The social care levy, announced yesterday and voted on today, is a big moment in Boris Johnson’s premiership. The prime minister has broken a manifesto commitment not to raise any of the main rates of income tax, national insurance or VAT. And he has done so with a tax increase that exceeds even the 1 per cent national insurance increase New Labour introduced to pay for higher NHS spending in 2002. Much as Johnson and others will point to the pandemic as justification, at some point politicians were going to have to acknowledge that permanently higher spending on health and social care—as an ageing population demands—had to be met with large tax rises.
The key decision was then which tax (or taxes) to increase. Different tax increases fall more heavily on some people than others, and some change economic decisions and so distort the economy more. The government chose the social care levy—a 1.25 per cent charge on employers and employees on earnings above the national insurance threshold—and an accompanying 1.25 per cent extra on dividend taxes. This is by no means the worst way to raise £14bn a year, but it will also fall more heavily on the young than other available options, while worsening existing distortions in the tax system.
First, the positives. When trying to raise a substantial sum like this, it is much better to do so through broad-based taxes: taxes that are paid by many people so the effect is spread thinly, and the tax is difficult to avoid. The alternative—to raise a large amount from a small group—risks distorting those people’s decisions more, and opens up avoidance opportunities. For this reason, the “tax triple lock” manifesto commitment was never sensible. Between them, those three taxes account for two-thirds of the tax take, and hiking their rates is the simplest and least economically damaging option when seeking to raise large sums.
It is therefore understandable that the government chose national insurance when it needed to find £14bn. This will raise what is expected, be hard to avoid and will not do undue damage to the economy.
Yet while the social care levy is not the worst option, it has defects which means the government could have picked a still more appropriate broad-based tool. National Insurance has a broad base, but not as broad as income tax. The former applies only to earnings, while the latter also applies to other sources like rental income and pensions. The social care levy will apply to the earnings of pensioners (which national insurance does not), but this only accounts for a small fraction of their income as a group.
A further problem is that national insurance biases the tax system against employees and towards the self-employed. The tax rise this week is effectively twice as large for employees (because both employers and employees saw a tax increase) than for the self-employed or those who receive their income as dividends. Eventually, we would expect much of the employer social care levy to cut at wage growth. This means that the tax system is pushing people towards self-employment, and away from employment, for no good reason. This was an existing flaw in the tax system, and by carrying it over into the new levy, yesterday’s announcement made it worse.
These problems with national insurance are well known and civil servants will have explained them to the chancellor and prime minister. Yet still they went ahead. The simplest explanation is politics: national insurance increases have long been more popular with the public than income tax rises, due to a false perception that national insurance pays for health spending. In reality, it is a tax like any other, with no special properties that mean it contributes more to NHS funding. The prime minister said yesterday that the new levy would be “hypothecated in law”—legally set aside to be spent on health and social care; this too is not true in any meaningful sense.
The social care levy will not be the worst tax on the statute book. Indeed, it will be better than many others and will raise the money the government hopes. But it will worsen the bias in the tax system against employees, and only a small fraction of it will be paid by the pensioners who will benefit most from the additional spending. The most compelling reason that can be offered? Politics.
