Thursday 20 October 2011 7:47 pm

Merging national insurance with income tax will boost transparency and cut costs

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NEXT month George Osborne will deliver his Autumn Statement, and it will have to be a good one. With the economy stalled and high unemployment, he needs a credible plan for economic growth. The credibility of the fiscal adjustment is on the line. Spending cuts are right and necessary but they are only one part of delivering a strong economy and sustainable public finances. And the government’s political fortunes are on the line too. Tactical triumphs or disasters now will be much less important to whether or not the government is re-elected than whether or not David Cameron can echo Ronald Reagan and tell voters in 2015 that “It’s morning again in Britain”.

There is a whole catalogue of measures that could make it easier for businesses to invest and grow: refusing to implement expensive EU regulations like the agency workers directive; reforming a welfare system trapping people on benefits; allowing new airport capacity; getting rid of expensive energy policies; more aggressive cuts to corporate tax; and scrapping the 50p tax rate.

But while all of that would be worthwhile, Osborne’s plan needs a centrepiece, a big announcement that can capture people’s imagination. Funnily enough, he has already identified one candidate. He should revisit the idea of merging income tax and national insurance (NI). Not the worthy but unimaginative proposal to align them behind the scenes which he retreated to but a complete merger including employers’ NI.

There would be challenges. The well-respected former chancellor of the exchequer Nigel Lawson has called it an “elephant trap”. But none of those challenges are fatal.

Common objections include the possibility that pensioners would pay more. But pensioners are already treated differently within the income tax system, with a different personal allowance, so there is no reason they need to pay the same rate if politicians want to keep giving them a better deal. Similar provision could be made for the self-employed if necessary (levelling down the rates over time might be fairer).

There also used to be some people who were above the national insurance upper earnings limit but below the higher rate of income tax, who would pay more if the two systems were merged. But that barrier has since been removed as the higher rate threshold has crept down over the years.

The national insurance fund is little more than an accounting fiction. The government is already consulting on moving to a flat rate pension and qualifying years for that benefit could as easily be assessed on number of years paying income tax as number of years paying national insurance.

Finally the government would need to make it clear that this wasn’t a tax hike. Other “reforms” like changes to vehicle excise duty have been used as cover for higher taxes too many times before.

In particular, employers’ NI has been a stealth tax for years that drives a wedge between what an employee earns and an employee receives, in just the same way as income tax does. Bringing that out into the open would increase the amount of visible taxation and might be unpopular if people aren’t clear about what is happening. So some interim arrangement where all national insurance is recorded on pay slips for a couple of years before a merger of the two would be wise.

But such transparency is fundamentally a feature of this tax reform, not a bug. If the real basic rate is 40.2 per cent, not 20 per cent; the real higher rate is 49 per cent not 40 per cent; and the top rate is 57.8 per cent, as the Centre for Policy Studies has suggested, then it is better people should know that than be misled into thinking they are getting a better deal than they actually are. An honest tax system would mean a better-informed public debate and could even improve industrial relations.

At the same time, there has to be a huge saving for business and the exchequer if they only have to pay and collect one tax instead of three. All of the different rules, from assessment periods to how expenses can be deducted, could be consolidated. KPMG puts the cost of just three of the “information obligations” the separate NI system imposes on business at £146m. The true savings from consolidating the three taxes into one payment could be really substantial.

Tax reform is a vital long-term project. But there is nothing to stop the chancellor getting started now. The Institute for Fiscal Studies, the British Chambers of Commerce and the Institute of Directors have all said that this change should be considered. One income tax is bad enough – we can’t afford three.

Emma Boon is campaign director for the Taxpayers’ Alliance.

Osborne’s plan needs a big announcement that can capture people’s imagination

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