Chancellor prepares reform of National Insurance to create jobs

Gordon Brown, the Chancellor of the Exchequer, is preparing a radical change to employers' National Insurance (NI) rates in an attempt to create jobs by abolishing disincentives to employing workers on low pay.

In proposals expected to form a key plank of the Budget, the Chancellor is expected to lift the lower earnings limit for NI, allowing employers to pay up to pounds 80 a week without contributing to the fund. It would be the most radical change to NI in a decade.

Crucially, higher paid employees would cost more in NI, effectively shifting the burden of tax from small to large employers. To make the reform tax- neutral, employers would have to pay higher NI contributions (NICs) on any salaries over pounds 440 a week.

A document setting out the proposal was yesterday circulated to interested parties by Martin Taylor, the head of the government's tax and benefit review and chief executive of Barclays.

In the document, Mr Taylor said he was following Mr Brown's pledge to review the NI structure for the low paid, bringing it much closer into line with income tax.

The document says: "These proposals aim to encourage the creation of `entry jobs' for the unemployed returning to work, and to reduce burdens on business by simplifying the complex structure of employer rates."

Later, Mr Taylor adds: "The main consequence would be to increase employer NICs slightly in respect of higher paid employees (is over pounds 440 a week)."

As well as lifting the burden on the lowest paid employees, the reform would eliminate "distortions" in the system which lead to employers paying marginal rates of tax of over 100 per cent when they raise pay.

Under the current system, employers are encouraged to pay less than the lower earnings limit (to be pounds 64 a week from April) because they do not then pay any NICs. Above pounds 64, the employer pays 3 per cent on all pay - not just the excess.

For an employee paid pounds 64, rather than pounds 63, an employer pays pounds 1.28 in tax on the extra pound - a marginal rate of 128 per cent. This causes employers to "bunch" employees below pounds 64 a week.

A similar effect occurs as income rises. Earnings over pounds 110 require a 5 per cent contribution on all pay; earnings over pounds 155 are at 7 per cent; and earnings over pounds 210 are at 10 per cent.

Instead, the government proposes to have a rate of 12.2 per cent - but only on earnings in excess of pounds 80. "The previous system would be replaced by one in which only earnings above the threshold of pounds 80 would be liable to the employers' charge, levied at a single rate," the document states.

An increase in earnings from pounds 109 to pounds 110 a week would generate contributions of 12p a week - rather than pounds 2.23 a week at present.

Mr Taylor, together with the Treasury, have been at pains to stress that the proposed reform would be "tax neutral" - that is, no extra tax would be raised. However, it would also be the first attempt since 1979 to shift the tax burden from the lower to the higher paid.

Adair Turner, director-general of the CBI, said: "Such a reform could have a positive impact on employment. We will however, have to consider in more detail the overall impact on companies with a high average salary bill."