Contractors should start to receive their personal tax summaries during November and December 2014. The summaries show how much income tax and National Insurance Contributions (NICs) an individual taxpayer pays during the tax year.
The Chancellor George Osborne and the Coalition are clearly taking the long view by issuing these, as they will help to manage wholesale reform of the tax system and highlight any future increases in stealth taxes.
What is glaringly absent from the personal tax summaries, though, is the total percentage of tax that individual taxpayers contribute to the Exchequer. This would have been a relatively straightforward step for HMRC to take when generating the tax payment summaries.
That’s probably not desirable right now for political reasons. If taxpayers start thinking in percentage terms, and the whole tax system is changed, then any new percentage-based income tax rates would be compared with the old ones and used to score political points.
Let’s look at an example. Robert earns say £23,000 per year and pays a total of £4,541 in tax. Charlotte earns £60,000 per year and pays a total of £18,236 in tax. This is how these translate in percentage terms, which won’t be in the tax summaries:
- Robert is paying 19.7% tax on his income, with a marginal rate of 20%
- Charlotte is paying 30% tax on her income, with a marginal rate of 40%.
The recent trend has been for the UK’s supposedly progressive tax system to take as many people out of income tax as possible. But not necessarily out of paying NICs. Economic commentators believe that taking people out of taxation completely is not actually a positive step, as they then have no stake in the system.
So let’s say the tax system is reformed. Income tax and NICs are merged into a single earnings tax, but the personal allowance is scrapped and new bands are introduced so that Robert on £23,000 a year is paying 19.7% and Charlotte on £60,000 per year is paying 30% of their income in tax.
Both Robert and Charlie are paying the same amount of tax in cash terms as before, only now when you compare their tax statements with the old system Robert on £23,000 used to only pay 20% tax, and has had a 1% drop in tax rate. Charlotte on £60,000 a year used to be in the 40% tax band and is now only paying 30%. That looks like Charlotte has benefitted from a 10% tax cut, which is a political hot potato as it hardly looks progressive.
The personal tax statements in their current form focus on the total cash that people pay in tax rather than the percentage. That means tax changes can be introduced that refer to amounts and not percentages.
The benefit is that if a tax raising party secures power then it will be very obvious if they increase taxes by stealth. No one considers NICs to be an income tax, but if course that is exactly what they are.
And NICs have been increased significantly in the last decade. If a simplified earnings tax was introduced alongside the personal tax statements, politicians would find it impossible to raise taxes by stealth such as increasing NICs again.
Perhaps it is no coincidence that the Office of Tax Simplification (OTS) is working on a better definition of employment and self-employment for tax purposes. No one is denying that the problem of ‘disguised employment’, resulting in workers and businesses avoiding NICs, would be eliminated if NI and PAYE were merged into a new earnings tax.
And with the growing number of self-employed workers including contractors, politicians will have to act to protect Exchequer revenues. NICs are major source of tax revenue that needs protecting. Merging NICs and income tax would appear to be the sensible way to do it.
Personal tax statements are a clever strategy to help manage the impact of any future merger. The Chancellor and the Coalition might be thinking very long term here by starting to change taxpayers’ mindsets and proactively managing the debate so that there is limited scope for anyone to cry ‘foul’ if and when the tax system is overhauled.