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Rationalising income taxes is overdue – why won't it happen?

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Philip Fisher believes correcting an anomaly regarding tax on income could aid levelling up and cut legislation. So, why will it never happen?

19th Oct 2021
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As accountants, we feel obliged to accept that while taxes are painful, they are also necessary in order to permit the operation of government.

A second equally obvious principle is that, as a general rule, the more that you earn the higher the marginal tax rate you pay. It surely also goes without saying that this is the way that the UK tax system operates.

That was what this writer thought, until his editor issued a flattering offer to step into the Chancellor of the Exchequer’s shoes and write his own fantasy budget.

Inevitably, this is the kind of invitation that makes even those who spend much of their lives embroiled in a subject think outside the box.

It is hard to imagine then that anyone would disagree with a proposition suggesting that income tax rates should start at zero then gradually increase to a top rate. Arguments could arise very quickly over what each rate should be and when they should start but that is a debate for another day.

An income tax anomaly

In the United Kingdom, that is broadly how income tax operates, although given a complicated tax system there are a few anomalies, for example when the personal allowance is withdrawn.

Successive governments have cleverly hidden the fact that we also pay a supplementary income tax the rate of which, quite bizarrely, reduces by close to 85% when earnings hit around £50,000.

While some readers might well be nodding sagely, others could have been hoodwinked along with 99% of the population.

That is because we have been led to believe that national insurance contributions are something other than an income tax. This might have been the case in the past, but certainly is not the position today.

A brief history lesson

The long-retired might just about remember purchasing national insurance stamps, which really were stamps and represented an investment in health and pension rights.

This system gradually morphed into an arrangement where contributions ceased to have any direct connection to rights and were taken directly from salary or assessed on the self-employed.

Getting rather closer to the present time, for a long period since the contributions were theoretically connected to benefits, once you had accounted for enough insurance premiums for a relevant year, nothing extra had to be paid. That is exactly the same as private health insurance today, where we pay a fixed sum to receive defined benefits.

Along with this plan, a tax for employers on payroll costs was introduced under the NIC same branding.

Supplementary income tax

For many years, even Chancellors of the Exchequer have given up the pretence of claiming that national insurance contributions are anything other than an additional tax.

Therefore, it makes no sense to have a system where the rate is 12% for earnings between a zero-rate band and around £50,000 with only 2% due thereafter. The numbers are due to change next year, after Rishi Sunak discovered like so many of his predecessors that this was the ideal stealth tax, ignored by that same 99% of the population who honestly believe that they are paying income tax at 20%/40%/45%.

The solution

If politicians were honest they would immediately abolish employee’s national insurance contributions and simultaneously re-brand those for employers.

This would cut hundreds of pages from tax legislation and make life significantly easier for not only the man or woman in the street but also accountants.

The quid pro quo would be an inevitable increase in other taxes but at least we would understand what we were paying.

Before that, since Sunak is desperate to raise taxes stealthily, then surely it is time to remove the anomaly and replace the 2%/3.25% rate of National Insurance contributions with a flat 12%/13.25%.

This would bring in much-needed cash for the Exchequer, make the system fairer, aid levelling up and perhaps even avert some other tax rises or cuts to public services.

In reality, there is no way that the Chancellor is going to forego a chance for additional austerity at the expense of high earners.

The irony is that even if the Labour Party were to come back into power at some point in the distant future, this columnist can’t imagine that it would have the guts to scrap NIC and recover the lost funds via a massive hike in income tax or, perhaps more fairly, VAT or an equivalent sales tax.

Replies (4)

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By Paul Crowley
19th Oct 2021 13:57

Those stamps were on cards that employee took to next employer
Hence collect your cards means you are being sacked

I point out regularly to the high rate tax payer that the real increase is trivial
The tiny rates over the upper threshold really serve no purpose and a full time landlord contributes less to the communal pot than a minimum wage earner as an effective combined tax rate
NI has time expired
It is just tax being raised predominantly on the Basic rate taxpayer

BUT you are correct, no politician would dare to take such a bold action

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By raybackler
20th Oct 2021 14:07

The graduated increase of the tax burden as earnings increase, as you say, is a fundamental principle of the tax system. Those who can pay more, should pay more, to fund lower taxes on those with lower earnings, but only up to the point where the tax burden doesn't cause a fall in the overall tax take.

Under PAYE the employee bands for tax and NI are ludicrous and Employer's NI is just a tax on jobs and should be abolished. No tax or NI for employees is payable until £9570 is earned, but employers start getting caned above £8840. This militates against full time employment, because it is better to have two part timers than one full timer, if you are an employer.

However, when someone has two jobs, they in effect get two NI allowances, so it is better for employee's net pay to have two part time jobs. This is a nonsense.

Those working after state retirement age pay no employee's NI , thereby saving 12%. Surely this can't be right? (I am in this category).

