National Insurance

Cambridge 2000 memos

May 2001

National Insurance is an odd British tax, and for several reasons. Firstly it is odd because the British government pretends it is not a tax. Secondly it is odd because the way it is set up the marginal tax burden actually decreases for a wide tax band (before it goes up again). Thirdly it is odd because there is an employer as well as employee contribution, and the former means the tax burden is much higher than it is normally stated.

Ever since it was introduced early in the 20th century National Insurance (NI) has been allegedly used to pay for social security. For some reason this was meant to imply it was not a tax. But of course it always has been and always will be a tax.

One particular social security payment is pensions, and because of the way NI has been sold to the public, when people pay NI they believe they are implicitly setting aside money to pay for their future pension (and health care) requirements but in fact they are only setting aside money for current pensioners, not themselves. This particular scam would have been uncovered long ago were it not for the baby boomers, who have managed to fund current pensioners even though the average retirement span is increasing markedly. When the baby boomers retire the entire facade will crumble, which is why many politicians are desperately trying to think up new ways to convince the next generation to start their own pension scheme.

The following numbers are for the 2001-2 tax year. The employee NI tax rate (for most people) is 10% on (annual) income earned between 4535 and 29900 pounds. So the (marginal) NI tax rate is

The ordinary income tax rate is dependent on your tax allowances, which for many people is 4535 pounds, so assume that for the sake of the argument. Then the (marginal) income tax rate is

Thus the total employee tax rate is

Spot the obvious stupidity. Even a 10-year old would see that the tax system is unfair as it stands, there is no way that there should be a drop in the marginal rate of tax, even if it is "only" for a 4000 pound band. The obvious solution is just to get rid of the NI charade and make the income tax explicit. Because of all the other extra complications piled on with both NI and income tax by government after government nobody has attempted this obvious reform.

As it happens the above is not the real tax rate. There is also an employer NI contribution, which is 11.9% on all income above 4535 pounds (so in particular there is no upper threshold, unlike for employee NI). This might seem not to be an employee tax but in fact it is since if the employer did not pay this tax they could increase salaries (and would). If the nominal tax rate is x% then the real tax rate is (x+11.9)/111.9. Thus the real tax rate is

This is how the government manages to take around 40% of national income while pretending that the tax rate for most people is 22%. It's a lie.

Again the obvious solution is just to get rid of this charade and make the employee income tax rate explicit. The existence of the employer NI contribution means that tax avoidance by small companies is possible, and in particular this is the source of the ridiculous decision by the government to introduce IR35. Instead of solving the fundamental problem (the existence of NI) they have decided to opt for arbitrariness and bullying, the usual government way out of a difficult situation.

Cambridge 2000 memos