There’s 13.8% employer national insurance when someone’s employed, and nothing when they’re not. That’s unfair – but also creates a huge amount of uncertainty, litigation and tax avoidance.
There are reports that Labour is considering increasing employer national insurance. We shouldn’t be talking about raising employer’s national insurance – we should be talking about abolition.
This Government was elected on a platform of kickstarting economic growth. It has a large majority, and four or five years until the next election. It’s a rare chance for real pro-growth tax reform. That’s all the more necessary if we are going to see tax rises.
We’ll be presenting a series of tax reform proposals over the coming weeks. This is the third – you can see the complete set here.
Who pays employer NICs?
The answer is, mostly, employees.
Because, in the long run, the economic cost of employer national insurance is born by employees. The reasons why come down to “economic incidence” – it’s a concept many readers will be familiar with, but for those that aren’t, I’ll run through a short explanation.
Who pays a tax? The obvious answer is: the person responsible for paying tax. This is the “legal incidence“. When I buy a bar of chocolate, the person legally paying the VAT is the shop. If Labour increase employer NICs, it’s the employer paying the tax.
But who is *actually* paying the economic cost of the tax?
If VAT goes up on all products, the shop pays more VAT. But everyone knows they’ll pass the cost on to me, buying the chocolate. The “economic incidence” is on me. (It’s different for VAT increases on individual products; they’re not always passed on.)
If Starmer said “we’re increasing VAT. That’s a tax on business not on workers”, everyone would know that was nonsense. We all intuitively understand economic incidence and VAT. Employer NICs are less obvious.
Conventional economic theory says the burden of all employer NICs and similar payroll taxes are shifted onto workers. In the long run, wages go up if NICs are cut (and/or more workers hired) and down if NICs are raised (with fewer workers hired). The evidence is extensive:
- An extensive review by Stuart Adam (of the IFS) and others found that, in the long term, 2/3 of employer NIC increases/cuts were shifted onto workers’ wages. More in some cases.
- This reflects a large body of work going back to the 70s.
- A more recent IFS paper on a Hungarian payroll tax cut showed that high skill workers got a pay increase. Low skill workers didn’t; but more were hired. On that basis, an employer NIC increase would likely do the reverse.
- A recent study in Singapore found that 76% of a payroll tax cut went to higher wages.
- Another study from Brazil found that, outside of unionised sectors, there was a bigger effect on employment than wages. Cutting NICs increases employment; raising NICs reduces it. (Again that’s a conventional economic result: you tax something; you get less of it.)
- A big US study for the Congressional Budget Office found that, even in the short term, up to 62% of a payroll tax increase would be passed to employees. The long term effect could be less if the tax was used to reduce Government debt (which seems unlikely).
- There is some contrary evidence. A study of small businesses in Virginia found that payroll tax increases resulted in higher prices, not lower wages. This may be a special case, but it isn’t a compelling argument for a NIC increase.
- And a study on Finland found that businesses bear the burden of Finnish payroll tax, resulting in lower employment of low-skilled workers and reduced investment. The result may reflect evasion rather than actual behaviour, but (if the results are “real”) then most policymakers wouldn’t see them as desirable.
- It was likely on the basis of this evidence that the OBR advised the Government in 2021 that 80% of any rise in employer’s national insurance would be borne by workers.
None of these results are comforting for anyone who thinks that increasing UK employer national insurance is a good idea. It’s one of the *worst* tax increases Ms Reeves could introduce.
I listed 32 ways Labour could raise £22bn here. Some are good(ish). Some are bad. Almost all are better than increasing employer NICs. I’ll be very surprised if this is what Labour do.
The wider point is that nobody should ever discuss a tax cut, or a tax increase, without first thinking about who will bear the economic incidence.
Labour’s manifesto
Labour’s manifesto said:1On page 19.
“Labour will not increase taxes on working people, which is why we will not increase National Insurance, the basic, higher, or additional rates of Income Tax, or VAT.“
On my reading, any increase in employer’s national insurances breaches the letter of the pledge, because employer’s national insurance is (obviously) national insurance. But it also breaks the spirit, because an increase in employer’s national insurance would, in practice, amount to a tax increase on working people, for the reasons noted above.2Most of the current reports suggest Labour is considering a general increase in employer NICs. A different – but more rational – proposal would be to end the employer NIC exemption for pension contributions. That in principle could raise around £20bn. Again, in the long run the cost would be borne by employees. Like many pension changes, this would also have the disadvantage of (in practical terms) applying only to defined contribution pensions; the large (and mostly public sector) defined benefit pensions would be unaffected. That feels unjust.
