NICs are an important source of government revenue. The total paid in 2009/10 was £97bn, significantly more than VAT (£84bn), and over 20 percent of government receipts for that year. Yet how the NIC system works, who pays, and where the money goes, is not well understood.
In fact, as my report published today by the Centre for Policy Studies shows, someone paying NICs gets very little back in contributory benefits. Even if you qualify for the full state pension you might have a lower income than someone on pension credit. Over £20bn NICs are paid direct to the NHS, which is available to everyone whether or not they have paid NICs. Over £13bn has also been lost to the National Insurance Fund because of an illogical interaction with green taxes. On top of that, contributory benefits, such as Jobseeker’s Allowance, can be less generous than the corresponding income-based Jobseeker’s Allowance. The National Insurance Fund has become an accounting device largely ignored by the Treasury, who treat payments in and out in the same way as other government receipts and expenditure.
Anomalies in the system abound. The level of NICs paid by different groups reflect hidden cross subsidies. (Some groups don’t even need to pay – for example, no action is taken by Government to enforce payment of Class 2 NICs by the self-employed, because it is not cost-effective to do so). The rules are needlessly different than for income tax, which causes extra administrative burdens and the need for careful planning if you want to do such things as pay a lump sum into a pension fund or issue shares to employees. The NIC regime has caused much angst to many thousands of small companies potentially caught by the notorious “IR 35” rules, a Labour initiative that was supposed to raise £900 million a year but which has only brought in £2 million a year. All this complexity exacerbates the huge problems for government of managing and reconciling millions of NI accounts.
Further, NICs are a major tax burden - especially for the lower paid, who are likely to suffer a much greater loss from NICs than from income tax.
The contributory principle was never applied in a clear cut way. When National Insurance began in 1948, it was immediately undermined by the need to pay benefits to people without a full contribution record, contrary to Beveridge’s own intentions. Since then the majority of changes, apart from further tangling and confusing the system, have tended to undermine the principle further. With the introduction of a universal pension we need to recognise that the old concept of the contributory principle has effectively died out. We should move on and merge the NIC system with income tax. People will get their benefits entitlements by paying whatever income tax is due. We will then have taken a major step towards a more honest and a transparent tax system.