he added, “chickens will come home to roost”.
It is desirable that people are clear about how much they pay, but what happens when they don’t like what they see? The government of the time will most likely pay at the ballot box and a coalition administration embarking on cuts to public services does not have political capital to burn.

It also helps that the losers in these changes are those usually receiving benefits, especially elderly people – as Dodwell put it, no government would dare impose a tax on pensioners. So the government will need significant funds. But this government does not have significant funds.

Removing reliefs that needlessly complicate the tax system is a worthwhile exercise and is relatively cheap in terms of cash and political capital.

But if the chancellor is genuine about simplifying the whole system rather than tinkering with the current flawed one, he has to not only acknowledge the elephant in the room but risk political capital and funds to remove it.

It’s likely our big grey roommate will be around for a while longer.


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