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16 January 2014

Progressive parties should cut National Insurance, not income tax

Rather than raising the personal allowance or introducing a 10p rate, the Lib Dems and Labour should cut NI if they want to help the poorest.

By Adam Corlett

With the income tax personal allowance at long last rising to £10,000 this April, attention can turn to what further tax cuts might be offered at the general election. The Lib Dems want to build on their most high profile policy win and raise the allowance again, to an annual equivalent of the minimum wage. The Conservatives may follow suit, and Labour have been forced to differentiate by offering a tiny and unnecessary 10p tax band.

Whether cuts in direct tax should take priority over VAT and other indirect taxes is a question for another day. But even amongst direct tax cuts, a new report from CentreForum argues that changes are needed to ensure future offers really do help the low paid. For one, all three parties are wrong to focus on income tax when National Insurance cuts are ripe for the picking.

Why focus on raising the income tax threshold to over £12,000 when National Insurance begins at under £8,000 (£6,000 for some)? Most workers on the minimum wage pay more in National Insurance than income tax. By focusing only on income tax, whether a higher allowance or a 10p band, and ignoring National Insurance, politicians will pass over millions of low income workers and the self-employed. These are the same people they profess to be helping.

The priority should be to increase the National Insurance thresholds to £10,000 – in line with income tax. This would simplify the tax system , too, where basic taxes can begin at ten different thresholds. And while cutting National Insurance for low earners, we shouldn’t ignore the (separate) threshold for employers – especially as a rise could allow for a higher minimum wage without increasing employment costs.

Our report also looks at whether tax thresholds should be linked to the minimum wage, as the Lib Dems have suggested. It concludes that an expert-recommended, hourly wage, limited to avoid risking jobs, could not remain linked to an annual, political, tax level: they are both too important. A better goal would be to take the absolute poverty line out of all tax. This is around £10,050 in 2014/15 for a single adult. It would make sense for our tax system to avoid pushing non-parents below the government’s own poverty line (if you have many children your poverty line goes up). The coalition’s changes have almost taken this line out of income tax, but now action is needed to ensure National Insurance does not turn low pay into poverty pay.

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There are many more questions surrounding direct tax cuts, but the big one is cost. The coalition’s allowance increases have cost a massive £11bn, and the Lib Dems’ new tax proposal would likely be even more expensive – particularly if the minimum wage is boosted. Parties therefore need to be honest about how tax cuts would be funded. Would the Conservatives cut welfare to pay for tax cuts that go to richer families? And the Lib Dems may find the many tax increases they would need, but would that leave any room for progressive, tax-funded deficit reduction? National Insurance cuts would be cheaper than raising the Personal Allowance, and could be well targeted on low earners through small rate increases.

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The Lib Dems should rethink their policy, and other parties should seize the chance to help a poorer set of workers than the Lib Dems propose. And if we see another coalition in 2015, let’s hope the most progressive and sensible option prevails.

Adam Corlett is an economics researcher at CentreForum, the liberal think tank