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The end of national insurance? Five potential implications

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Written by: Your Money
22/07/2015
Chancellor George Osborne is considering merging income tax with national insurance (NI).

Gary Smith, financial planner at Tilney Bestinvest, looks at five potential implications:

  1. Potential reduction in tax liability – the starting rates at which you pay income tax (£10,600) and national insurance (£8,060) are different.

Logic would dictate that given the Conservative pledge to increase the personal allowance to £12,500, this would also have to be the starting rate for any combined income tax / NI rate.

This would mean that everyone could earn £4,500 more before paying any NI equivalent. It would also remove the anomaly for those who earn below the personal allowance, but above the lower earnings limit, having to pay NI but no income tax.

  1. It would enable the government to increase the rate at which people pay higher rate tax to £50,000, whilst reducing the potential loss to the Exchequer.

This is quite devious as, under the current system an individual pays 40% income tax and only 2% NI above the basic rate band. So, if they leave the system as it is, the Exchequer will be giving up 20% income tax on circa £8,000 of income if they do increase the Basic rate band to say £50k (including personal allowance).

However, if the government merges income tax and NI, the effective basic rate tax would be 32% and the higher rate 42%. Therefore, if they increase the basic rate band they are only giving up 10% on £8,000.

  1. The death of pension tax relief?

The government has already announced a consultation on the pension tax relief system, and I believe that a merger of income tax and NI would likely result in the floated idea of a pension with ISA-like tax treatment. This is because at present, a basic rate taxpayer gets 20% tax relief on pension payments but surely this would increase to 32% under a combined system. It seems illogical to increase tax relief at a time when they are actually trying to reduce the cost to the Exchequer. An equal tax treatment of ISAs and pensions could be a prelude to merging the two, potentially drawing ISAs into some form of limetime allowance.

  1. Would any new rate apply to dividends?

We have already seen the introduction of tax on dividends for basic rate taxpayers of 7.5% from April 2016. At present, NI isn’t payable on dividends and one could suspect that the government will also seek to increase this rate to reflect the merged rate. While probably below the 32% rate for people with earned income, the additional tax generated could cover the cost of increasing the basic rate band to £50k.

  1. Pensioners

I believe that this could be easily addressed by having a separate tax rate for pension income, similar to savings rate tax. So a 20% tax on the pension income in the basic rate band and 40% etc. thereafter.

 

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