National Insurance is an earnings tax that is highly regressive - especially the employee contributions part. In fact if it wasn't so complex (and therefore confusing) and so little talked about in the media it would be a tax scandal.
The progressive nature (the more your income, the higher percentage you pay) of Income Tax is largely undone by regressive National Insurance (NI) which disproportionately hits low to middle earners.
NI is currently levied in the following way;
To simplify matters I am going to refer to annual thresholds (2013-14 to tie in with latest government tax revenue figures), but it is important to remember that NI is mostly levied on monthly and weekly income which has the added effect of taxing more those employees mainly in low paid insecure employment. (Note: Insecure low paid workers who move jobs frequently are also more likely to have errors or gaps in payments. Even a one week gap invalidates a whole years contributions and affects entitlement to benefits and state pension).
First lets deal with the employee contributions part of NI.
Earnings below £7,775 a year are zero rated as long as earnings are spread evenly across the year [see above note].
Note the NI free threshold is well below the Income tax free threshold of £10,000 a year.
From £7775 to £41,450 Employee NI is charged at 12%.
Then scandalously, for no justifiable reason the rate drops to 2% for earnings over £41,450.
So, the more you earn over £41,450, the less NI rate you pay!
Examples are;
Working 40 hours per week on the minimum wage brings gross yearly earnings of £13,125. Employee NI is £642 - a 5% flat tax (on all earnings).
The UK average (median - half of workers earn less, half earn more) full time wage is £26,000 a year. Employee NI is £2187 - an 8% flat tax.
Earning £41,450 a year (which is in top 15% of earners). Employee NI is £4041 - a 10% flat tax.
So far so progressive, but now watch what happens;
A salary of £100,000 a year (top 2% of earners). Employee NI is £5212, a just over 5% flat tax.
A salary of £1,000,000 a year (top 0.01% of earners). Employee NI is £23,212, a just over 2% flat tax. So less than half the rate paid by someone on the minimum wage!
And in practise it gets worse, much worse.
National Insurance can be avoided on earnings paid into a pension fund. And guess what, the higher your earnings the more likely this is to happen and the higher the amounts of NI avoided.
This isn't surprising because the more you earn, your disposable income rises exponentially, so the more you can afford to lock away in long term investments like pension funds. Also the more you can afford the admin costs & fees to set yourself up as a company and receive pay as dividends which will reduce your NI contributions.
It is also worth remembering that unlike Income Tax, NI only taxes income from labour* and self employed profits** (actual work). Income from capital is largely untaxed. And the wealthier you are, the more income you are likely to receive from capital.
[*Those over state pension age are also exempt on labour income].
[**A flat rate stamp and lower NI rate of 9% apply (minus generous expenses claimed)].
Now, lets look at Employer NI contributions;
The zero threshold for Employer NI is lower than Employee NI set at earnings below £7696 a year.
The rate above this is a flat 13.8%. So Employer NI is not as regressive to anywhere near the extent of Employee NI.
But it is a "hidden" stealth tax that helps hide the truly huge amount of tax taken from low to middle earners. Also the combined Employee and Employer NI is still highly regressive.
For example;
Lets look again at our mimimum wage earner on £13,125 gross a year.
In a way the employee's true pay is £13,875 a year as this includes the "hidden" employers NI tax of £750 a year. Total NI for this employee is £1392 a year adding together Employee NI of £642 and Employer NI of £750. A flat rate of 11%. The Income Tax for this employee is by comparison a much lower 5% of total earnings at £625.
So total direct income taxes are £2017 a year. Or 16% of their gross wage. A huge amount of tax to be taken from someone on a wage £3,000 below what most believe is a basic livable wage. This doesn't happen in any other EU country where income (and other) taxes are far more progressive.
[Note: Council Tax, VAT and other indirect taxes hit low wage earners even harder than taxes on income].
Total NI (employee & employer contributions) worked out as a flat rate on all income increases incremently from 11% on earnings of £13,125 a year to 21% on £41,450. Then falls incremently towards 14% on earnings over that.
Compare that to the more progressive Income Tax worked out as a flat rate on all income, which works out as 5% on the minimum wage salary of £13,125, 12% on the average wage of £26,000, 15% on £41,450, 30% on £100,000, increasing incremently to 44% as we reach £1,000,000 incomes and beyond.
National Insurance is 21% of government tax revenue. £107bn for 2013-14. Which is not much less than Income Tax revenue which raises £155bn.
If we divide these figures by 30m, which is roughly the total number of taxpayers;
The average taxpayer should pay £3,600 in total NI and £5,200 in Income Tax.
In actual fact the average full time earner on £26,000 a year pays £4,700 in NI and £3,200 in income tax.
So £1,100 more than the average in National Insurance and £2,000 less than the average in Income Tax.
If National Insurance were set with as progressive rates as Income Tax;
Someone earning £13,125 would have total (employer & employee) NI contributions of £960 LESS per year.
On £26,000 earnings, £2504 LESS.
On £100,000 salary, £1560 MORE.
On £1m salary, £151,000 MORE.
This gives us a measure of how regressive NI is and how progressive Income Tax is.
It also, perhaps explains why the rich and the media they own are always moaning about Income Tax but never mention National Insurance!
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