Synopsis: The Centre for Policy Studies (CPS) has published a paper examining the finances of the National Insurance Fund. The CPS says that the fund will run out of money imminently and that the situation offers an opportunity both to scrap NICs and to revisit the idea of a single combined earnings tax, covering income tax and NICs.
Date posted: Thursday, October 16, 2014
‘The state pension fund will run out of cash next year.’ You can rely on the Mail online to give a shock horror headline, but other media produced similar dire warnings, e.g. the Telegraph said ‘Time for the truth: Young people, don’t expect a state pension.’
The blame of all this gloom can be pinned on a report, ‘NICs: The End Should Be Nigh,’ from the Centre for Policy Studies (CPS) written by Michael Johnson. Mr Johnson has history in terms of radical ideas (see, for example, this Bulletin). The CPS is often viewed as a Conservative think tank – it was set up by Sir Keith Joseph – and some of its earlier proposals have become reality under the current government (e.g. see this Bulletin).
In his latest report, Mr Johnson has chosen to attack something of a straw man, the National Insurance Fund (NIF). The NIF started life (in 1948) as a real fund, a point which some of the press reports suggest journalists believe still to be the case. The reality is, to quote Mr Johnson that the NIF is now ‘an accounting creation and merely an extension of the Treasury’s balance sheet.’ It is not a pension fund in the classic sense and is best thought of in terms of the following formula:
|NIF at start of year|
|+||NIC contributions received during year|
|+||Interest earned during year on NIF brought forward|
|–||Allocation to NHS funding|
|–||State pension and other benefit payments* during year|
|=||NIF carried forward to next year|
* Incapacity Benefit/Employment and Support Allowance (contributory only), Bereavement Benefits, Jobseeker’s Allowance (contributory only) and Maternity Allowance.
In practice, the cash inflows of NICs and outflows of benefit/NHS payments mean the NIF is more a conduit than a fund. HMRC says that in 2012/13 for Great Britain there were inflows of £102.4bn and outflows of £112bn, producing a net reduction of £9.5bn (after rounding’s). The NIF began 2013/14 with £29.1bn: at the beginning of 2009/10 it was worth £53.0bn.
Mr Johnson notes that the latest Government Actuary’s Department (GAD) projections show that the NIF will be exhausted by 2027 under current state pension rules and 2035 allowing for the measures in the Pensions Act 2014 (e.g. single tier state pension, SPA to 67 by 2028 and an end to contracting out). Mr Johnson then highlights the optimistic assumptions which the GAD has used, courtesy of the Office for Budget Responsibility (OBR). These include long-term earnings growth of 2.4% above CPI. Even for this year the OBR’s short-term assumptions look optimistic with projections of 1.9% for CPI (currently 1.5%) and 2.5% for average earnings growth (currently 0.6%). Both the GAD and Mr Johnson agree that using more lower (and more realistic) earnings assumptions would exhaust the NIF within a couple of years.
So what? The government will not reduce or stop state pensions simply because an anachronistic piece of accounting goes into the red. However, Mr Johnson feels that the exhaustion of the NIF would be ‘of considerable symbolic significance.’ He believes it ‘would confirm that even with all the recent cost saving measures (such as sending the SPA into rapid retreat) the forthcoming single-tier State Pension is unsustainable.’
That is a moot point. There is no reason why a hypothecated portion of NICs should always at least match the outflow of a certain mix of benefits. In the grand scheme of things NICs are just another tax and to the extent that they fall short of matching expenditure, then they repeat a problem of the government’s budget as a whole (an OBR projected £95.5bn in the red for 2014/15). Indeed, the original single tier White Paper was based on making sure the cost was no more than the current (basic + S2P) system: NICs income was ignored (not least because of the windfall from ending contracting out). However, the rapid arrival of the NIF shortfall raises the question of whether the single tier pension is still an affordable option.
The greater the period that earnings growth is below the assumed rate, the more there needs to be a future catch-up to boost NICs and bring the pay-as-you-go numbers back towards balance. Low inflation is also a bind on the cost side, as the Triple Lock is pushing through 2.5% increases, above both earnings and CPI, giving real terms uplift in pensions.
Mr Johnson has a four proposals to resolve the impending NIF deficit:
1. NICs and the structure supporting them should be scrapped.
2. Employee NICs and income tax on earnings should be replaced with a single earnings tax, ideally set at 32%, 42% and 47%, based upon today’s personal allowance and three marginal income tax bands.
3. HMRC should model the net effect of no longer collecting employer NICs receipts, offset by increased tax receipts from the additional income generated for companies and consumers. Any projected shortfall should be made up by additional consumer taxes.
4. The Chancellor should use the Autumn Statement to signal his intention to end NICs and introduce an earnings tax.
With less than seven months to go before the General Election, this quartet have no chance of emerging from the lips any politician (forgetful or otherwise). Post-election, the picture may be different. After all, the government has yet to announce the NIC rates for the single tier pension starting in 2016/17.
NICs are due to bring in £110.0bn in 2014/15, virtually the same as VAT, and over two and a half times the sum corporation tax produces. It would be a brave Chancellor who turned off that particular tap. On the other hand, a post-election NICs increase looks distinctly possible.
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