SIMON BAIN

 

Is George Osborne considering scrapping National Insurance by merging it with income tax? It emerged this week that the chancellor has commissioned a study into reforms which could lead to the creation of a single “earnings tax”.

It could mean a potential reduction in tax liability, given that NI starts when you earn £8,060, but the income tax threshold is already £10,600 and is promised to rise to £12,500.

Gary Smith, financial planner at Tilney Bestinvest, says: “This would mean that everyone could earn £4,500 more before paying any NI equivalent. It would also remove the anomaly for those who earn below the personal allowance, but above the lower earnings limit, having to pay NI but no income tax.”

But this is just one of five potential shake-ups from such a move, according to Mr Smith’s analysis.

“It would enable the government to increase the rate at which people pay higher rate tax to £50,000, whilst reducing the potential loss to the Exchequer,” he says. “This is quite devious as, under the current system an individual pays 40per cent income tax and only 2per cent NI above the basic rate band. So, if they leave the system as it is, the exchequer will be giving up 20per cent income tax on circa £8,000 of income.” But a merged system would mean the effective basic rate tax would be 32per cent and the higher rate 42per cent. “Therefore, if they increase the basic rate band they are only giving up 10per cent on £8,000.”

It could also herald the death of pension tax relief, Mr Smith says. “The government has already announced a consultation on the system, and I believe that a merger of income tax and NI would likely result in the floated idea of a pension with Isa-like tax treatment. This is because at present, a basic rate taxpayer gets 20per cent tax relief on pension payments but surely this would increase to 32per cent under a combined system. An equal tax treatment of Isas and pensions could be a prelude to merging the two.”

Dividends could be caught up in the new rates, following the creation of a new dividend tax for basic rate taxpayers, which will be 7.5 per cent from next April. “Whilst probably below the 32per cent rate for people with earned income, the additional tax generated could cover the cost of increasing the basic rate band to £50,000,” Mr Smith says.

For pensioners, he speculates that there would have to be a separate tax rate for pension income, similar to savings rate tax – for instance a 20per cent tax on the pension income in the basic rate band.

Tilnet Bestinvest has drawn up three scenarios based on the government’s pledges to increase the personal allowance to £12,500 and the basic rate band to £50,000 by the end of this parliament.

They show that the £20,000 earner would pay £533 less tax, the £50,000 earner would pay £230 more tax, while the £30,000 earner paying four per cent of salary into his pension would be better off by £384 a year.

Michael Johnson at the Centre for Policy Studies, the right of centre think tank, said: “The system of National Insurance Contributions is not transparent, is not progressive and burdens companies with its complexity.”

He is urging the chancellor to use his autumn statement to herald the new earnings tax, and the scrapping of the NI system. The CPS recommends the tax should be set at 32per cent, 42per cent and 47per cent, based upon today’s personal allowance and income tax bands.

It says any shortfall in tax revenues should be “made up by additional consumer taxes”.