For those with children, earning between £50000 and £60000, there is the ridiculously high tax impact of losing child benefit, which bumps the tax rate up from 40% to 51% for a single child, to 59% for two children and 65% for three children. This is unjust on those whose outgoings on living expenses will inevitably be higher than those with similar earnings without children. This should be abolished.

Losing the personal allowance between £100000 and £125140, effectively puts up the tax rate to 60% for this band of earnings. In the first year that someone enters this band, self assessment payments on account mean that the tax payment rises to 120% of income, which is also unjust. This should be abolished.

The present combined scales for employees are:

£0 to £9570 - nil
£9571 to £12500 - 12%
£12501 to £50270 - 32%
£50271 to £100000 - 42%
£100001 to £125140 - 62%
£125141 to £150000 - 42%
above £150001 - 47%

There is plenty of room for smoothing this out with a sliding scale, whilst incorporating the same tax take and getting rid of the above anomalies, except for employer's NI.

Employer's NI is often the only tax that big international corporations pay, because they have the tax planning skills to avoid Corporation Tax. Small businesses are given relief for Employer's NI through the Employment Allowance and many can get further relief from Employer's NI by using part time workers. How about abolishing Employer's NI altogether? Corporation Tax for larger employers could also be abolished and replaced with a Community Tax based on the gross payroll cost at the level that covers the Employer's NI and the desired Corporation Tax take? Small employers would continue to pay Corporation Tax at a lower rate and not have Employer's NI or the Employment Allowance.

The Office of Tax Simplification could wrestle with these numbers so the overall tax take is at the needed level. But is there the political will?

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Replying to raybackler:
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By AndyC555
22nd Oct 2021 12:13

"For those with children, earning between £50000 and £60000, there is the ridiculously high tax impact of losing child benefit,"

Well, you were asking that those who earn more pay more tax. And under this they do. If you earn more than £50k a year, the government has deemed that you are well off and don't need as much Child Benefit. If you earn more than £60k a year they deem you don't need any Child benefit.

I don't see why you are calling for this to be abolished. Why should someone earning (say) £100k a year get Child Benefit? Don't they have 'broad shoulders'? Shouldn't that money be going elsewhere?

Yes, if you decide to have children, your living costs will be higher. This is called a 'choice'. I've no problem with paying taxes to help those hard up. I really don't see why I should be paying taxes so someone earning £100k a year gets some of that given to them.

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By Charlie Carne
20th Oct 2021 15:46

Politicians are loathe to mix income tax and NI because there is a misconception by the public that NI is a lovely tax that we're happy to pay for health and social security, while income tax pays for both essential things like education and nasty things like weapons. Merging them both (while collecting the same sums from the same sources) deprives politicians of a tool via which they can, from time to time, raise the rates of the 'nice' tax (NI), while leaving IT alone, and would entail the politically sensitive necessity to change the headline basic rate of IT to 32%.

Since a full merger is politically sensitive but, as Philip points out, the system needs simplification, this might be achieved by charging both IT and NI on exactly the same base, with exactly the same exceptions (for employment and self-employment income). If the NI primary & secondary thresholds were abolished and replaced with the personal allowance*, then tax and NI could be levied on the same income. To be clear, I'm not suggesting that the personal allowance and NI threshold simply be set at the same level, as a future chancellor could just adjust them again by different amounts (as happened when the primary and secondary NI thresholds merged for a few years and then diverged again recently), but that the legislation only allows for a single, lower threshold, above which both IT and NI are levied. (* merging the primary & secondary NI thresholds with the personal allowance would require an increase in the rates of ee's and er's NI to compensate for the loss of NI between those current thresholds and that of the PA, but that would aid the very low-paid and charge a little more to the higher paid).

Taxpayers could continue to be deluded that these are separate taxes (as they will maintain their names and be nominally charged and shown separately, especially on payslips), while anyone savvy enough to understand how it works could calculate basic rate 'tax' (to include NI) at 32% on income from £12,570 to £50,270, then at 42% to £100k and 47% above £150k etc (with 62% on that small band above £100k, if necessary). We could go back to calculating in our heads the costs and taxes involved in any salary changes. Employer's NI would be at 13.8% on income above £12,570. The health and social care levy could also be taxed at 1.25% above the same lower threshold. The upper thresholds for basic rate tax and ee's NI (currently £50,270) could also be set in legislation as a single threshold, so it remains in sync in perpetuity.

Under this system, PAYE could be greatly simplified, as both IT and NI would permanently share thresholds (as adjusted with tax codes) and P45's could also show NI deducted to date and allow NI to be calculated cumulatively (across consecutive employments in the same tax year, as is done for IT) instead of on individual weekly or monthly bases (which adds huge complication and unfairness into the system). This would automatically remove the need for much of the separate NI legislation (achieving Philip's desire to "cut hundreds of pages from tax legislation") as both 'taxes' (or all three, including the new 1.25% levy from April 2023) would have the same base for their calculation.

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