The case for abolition
There’s 13.8% employer national insurance when someone’s employed, and nothing when they’re not. That’s unfair – but also creates a huge amount of uncertainty, litigation and tax avoidance.
All the many, many schemes to shift an employee into something that looks more like self-employment? They’re all about employer NICs. You can change definitions, and create new anti-avoidance rules; but if you’re going to have a massive tax difference between employment and self employment then avoidance and disputes are inevitable.
The answer in principle is easy: end employer national insurance.
Whilst we’re at it, we should abolish the apprenticeship levy. This was introduced in 2017 — a 0.5 per cent tax on employers’ wage bills. It sounds virtuous, but actually the connection to apprenticeships is almost non-existent. The name of the tax is just a marketing trick, when the reality is that it’s a tax on employing people, and (again) its effect is to depress wages. Keeping an entire tax on the books – and a fairly complicated one – just because the name is politically attractive is an insult.
Why do employer NICs exist?
Partly it’s because, just as employers contribute towards their employees private pensions, it was thought sensible that they contribute towards their state pensions (although national insurance doesn’t actually work like this).
But, in recent times, it’s mostly because it’s been politically easier to raise employer labour taxes than employee labour taxes. The electorate, goes the theory, doesn’t see it the same way.
And so we see very sizeable employer labour taxes in most developed countries (it’s the light blue bar):
Denmark, New Zealand and Australia are the only developed countries which have (almost) no employer labour taxes. That doesn’t mean the overall level of personal tax is any different (and Denmark is a high tax country). It means that it’s clear to people how much tax they’re paying, and there’s a much lower incentive and ability to avoid tax by shifting income from wages to dividends, consultancy fees, etc.
We should aim to join them.
Why abolition is hard
The problem is that employer contributions raise about £109bn and so can’t simply be abolished. The apprenticeship levy another £4 billion. We’d practically have to increase income tax commensurately. That would be a very large tax increase, given that income tax currently only raises £300bn.
In the long term things should even out, given that the economic incidence of employer national insurance largely falls on employees (because it reduces pay packets). However in the short term it would represent a huge tax rise for employees, and a huge tax cut for employers. That’s unjustifiable and surely politically unthinkable.
The question is: is there a clever way to bridge the gap? To, for example, oblige the NIC savings for employers to be paid to employees? It’s not clear to me that can be done, but the prize is so substantial that it’s worth very clever people spending time finding a solution.3One could imagine an obligatory 13.8% bonus that employers are required to pay to employees, tapering down over time (in the hope that tax incidence does its thing). Any real world solution would have to be considerably more sophisticated. It might be tempting to pick on individual sectors (like professional partnerships), but that would be unprincipled and drive avoidance.
Absent a brilliantly innovative solution, I have two suggestions:
First – next time Government is thinking about cutting corporation tax, consider cutting employer national insurance instead.
Second – don’t increase employer national insurance again.
- 1On page 19.
- 2Most of the current reports suggest Labour is considering a general increase in employer NICs. A different – but more rational – proposal would be to end the employer NIC exemption for pension contributions. That in principle could raise around £20bn. Again, in the long run the cost would be borne by employees. Like many pension changes, this would also have the disadvantage of (in practical terms) applying only to defined contribution pensions; the large (and mostly public sector) defined benefit pensions would be unaffected. That feels unjust.
- 3One could imagine an obligatory 13.8% bonus that employers are required to pay to employees, tapering down over time (in the hope that tax incidence does its thing). Any real world solution would have to be considerably more sophisticated.
14 responses to “How to reform employer national insurance – don’t increase it, abolish it”
This will persist until actually defines what employment is so “contractors” can be easily taken on fixed term contracts as an employee without the fear of employing staff by the employer.
As a freelancer of some 20 years, I know full well that employers (clients) want someone off the books to do work because (a) ErNIC, (b) pensions and other welfare costs, (c) reporting fewer FTEs in annual accounts. We are forced to use Limited Companies because the risk of hiring someone that is self employed is too great to the hiring company. So we reduce total NIC by partially paying in dividends. But the flip side of that is our profits are taxed so the net difference is minimal (more so since dividends are now taxed). Being pushed onto an umbrella following an “inside IR35” determination means the headline rate being offered is now subject to ErNIC, EeNIC, AL and PAYE. However, the client still only wants to pay the same day rate that they used to because they never used to pay NIC on contractors, so why should they now? I’m all for a better blending of taxes on all forms of income to level the playing field across all types of worker. However, it can’t come at the cost of a two-tier worker rights. I (used to) take home more as a freelancer because I had to cover all my own welfare costs and was rarely eligible for SSP. Currently, you can be self-employed for rights and employed for tax purposes, that should not be allowed to continue.
