Unpleasant choices

Funds are needed to reform the social care system …

Fiscal strategies around the world have been blown off course by the pandemic which has forced governments to reconsider ways to pay for the demands on the public sector. Indeed, one consequence of the pandemic is that it has highlighted the need for a strong public sector to marshal the resources required to meet unprecedented circumstances. It has also highlighted the need to fund areas of public sector engagement which have been neglected for too long.

One such issue in the UK is the provision of social care. Scarcely a week goes by without news that one of yesteryear’s footballers has been diagnosed with some form of dementia – a particularly distressing condition which robs people of their identity – with the latest victim being former Liverpool and England footballer Terry McDermott. Whilst professional footballers appear particularly prone to the disease, due to the repeated application of blows to the head as a result of heading the ball, it affects many hundreds of thousands of people in the UK alone. According to the NHS, there are more than 850,000 sufferers, with 1 in 6 aged over 80 afflicted. Social services struggle to provide the requisite care for this and other conditions, and upon acceding to office in July 2019 Boris Johnson promised to “fix the crisis in social care once and for all with a clear plan we have prepared.”

It turns out that the “clear plan” did not exist. But the Conservatives did promise in their 2019 election manifesto to “build a cross-party consensus to bring forward an answer that solves the problem.” Unfortunately Covid blew the government off course but as we start to cautiously look ahead to the post-pandemic world it appears to be seriously considering how to tackle the issue. Media chatter in recent days has focused on the likelihood that the government will announce a rise in National Insurance Contributions (NICs) – a form of payroll tax – to fund it. It is being suggested that both employers and employees will pay an additional one percentage point, which it is estimated will generate an additional £10bn of revenue (around 0.5% of GDP). One problem with this policy prescription is that it flies in the face of the 2019 manifesto commitment that “we will not raise the rate of income tax, VAT or National Insurance.”

This was, as I noted 2019, “not good policymaking” because “taking these key levers out of the fiscal equation could severely limit the Chancellor’s room for manoeuvre” – a lesson amplified by the unexpected nature of the Covid pandemic. Nonetheless, whilst the plan to raise taxes has been widely criticised as a break with the manifesto commitment, there has been rather less acknowledgement of the fact that it is designed to fulfil another one. That there is a need to provide additional funding for the social care system is undeniable. As the Kings Fund has pointed out, the one percentage point rise in NICs back in 2003 to fund the NHS resulted in “a generational improvement in waiting lists, major investments in key causes of death such as cancer and heart disease, and improvements in mental health.” Providing the funds alone is not enough and significant reforms to the system are also required. Nonetheless it would represent a good start.

… but NICs are not the best way to raise them

The planned tax rise has also come in for significant criticism for a number of economic reasons. For one thing, it is a tax on those in employment whereas those of retirement age are the prime beneficiaries which strikes many people as unfair. It also comes at a time when the government is planning to phase out the temporary increase in Universal Credit to help low paid workers during the pandemic. According to one MP quoted by Sky News, “I'm very concerned about the fact we seem to be protecting the inheritances of those with means at the same time as stripping the £20 uplift [in Universal Credit].”

NICs are also regressive. All employee income between the lower earnings limit (£9,568 per year) and upper earnings limit (£50,270) is taxed at a 12% rate but any income exceeding the UEL is subject only to a 2% rate. This has the effect that the average rate of National Insurance Contributions falls the further incomes are above the UEL. Thus, whilst those earning £50k per annum pay an NIC rate of 9.7%, those earning gross income of £100k pay an average rate of 5.9%. Even more egregious is the fact that those earning half the average wage (around £15k per year) pay a higher NIC rate than those earning £200k. If the government is intent on raising NIC rates, it really ought to review the structure of the tax first. It could, for example, raise the tax rate applied above the UEL so that the average tax rate falls more slowly at higher earnings levels (see chart 1 demonstrating the impact of various options).

Another problem with hiking NICs is that the incidence will also fall on employers. The empirical evidence does not suggest that hikes in employer NICs will have a significant impact on employment but it may at the margin impact on firms’ willingness to create new jobs, particularly in the post-Covid environment where many service sector firms face uncertain revenue prospects.

It is not even clear why we need NICs at all. They were originally intended as a tax to fund the social welfare system but they have long since been subsumed into general taxation (only around 20% goes directly to the NHS). In effect, they are perceived as a form of income tax. Some years ago I performed some calculations which suggested that it would be possible to abolish NICs altogether and set higher rates of income tax whilst still giving a post-tax income boost to the lowest earners. In my view this would not be a bad place to start in order to reform the tax system – a subject to which I will undoubtedly return.

What are the alternatives?

One possibility is a rise in income taxes. As the IFS has pointed out an increase of 1.5 percentage points in the basic and higher rates of tax could generate the same revenue as the proposed rise in NICs. The incidence of the tax is also skewed more to older workers, with 14% of the revenue coming from pensioners versus 1% in the case of NICs – not a huge amount but it is an improvement. However, an increase in income taxes would also violate the manifesto commitment.

Unions have suggested that capital gains taxes be increased although according to the HMRC ready reckoner, each one percentage point increase across the board would only generate around £175 million. A rise in CGT rates would go a long way as a signal of intent to the low paid, but as a practical revenue raising measure it would not deliver much. Increases in stamp duty land taxes by one percentage point could generate around £1 billion. But this is only 10% of the yield generated by higher NICs, so here too, a significant hike would be required to make up the shortfall. It would thus appear that an alternative to hiking NICs would require a combination of tax increases across a variety of areas. For example, a two percentage point rise in stamp duty plus a five percentage point increase in CGT would yield £3 billion. Another £1 billion could be squeezed out of inheritance taxes whilst a 4 percentage point rise in the additional NIC rate (paid by those earning more than £50k) would yield £4.6 billion (chart 2).

However, it is unlikely that a Conservative government would be willing to sanction higher taxes on capital and the well-paid. Ultimately, however, they may have little choice in the long-run and I maintain that a discussion about some form of wealth tax is one which the electorate needs to have. Income taxes exist in part to address the problem of income inequality. But with official statistics suggesting that the richest 10% of UK households hold 44% of all wealth whilst the poorest 50% own just 9% it is a problem that, like it or not, our society needs to address.