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National Insurance – the forgotten tax

3rd January 2018

Surprisingly costly

National Insurance (NI) is one of the most important, overlooked, taxes for most working people. 

In context, an employee earning between £11,500 and £45,000 per year, for every extra £1 they receive in net pay, the Treasury receives 67.35p (29.41p in Income Tax and 37.94 in NI (of which 17.65p is Employee’s NI and 20.29p is Employer’s NI).  Quite shocking.

This is often accepted with a shrug – partly because people think it goes towards their State Pension and is not a pure tax.  In fact, NI goes to the Treasury like any other tax. 

There are a couple of plus points to paying NI:

  1. If you pay some NI you get a Qualifying Year towards your State Pension (whether you pay 10p or £10,000) – and 35 Qualifying Years mean you get the full State Pension;
  2. To claim Contributions-based Jobseekers Allowance, you have to have paid enough NI contributions in the previous two tax years to qualify.

But, generally NI is just another tax to avoid where possible.

The battle over employment status

Because NI is so important to the Treasury, the Government is constantly fighting a battle to define workers as employees (NI mostly at 25.8% NI) rather than self-employed (NI mostly at 9%) – and cases  like the recent Uber case where the drivers have been classified as ‘workers’ rather than self-employed contractors are very good news for the Treasury (and  may turn out to be a hollow victory for many workers).    

Historically, one of the ways some taxpayers sought to minimise NI was by operating through their own Limited Company, so that they could avoid NI by paying themselves dividends (as shareholders in their own Company).  But in 2000, the Government attempted to counteract this for Personal Service Companies by introducing a law known as IR35 - which seeks to collect tax from these Companies as if they were employees (although with no employment rights).  This has only proved partially successful so, since April 2016, many Limited Company contractors working in the Public Sector have had PAYE and NI deducted directly from their sales at source.  This has not gone down well with many Public Sector contractors – including many NHS workers – with the result that many Public Sector projects are (as reported) now falling behind schedule as contractors leave for the Private Sector.  And the battle continues…..

Why not scrap National Insurance?

It has always struck me as perverse that much more tax (including NI) is payable on earned income than on unearned income.  So someone who has to sweat for their wages pays a much higher percentage of their income to the State than someone who sits at home with their feet up while their dividends and interest hits their bank account.  An obvious thing to correct this apparent unfairness would be to scrap NI and raise Income Tax.  But, unfortunately, that would mean simplifying the Tax system – which is not what Chancellors of the Exchequer like to do!