National Insurance is still the wrong tax, at the wrong time

Sajid Javid has made a good attempt at defending the increases in National Insurance rates for workers and businesses, arguing that they are both right and fair. But he is still wrong.

Speaking to Sky News, Javid said that “when we spend money on public services, whether it’s NHS or anything else for that matter, the money can only come from two sources. You raise it directly for people today, that’s through taxes, or you borrow it, which essentially you are asking the next generation to pay for it”.

This seems fair enough. However, let’s break it down a bit.

For a start, the money raised from the increases will initially be used to fix the backlog of NHS work caused by Covid, not to fund a structural increase in spending on health and social care. This is another one-off cost of the pandemic. As such, it would be perfectly reasonable to spread this cost over time, by adding it to long-term borrowing, instead of funding it from current taxation.

This would have been consistent with how the government has financed other emergency measures, such as the cost of the furlough scheme. No-one is seriously arguing that we should raise all of this money straightaway.

If it were down to me, I would have used the windfall from higher-than-expected tax revenues to delay the increase in National Insurance contributions for at least a year. There is never a good time to raise taxes, but now – in the midst of a massive external shock and a cost of living crisis – is especially bad.

But let’s suppose that it is right to raise taxes now. National Insurance is still a bad choice.

Here, Javid has said that “it is right that we pay for what we are going to use as a country but we do it in a fair way. This levy, the way it is being raised is the top 15% of earners will pay almost 50%”.

It is true that, like many other taxes, more of the total amount raised from the increase in National Insurance will come from those on higher incomes. But this is because they earn (and spend) more money in the first place.

The usual measure of fairness is the ‘progressivity’ of a tax – in other words, whether people on higher incomes will pay a higher proportion of their income in tax. But National Insurance does not score particularly well here, for two reasons.

First, while National Insurance is progressive for lower to middle earners (thanks to the fact you do not pay any at all on earnings below a certain threshold), it becomes regressive at higher incomes (because you also pay a lower rate on earnings above an upper limit).

Admittedly, it would be wrong to describe the increases in National Insurance contributions as regressive, because the 1.25 percentage point hike will apply to all qualifying incomes. across the board. But nor could you really describe these increases as progressive.

Second, National Insurance is only paid on some forms of income. Traditionally, it has not been levied on income from property or dividends (I note Javid was careful to say ‘earners’), or the earnings of those working who are over the state pension age. The burden therefore falls disproportionately on people in work, and younger ones at that.

To be fair, the government has acknowledged these points. The National Insurance hike will now be applied to income to dividends, and from April 2023, when it is rebadged as a new ‘Health and Social Care Levy’, it will also be paid by anyone still working who is over the state pension age.

In addition, in the Spring Statement the Chancellor raised the threshold at which you start to pay National Insurance by £3,000. This will reduce the NI bill for many low earners – although not until July.

These are reasonable changes, but the fact that they have to be made at all also underlines the point that National Insurance was probably the wrong tax to target in the first place.

Last September, when the Prime Minister first announced the tax increases, he attempted to justify the use of National Insurance by arguing that it is also paid by businesses, in the form of employer contributions, thus reducing the burden on individuals. This is poor economics.

Like any corporate tax, the increase in employer contributions will inevitably be passed on to real people, including in the form of lower wages and higher prices. For many people, then, the effective tax increase will be more like 2.5 percentage points than the headline increase of 1.25 percentage points, because this is applied to both employee and employer contributions.

And while it is hard to model the knock-on effects, it is plausible that the pass through to wages and prices will disproportionately hit poorer households, increasing the chances that these increases are regressive at lower incomes too.

In sum, raising National Insurance now is neither right, nor fair. It is still the wrong tax, at the wrong time.

This article was first published by CapX on 6 April 2022

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