Jeremy Hunt seems to enjoy setting traps for other politicians, but he appears to have stumbled into one of his own making. Having spent £9bn on a 2p cut to National Insurance contributions (NICs) in last week’s Budget, Hunt added a remark that quickly became the headline: “Our long-term ambition is to end this unfairness.” Hunt and Rishi Sunak have since faced demands to explain what they think would happen to our already rather cash-strapped state if it abolished its second-biggest tax.
This gave Labour space to describe the ambition as a “£46bn threat to the funding of state pensions and the NHS” that could, like the Truss-Kwarteng mini-Budget, only be funded by unsustainable borrowing.
This is a pity, because tax experts I’ve spoken to say abolishing NICs is a great idea, and one that Labour should use. In fact, I’m told that this idea has been discussed within Labour, because it would offer the opportunity to cut taxes for workers without any impact on spending.
“You don’t have to be a politician of any great imagination to sell this to most people as a tax cut,” says Dan Neidle of Tax Policy Associates (who Anoosh Chakelian recently interviewed here). Neidle told me that the current rate of employee NICs – the 8 per cent deduction that appears on most people’s payslips – could be replaced by a 5p increase in income tax, and the Treasury would get the same amount of money. This magic is achieved because the people who don’t pay NICs – people who get their income from dividends, landlords, pensioners – would pay more. Every employee in the country would get a tax cut.
Even better would be the replacement of the extra 2p NICs currently paid by higher earners with a slightly more than 1p increase in the top rate of income tax. “Again,” says Neidle, “that is a tax cut for highly paid employees, worn largely by people receiving dividends and rent. You’re distributing from wealthy investors to wealthy employees.”
So why not do it? The answer is that National Insurance is a fiction to which many people cling. Last week, the Guardian’s editorial board wrote that “the shared responsibility for paying NICs still represents the foundational, and to many people almost sacred, principle of the welfare state… NICs are based on the need for solidarity across class, age and gender.”
This is piping-hot nonsense. NICs are income tax that some people, notably landlords and wealthy pensioners, don’t have to pay. If they represent a national principle it is this country’s generational tilt towards the wealth of the old over the earned income of the young, a principle that aggressively opposes economic growth and opportunity for workers.
At this point some readers will seize their keyboards, fire up the caps lock and begin admonishing me that ACTUALLY National Insurance is SEPARATE and SPECIAL because it goes into the National Insurance Fund. But the NIF is not, as the public has been allowed to think for the past century, a national pension pot. It doesn’t invest its income in assets to cover future liabilities, we do not “save up” NICs through our careers and receive the benefit when we retire. It’s a current account: the latest estimate for 2023-24 is that the NIF will receive £135.7bn (from people in work this year) and pay out £133bn (to people who have long since retired), with £70.3bn of overall surplus that is held by the Debt Management Office as part of the government’s overall finances.
If there isn’t enough money in the NIF to pay the state pension, the Treasury just tops it up. If you really insist on believing there’s something special about NICs, head to page ten of the most recent “Government Actuary’s Quinquennial Review of the National Insurance Fund”, where you’ll see a graph that shows the NIF becoming empty in about 15 years. From that point on, there will be no point in the NIF existing because there will be no surplus for it to hold.
Stuart Adam, senior economist at the Institute for Fiscal Studies (IFS), agrees that National Insurance is an “accounting fiction”, but it’s one that is useful to politicians. Tony Blair promised not to raise income tax in his 2001 manifesto because he could raise NICs instead; Boris Johnson and Rishi Sunak proposed an NICs hike in 2021 “to fund the NHS”.
“Politicians,” Adam told me, “take advantage of the fact that people misperceive these things. We’ve seen that increasing National Insurance is less unpopular than increasing income tax, because people perceive it to be either going towards the NHS or their state benefits. That’s no more true for National Insurance than it is for income tax, but the perception is there.”
This subterfuge is what tilts our tax system in favour of wealthy pensioners. It is right that pensioners should pay more, because the whole point of pensions taxation is not to make retirement savings tax free, but to move income from your highest-earning years into your retired years, and pay the appropriate tax on it when you do. Pensioners have been the biggest beneficiaries of fiscal policy for more than ten years and are now the group least likely to be in relative poverty. The group most likely to be in relative poverty is children.
The harder part of removing National Insurance is the 13.8 per cent contributions paid by employers. These, too, are a fiction: work by the IFS and others have shown they are also income tax by another name, and that if removed they would eventually result in higher wages. The politics of replacing this with income tax would be horrible – it would be seen as a tax break for business paid for by workers – but the rewards in terms of a simpler, more honest, less easily manipulated tax system could be huge. (It might perhaps be made palatable by mandating pay rises or a significant increase to the minimum wage.)
Hunt is right to set this out as an “ambition”; it is an ambition Labour should share.
This piece first appeared in the Morning Call newsletter; receive it every morning by subscribing on Substack here.
[See also: Jeremy Hunt is right about the economy – but he can’t fix it]
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