Understanding National Insurance and Income Tax in the UK

As the UK prepares for the upcoming autumn Budget on 30 October, Chancellor Rachel Reeves has indicated that tough decisions will be necessary. Despite this, Labour has committed to not increasing income tax, National Insurance (NI), or VAT rates.

Recent Changes to National Insurance

In 2024, National Insurance has seen two significant reductions:

• January 6, 2024: The starting rate for NI decreased from 12% to 10%.
• April 6, 2024: The rate further dropped to 8%.

According to the previous Conservative government, these cuts could save a worker earning £35,000 approximately £900 per year. For self-employed individuals, Class 4 NI contributions on earnings between £12,570 and £50,270 were reduced from 9% to 6%, offering a potential saving of £350 for someone earning £28,200. Additionally, self-employed workers are no longer required to pay Class 2 contributions.

The NI rate remains at 2% for income and profits exceeding £50,270.

What is National Insurance?

National Insurance contributions (NICs) are essential for funding various benefits and supporting the NHS. Here’s how it works:

• You begin paying NI at age 16 if you earn over £242 per week or have annual profits exceeding £12,570.
• Individuals over the state pension age do not pay NI even if they continue working.
• Your eligibility for certain benefits, including the state pension, is based on your NIC record throughout your working life.

If you are not employed due to caregiving or receiving benefits, you may qualify for NI credits that ensure you still receive relevant benefits. It is also possible to make voluntary contributions to fill any gaps in your contribution history.

Why Are Many Paying More Tax?

Despite the recent NI cuts, many individuals will see an increase in their overall tax burden due to changes in tax thresholds:

• The NI threshold and tax-free personal allowance have been frozen at £12,570 until 2028. This means that as wages rise with inflation, more people will start paying taxes or move into higher tax brackets.
• By 2028, an estimated 3.2 million additional taxpayers will emerge, with 2.6 million paying higher rates according to the Office for Budget Responsibility (OBR).
• The Institute for Fiscal Studies (IFS) suggests that while an average earner might experience a tax cut of about £340 in 2024-25 due to combined changes, by 2027 this benefit would reduce to only £140.

Current Income Tax Rates

Income tax applies to various sources of income including employment earnings and profits from self-employment. Here are the key rates:

• Basic Rate (20%): On earnings between £12,571 and £50,270.
• Higher Rate (40%): On earnings between £50,271 and £125,140.
• Individuals earning over £100,000 start losing their personal allowance at a rate of £1 for every additional £2 earned beyond this threshold.
• Additional Rate (45%): On earnings exceeding £125,140.

These rates apply across England, Wales, and Northern Ireland; Scotland has different income tax bands.

Who Pays the Most Tax?

For most families in the UK, income tax represents their largest tax burden. However, lower-income households often pay a larger share of their income through indirect taxes like VAT. For instance:

• The poorest fifth of households primarily contribute through VAT as their biggest single tax payment.

Comparing UK Taxes Internationally

When assessing taxation as a percentage of GDP:

• In 2022, the UK’s tax revenue was approximately 35.3%, placing it in the middle among G7 economies.
• Countries like France and Germany impose higher taxes compared to the UK’s historical rates; predictions indicate that by 2028-29 the government may collect about 37.1p per pound generated in the economy—the highest level in eight decades.