Why simplifying our tax system is just too complicated

We have written here before – several times before – that merging National Insurance (NI) and income tax would be an honest thing for a government to do.

There is no special insurance fund in the UK that somehow pays for welfare, social care and the NHS, everything goes into and comes out of the same pot. National Insurance is just income tax by another name, so why not just say it like it is (we are keen on this kind of thing) and call it income tax?

The Independent suggested at the weekend that George Osborne is keen to have a go – so much so that he almost announced it in his last Budget, and is sure to do so if his party wins another election. I wonder if he really will.

His excuse for not doing it already is apparently that it would involve the merging of two computer systems – and that’s complicated. But it is nowhere near as complicated as some of the other issues that merging the two taxes would throw up.

There is the fact that NI kicks in at a lower rate than income tax – so it would suddenly become obvious that the raising of the income tax threshold to £10,000 hasn’t actually taken x number of people out of the income tax net.

Then there is the fact that pensioners don’t pay NI – so, it would suddenly become obvious to the already resentful younger generation that they are paying a lot more tax than the older generation, despite the fact that they are unlikely to see the same benefits (is anyone expecting there to be non-means-tested winter fuel payments in 30 years?).

Next is the way it would affect pensions. If you save into your pension via salary sacrifice, your NI gets chucked in too. If you don’t, it doesn’t. But if NI were income tax, everyone would get the extra relief. That could be expensive. There are similar problems with other employee benefits.

Then there is the difference between the tax rates on earned income and unearned income. It is irritating that you pay more in income tax than you pay on dividends. But call NI an income tax and it will become clear just how much more.

Earn over the higher rate threshold and you pay 42% on your earned income and 25% on your dividends (the 10% tax credit is a notional nonsense – I’m ignoring it). At the lower rate, it is 32% (yes, the basic rate of tax in the UK is 32%) and 0%.

The same problem would arise with savings accounts – you pay no NI on the interest from these, so it would immediately be obvious to people that if they were working, they would be paying 32% in income tax, but that if they were living off savings, they would be paying 20%.

I’m all for the merger and all for tax simplification, but this discussion makes one thing at least clear: our tax system is so complicated that it is virtually impossible for even well-meaning politicians to simplify.

PS Want to know what your effective income tax rate is? Damien Fahy of Moneytothemasses.com suggests visiting listentotaxman.com. Enter your gross salary and tax code and click ‘calculate’. Take the resulting number and divide it by your gross salary. Tell us how shocked you are (or not) below.