Simplifying our tax system is more complicated than it looks

Should we give up on pretending National Insurance (NI) and income tax are actually different taxes? George Osborne clearly thinks so – in his Budget he said there was to be an inquiry into how they can be merged.

It is a brave move. Why? Because it would, at a stroke, mean tax payers would suddenly understand a little bit more about just how much tax they are paying. Everyone would stop referring to the basic rate of tax being 20% and know that it is actually 32%. They’d also stop referring to the top rate as 50%. Everyone would immediately understand that the highest income earners in the land are paying over 50% of their marginal income in tax, a rate that most people recognise as some kind of tipping point in the deal between tax payer and tax collector.

That isn’t the kind of thing that governments usually encourage – in general the more smoke and mirrors around how it gets its hands on tax revenues, the better. However Osborne clearly hopes that if the average taxpayer really understands how much they pay in tax in the first instance (let’s not forget that these PAYE taxes are just the beginning of how much we end up paying) they’ll lobby for lower taxes – and by default, lower spending and a smaller state. That in turn would make the Conservatives more electable than the other parties.

However, while this kind of honesty and simplification sounds fantastic, implementing it is going to be very complicated. First, the pensioners have to be exempted – they don’t pay NI at the moment and, as Osborne recognised in his Budget, they would hardly take kindly to seeing the rate they pay on their income leaping, even at the lowest level, from 20% to 32%. That’s particularly the case given the low interest rates they have been living with for the last few years, and given that they are already up in arms about not getting the £140 flat rate state pension that future pensioners should.

Then there are the self employed – they pay much less National Insurance (and tax all round for that matter) than the employed. This will drive them to a similar frenzy of fury. The same goes for those living off saving and dividend income. They don’t pay NI on this at the moment. And they won’t want to. Then there are those who get employee benefits such as cars – there’s no NI payable on these and there’ll be all manner of fuss if anyone tries to introduce it.

Finally remember that NI isn’t just the 11% (12% next year) that we pay. Employer NI comes in at another 13.8%. That can’t just be abolished – it raises £60bn. But who is going to admit that it is effectively a part of income tax and add it on to the new combined rate? Osborne is clearly brave. But he isn’t that brave.

So to get this through, Osborne has to exempt pension income, pensioner savings income and, if he wanted to ever be invited to a middle class dinner party again, even non-pensioner savings and dividend income. He has to mollify the self-employed. And he has to figure out what to do about employers NI.

Combining NI and income tax might look simple in the end and that is why I am all for it – and for the lower overall tax levels it should lead to. But it will come at quite a cost for our chancellor: it means a real structural change to much of our tax system. Which is probably why he considers it a “long term project”.