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Opinion: “The first £10,000 you earn tax-free”? Not unless we act on National Insurance

November 2, 2011 11:01 AM
By Adam Corlett in Liberal Democrat Voice
Originally published by East Midlands Liberal Democrats

At Conference, Danny Alexander repeated his view that the personal allowance for income tax should be raised beyond £10,000, saying:

In the next Parliament, I want us to go further; our aspiration should be that someone working full time on the minimum wage should pay no income tax at all. An income tax threshold of £12,500 - think what that would do to work incentives, think what it would mean for basic fairness. Let's put that on the front page of our next manifesto.

The idea certainly seems popular within the party. But remarkably absent from these discussions is any mention of National Insurance. The very first point in our 2010 manifesto was "the first £10,000 you earn tax-free" but, while it later clarified it meant income tax (IT), it's hard to see why the parallel income tax that is National Insurance (NI) should be treated any differently.

To mitigate the rise in NI rates, the "primary threshold" for National Insurance contributions (NICs) rose from the equivalent of £5,720 per year to £7,228 this year. For 2011/12 that's similar to the IT personal allowance of £7,475. But, like many benefits, the primary threshold will now rise only with CPI (presumably to £7,604 next year) while the IT personal allowance will rise to £8,105 in April and then by at least RPI subsequently to reach £10,000.

All this suggests that on May 7th 2015, income will still be taxed not from £10,000 but from around £8,000-£8,500 (an inflation-adjusted £7,228): with the 12% NI rate that would be a significant £180-£240 of tax paid on the first £10,000.

Some may think that NICs are - surely! - insurance contributions and not a tax but, to quote Stuart Adam of the Institute for Fiscal Studies, the link to benefits received is now "vanishingly weak". It will be weakened yet further if Steve Webb succeeds in introducing the laudable single tier state pension. And the primary threshold is distinct from the lower earnings limit which determines, amongst other things, qualification for statutory maternity pay and state pensions. Certainly what one gets back from NICs - if anything - isn't worth the lost income, and raising NI rates now seems to be established as a preferred (ie, opaque and deceptive) way of increasing taxation.

For these and other reasons, National Insurance should be scrapped entirely. Others on this blog have said the same, as have the Institute for Fiscal Studies and the Office of Tax Simplification [pdf]. This is something we should commit to as a medium-term goal in our next tax policy paper and manifesto. (Incidentally, I'm steering clear of employer NICs - and their threshold - in this article but if you see them as yet another opaque tax on wages and employment then total NI is more significant than income tax for the vast majority of taxpayers.)

The issues that merging NI and income tax rates would raise are at least surmountable - as with pension income and employee benefits - or at best are excellent opportunities for those who want a local income tax, changes to dividend and other non-wage income taxation, or a shift away from taxing income.

George Osborne, however, doesn't seem up to the challenge. In the last budget, he revealed only that there will be a consultation by the end of this year on greater merging of the operation of the two taxes. This might include aligning the NI and IT earnings periods. As well as saving tens of millions [pdf] in administrative costs, an annual NI allowance would be fairer on many, such as those who are in and out of work.

And, returning to my main point, another consideration should be merging the lower thresholds (the NI "upper earnings limit" is already aligned with the higher rate IT threshold). The consultation's focus will surely be on making life easier both for businesses and HMRC. Aligning the thresholds would do this, and pave the way for greater simplification in future, but Liberal Democrats must also emphasise the importance of the primary threshold to the least well-off, to the economy, and to the spirit of our manifesto.

One criticism of raising the personal allowance beyond £10,000 is that it wouldn't mean any more cash for the millions of workers earning less than that.

As long as it is lower, raising the NI threshold is the more progressive move; helping people that a personal allowance raise would not. And if we get both thresholds to £10,000 and want to go further than inflation, it will be more progressive to raise both NI and IT thresholds at the same time, say to £11,560, than to raise only IT to £12,500. It would also have been better, politics aside, to have had a target lower than £10,000 but applied to both but that's now politically impossible. For now, therefore, our priority for tax cuts should be also raising the NI threshold to £10,000.

Bridging next April's expected £500 gap in thresholds would (only) cost around £1.8bn for that year, if there were no corresponding tax rises for those on higher incomes (which there should be). Shifting a fraction of the thresholds' annual rises to later in this parliament could limit further costs of the alignment, but it would still surely require considerable persuasion by Danny Alexander. However, even more than most tax cuts, he would have on his side the argument that it would be good for the economy while further improving work incentives.

Repeating our income tax success with National Insurance may not be so politically glamorous, but this additional tax cut for the least well off is the right thing to do. We must push for this alignment in the earliest possible year (look out for that consultation). And, that done, we mustn't forget about National Insurance in future tax and personal allowance policy development. I want us to truly be able to say we've taken millions out of income taxation. * Adam Corlett is a party member and vice-chair of the Liberal Democrats for Drug Policy Reform.