This piece was originally published by the Telegraph as part of their General Election series.
The world of work is changing quickly – and the extraordinary success of the Government in presiding over an economy with almost full employment is a tribute to the broadly flexible nature of the UK labour market. Today the employment rate stands at an all-time high of 74.6 percent.
And yet the tax system is extraordinarily complex and in many cases incoherent. Since 2009, the word count of Tolley’s Tax Handbook (the authoritative guide to tax law) has increased by approximately 5 million words and now stands at around 10 million – 12 times the number in the King James Bible. The Hong Kong tax code, widely held by tax lawyers to be the most admirably efficient in the world, is just 276 pages long.
As a result tax advice services are at a premium – top tax advisers in the UK now charge up to £1,000 per hour. This is a higher figure than almost all overseas tax advisers – with the possible exception of the US, where there is a tax code which is almost as over-complicated as that of the UK.
One aspect of all this complexity is the different way in which normal employees and the self-employed are taxed. Normal employees are taxed at source through the PAYE system. But on top of their income tax, they have to pay Class 1 national insurance contributions (NICs) of 12 per cent of their salary (between the Primary Threshold and Upper Earnings Limit), and 2 per cent on earnings above the UEL, while their employers have to pay an additional 13.8 per cent on earnings above the Secondary Threshold (of £680 per month – keep up! You were warned that it is complex).
The self-employed largely avoid such charges or have lower rates, meaning that their take-home pay is about a quarter higher for the same remuneration. This creates a huge incentive for individuals to opt for self-employment over traditional employment, where they can.
With the dividing line between traditional employment and self-employment becoming all the more obscure by the day, we can only expect more people (and their employers) to arbitrage the tax system at the Exchequer’s loss.
Coalition proposals for a universal flat-rate state pension effectively removed the last justification for our national insurance system. Whether we like it or not, the contributory principle underlying NICs will shortly be superfluous.
In any case, NICs are riddled with anomalies, complexity and a lack of cohesion. They can reward the profligate while penalising the thrifty. They can discourage saving. They can be unfair. They can impose high marginal rates on low earners. They have been used to disguise tax increases. And the introduction of a universal state pension under the recent Coalition Government provides the ideal opportunity to merge NICs and income tax.
Businesses would welcome the simplicity of a single tax. National insurance is a staggeringly complex system, with some 60 different categories into which employees may fall; merging income tax and national insurance offers the scope for substantial savings on administration costs for employers.
The idea of merging national insurance and income tax is not new. But what has always hampered any meaningful reform is the fact that any such reform would create a substantial number of “losers”. Unless the tax rates were changed, simply demanding that all the self-employed should pay the same rates as everyone else would mean that many would lose substantially. But this can be addressed by combining national insurance and income tax rates – at a lower level than currently. Everyone would benefit.
Some will claim that such a reform might be too expensive, overlooking the fact that the recent cuts in corporation tax from 28% to 20% have been accompanied by a significant increase in the Exchequer’s receipts. But if it were judged necessary to prove that the impact of such simplification would be tax neutral, the Government could fund this reform by replacing all pensions income tax relief (which overwhelmingly benefits the higher rate taxpayers) with a simple 25% flat rate bonus, paid irrespective of tax paying status.
Thus would deliver lower taxes, particularly for the less well-off, a broader tax base, and a simpler tax system which better reflects modern work patterns.