Who will benefit from plans to simplify National Insurance

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NATIONAL Insurance is to be simplified - and brought more in line with income tax - under proposals outlined by the Government.

Among the changes suggested are plans to tax workers in the same way for both National Insurance and income tax, to make it easier for self-employed people to pay their National Insurance Contributions (NICs), and to increase awareness about what our NICs actually do.

The report [pdf] from the Office of Tax Simplification (OTS) says that the proposals would mean 7.1 million people paying less in NICs - but at the same time around 6.3 million of us could find our contributions will increase.

Why does it need changing?

National Insurance (NI) was first introduced in 1911 as a form of insurance against illness and unemployment for working people. The scheme was expanded after World War II to help provide money to the NHS and other social security programmes.

Since then, NI has become less well defined, and some of the services it once paid for are now funded through general taxation - like the NHS - and many of us are uncertain about what exactly we're paying for.

Because NICs are related to earnings, the Government think it would make things easier if they were more closely aligned with the tax we all know we have to pay on them - income tax.

The OTS say that in its current form, NI is overly complicated - particularly for businesses, and the self-employed who have to make two types of contribution.

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The OTS say that misconceptions about NI - including what exactly it pays for and how it benefits us - can be damaging, and that the system should be more transparent.

For example, the Government says that it's "worrying" that some people believe they won't receive treatment under the NHS if they don't have a full contributions record.

The system currently works like this:

Class 1 contributions are made by employees who earn more than a certain amount each week. They are automatically deducted from monthly or weekly wages. The employer also pays Class 1 NICs for each employee.

These contributions give employees people entitlement to a basic state pension, contributions-based Jobseeker's Allowance, Maternity Allowance, and certain bereavement benefits.

Class 2 contributions are paid by the self-employed; they're fixed at £2.80 a week and are usually paid through self assessment.

They don't provide entitlement to contributions-based Jobseekers Allowance, but do count towards Employment and Support Allowance, the basic state pension, maternity allowance and some bereavement benefits.

Class 3 contributions are for people who have gaps in their contribution history - either through not working or because their earnings have been too low.

They're voluntary and solely designed to provide a complete contribution record; this then contributes towards entitlement to the state pension and bereavement benefit.

Class 4 NICs are paid by the self-employed if their profits are more than a certain amount each year - but they don't count towards any state benefits.

Part of the problem, says Angela Knight of the OTS, is that the current system gives different benefits depending on whether someone is employed, self-employed, or has more than one job.

The changes are designed to address these issues and will affect everyone who pays NICS.

How the self-employed would be affected

As already mentioned, the UK's 4.7 million self-employed people pay two forms of NICs, - and some people have to pay each type them in different ways

Class 2 NICs have already been simplified slightly: previously people paid once or twice yearly upon request, or monthly via Direct Debit. However anyone registering as self-employed in the past few years now doesn't have to pay anything until their first self assessment.

That brings it in line with how payments of Class 4 NICs are calculated and requested, as part of the annual self assessment process.

This change to how Class 2 NICs are collected has been broadly welcomed: as the Association of Accounting Technicians say, the newly self-employed "no longer need to immediately concern themselves" with sorting out their contributions.

The OTS also want to bring the NICs of the self-employed more in line with those who are employed by someone else.

This would require many to pay more, as the Class 4 rate is currently set at 9% of earnings, compared with a 12% rate paid by employed people.

But the OTS say that were self-employed contributions brought into line with those of employees they'd also gain entitlement to receive a range of welfare benefits that they're currently excluded from.

How employees will be affected

The OTS suggests employees' NICs should be calculated like PAYE - with earnings assessed annually rather than weekly or monthly, calculations made on a cumulative basis, and determining liability based on all employment through the year.

This would make it easier for people with several low paying jobs to build up a contribution record.

They suggest that such changes would result in approximately 7.1 million workers paying an average of £175 a year less in NICs - but they also point out that some 6.3 million workers would end up paying an average of £275 per year more.

One of the concerns here is that contributions will increase, but incomes won't - which could affect how much people have to live on. The OTS say, however, that people with lower incomes will generally be those who pay less.

The other thing to remember is that people who pay more under the changes are likely to benefit from increased entitlement to the benefits NI helps pay for.

The winners

Overall, a simpler tax system should make life easier for everyone - but there are some who will benefit more than others.

The OTS estimate that employees who earn between £10,000 and £15,000 stand to gain the most - somewhere between £200 and £300.

However, the simplified system should also benefit the self-employed, who will no longer have to deal with two classes of NIC.

The prospect of having to pay more NICs might be initially unappealing, but the hope is that for many the gains in the form of increased entitlement to welfare benefits now and in the future will be attractive.

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