Tax· Welfare National Insurance cuts: far from being the silver bullet for tax credit changes they miss the target 26 October 2015 by Torsten Bell Torsten Bell It was another busy weekend in the debate on the changes to tax credits that are set to be introduced next April. More suggestions about how the Government might ameliorate the impact on low income working families have been set out. In particular there’s been a bit of focus on the role National Insurance changes (specifically on increasing the amount you earn before you pay NI) could play in softening the blow. Since we did not discuss that option at much length in last week’s article on what could be done, here’s five things that you should know. First: it’s a (marginally) better option than raising the Personal Allowance. Around 1.8m low earners would benefit next year who do not from further Personal Allowance rises. That’s because next April you will pay National Insurance if you earn over approximately £8,100 – in contrast to £11,000 for Income Tax. There’s some history here – back in 2007/8, after some years of effort, the National Insurance and Income Tax thresholds were aligned (which makes sense in many ways). But since then successive governments’ wish to raise the Personal Allowance as a visible tax cut, without worrying about the level of the (less visible) National Insurance threshold(s), has resulted in a major divergence. Second: it is still a poor match for those losing tax credits. Tax credit recipients will start to lose out as soon as their household earns just £3,850. So many affected by tax credit cuts do not pay National Insurance in the first place. For some context it’s worth noting that 43 per cent of households receiving tax credits had earnings of below £10,000. And the winners would include those on higher incomes – including higher and additional rate payers – but exclude everyone over the state pension age because they do not pay NI anyway. The latter fact might be a good thing from fairness perspective, but is not when looking at a straight question of tax credit compensation. Third: the amount of compensation would be too small. Even for those that do pay National Insurance, very few will pay enough for a NI cut to be able to fully compensate them for tax credit losses. Raising the employee National Insurance threshold by nearly £3,000 so it was at the same level as the Personal Allowance would only save an individual a maximum of around £350. That compares to average tax credit losses in April of well over £1,000. It’s also worth noting that when people are moved from tax credits onto Universal Credit they will lose 65 per cent of any NI cut – further cutting the compensation. Fourth: it could be very expensive. That £3,000 rise would cost almost £7bn, well over the £4.4bn the tax credit cuts are supposed to save in the first place. And if the same change was made for employer contributions it would cost over £8bn again. As with Personal Allowance increases that is because everyone that pays National Insurance, not just those who lost from tax credit cuts, would be benefiting from the tax cut – a big ‘deadweight’ impact. Fifth: there are some wider benefits to National Insurance options that should feature in the debate. For example raising the self-employment NI threshold would help some of those losing tax credits who do not benefit at all from changes to the minimum wage (because by definition the self-employed aren’t employees). Any such change could sit alongside the detail the Chancellor still needs to set out about how and when Class 2 National Insurance (a flat weekly tax) for the self-employed will be phased out – a welcome policy first announced in the March Budget. So when you hear people saying that income tax cuts might not work, but National Insurance is the solution to compensating tax credit losses, raise an eyebrow. National Insurance changes aren’t the answer for households hit by tax credit changes even if (as previous Resolution Foundation work shows) they would be preferable to further increases in the Personal Allowance. Most of the problems that make Income tax cuts a poor compensation tool also apply to National Insurance, including the high price tag.