I will be so disappointed if this is the tax rise they go for. I work as an employee in an industry with many “contractors” (disguised employees). Both employer, I mean client,
and contractor go to great lengths and expense to try to stay on the right side of the rules. Poor for productivity as well as tax revenues. This is only going to make the problem worse.
I the government have promised themselves into a corner and are going to do something to employer NICs. What are your thoughts on applying employer NICs to pension contributions, as has also been speculated? Is it any better than increasing the rate?
Why is the tax being shifted onto wages a bad thing? Just makes it equivalent to an employee NI rise, having just seen an irresponsible 4pp cut. Sure, it breaks their election pledge but gives them plausible deniability and they’re effectively doing what they should’ve done which is reverse the NI cut.
it’s worse, because the cut was to employee and self-employed NICs. This increase would only be to employer NIC. It would increase the gap between the tax cost of employing someone and the tax cost of engaging a contractor. That disincentivises long-term jobs, and adds to the already large incentive to artificially shift into self-employment to avoid tax.
Just bad policy.
Fair enough, I hadn’t fully realised that (and that is a bad aspect of this policy).
Just feels like everyone’s going gung ho in criticism of this tax rise and having their cake and eating it with their critique of employer NIs by saying it gets passed onto wages (bad because incidence on workers) and it will reduce employment (which would only really happen if incidence on businesses). Of course it can be a little of column A and a little of column B but the relative merits of that versus all column A and all column B are not entirely clear. Some of the papers you cite also imply quite a different normative angle to your summary – Singapore paper concludes basically that passing on vast majority of gains to wages from a tax cut shows that payroll taxes are fine (in a flexible labour market like Singapore). Hungary case increases employment in low-productivity firms (is that what we want?). My reading of the Stuart Adam et al. analysis is that incidence actually lies with employer up to a year after reform (and they don’t look at long-term effect) and no effect of increase in marginal rate.
I’m mostly just trying to inject some uncertainty into the idea that employer NIs (in general) are bad policy.
“Who pays a tax? The obvious answer is: the person responsible for paying tax. This is the “legal incidence“. When I buy a bar of chocolate, the person legally paying the VAT is the shop. If Labour increase employer NICs, it’s the employer paying the tax.”
Isn’t it actually the case that individual citizens are ultimately who pays the real economic cost of any tax? A company, or a trust, or a charity or any other form of legal entity is simply a conduit between the government collecting the tax and the people who are paying it – either directly from citizen to government, or indirectly through increased prices for good and services, or lower returns on investments?.
The only difference may be the distribution of the payment across country borders, such that a government in country A may be collecting taxes ultimately borne in country B. This is also true in reverse so may make little difference in practice.
So if the tax burden in a country is increasing, it is the citizens of that country who are paying the increased taxes as a result – it makes little difference in the end as to exactly how they are levied?
of course that’s true, the question is which individuals carry the cost? shareholders? customers? employees? foreign owners?
Employers NI is a major factor in driving the shift from employee to self employment status. The pressure that Royal Mail faces from firms using “self employed” couriers is well understood. But the public sector is not a level playing field either. When the NHS tenders for NHS community physiotherapy, the winner now often uses self employed physiotherapists undercutting the use of NHS employed staff – the NHS does not factor in the lost revenue for the exchequer in its evaluation.
Non Equity “partners” in LLPs:-
Compared to traditional employee relationships, the partnership structure saves 13.8% employer national insurance contributions (NICs).
Treat as employees?
Taking the NI piece a little to one side. Employers NI is not a standalone factor. Governments, of all persuasions, push minimum wages as an act of generosity from them but, in practice, it is a money spinner for the exchequer with the biggest transfer being from employers to government. For some boring detail see https://benefitsinthefuture.com/the-government-is-continuing-to-be-extremely-generousto-itself-nlw-2024/
What would be interesting to know is how much PAYE/NIC debt is currently owed to HMRC?
Also I have noticed the government has decided to bat down the road, the tightening up of employment status.
I believe any increase of employer NIC will only result in fewer new ’employees’ being created, and potentially greater use of pseudo ‘self-employed’ which HMRC have serious problems dealing with.
As you said this will be disaster waiting to happen.
You may be right, but in 40 years of employing staff I never once considered national insurance in determining salaries. The only consideration was what my competitors were paying -and with existing staff how keen I was to retain them. I suspect.
I suspect that I was not the only one who looked on employer’s NI as an overhead
there is some evidence, in the studies linked above, that small firms are more likely to respond to payroll tax changes by hiring more/fewer people, rather than by wages changing.