How tax hike will affect you!

In LAST year's Budget speech Gordon Brown made reference to a higher than expected shortfall in the projected tax receipts he would need to put more money into schools and hospitals.

To shore up this shortfall, he then announced that National Insurance Contributions (NICs) would be increased by one per cent for both employers and employees (and also the self-employed), with the new rates taking effect from April 6, 2003.

So, there you have it. National Insurance is a tax, after all.

One year on and the dreaded day is almost upon us. So, what are we talking about? Let's start by taking a look at the current position, for the tax year 2002/03.

Both employers and employees pay nothing at all on the first £89 per week of earnings, or £385 per month. Employees then pay ten per cent on earnings above this level up to £585 per week, or £2,535 per month. On an annual basis, and this also applies to the self-employed, these figures translate to the first £4,615 being NIC-free and the part between £4,615 and £30,420 being "taxed" at ten per cent. No NICs are at present paid on earnings above this figure.

Employers pay NICs on their employees' salaries above £4,615pa at a rate of 11.8 per cent. There is no upper ceiling for the employer's contributions.

From April 6, employees will have to pay 11 per cent NICs on earnings above £4,615, up to a new upper earnings limit of £30,940, and then one per cent NICs on all earnings above this figure. Employers will pay 12.8 per cent on all earnings above £4,615, again with no upper limit. An employee on average or near-average earnings of £30,000 a year will therefore face an increase in NIC payments of ten per cent, i.e. £2,792 compared with £2,538. As the table (opposite) shows, all employees under pension age will be affected but higher earners face a much greater impact on their take home pay.

Businesses, especially in labour-intensive sectors, will also be badly hit. The extra, uncapped, one per cent will come straight off their bottom line.

There is also a knock-on economic effect. Ironically, NHS trusts, one of the intended beneficiaries of most of the extra revenue raised, are among the country's biggest employers and face hugely increased employment costs, which then have to be funded out of general taxation. Extra NI costs for schools and the police are largely passed down the line to council taxpayers!

It would be comforting to think that the extra contributions will result in a higher state pension in the fullness of time. Unlikely! The one per cent on earnings above £30,940 counts for nothing - it truly is an employment tax and the revenue generated goes into general Government coffers. The extra one per cent on earnings below that level does put in a little more money into the earnings-related element of your pension but, contrary to popular belief, people do not have a Government pension "fund", as they do with, say, stakeholder pensions. All pensions are paid for out of current taxation, which is quite a problem for the Government with an ageing population. This is why it is planned to scale down the earnings-related element of the state pension in future years.

Can anything be done to minimise the impact of the increase? Sadly, most of us will have no option but to grin and bear it. If they act immediately, those who have upcoming bonuses can ask to have payment advanced. As long as payment is physically made by April 5 it will be subject to the existing NIC rates.

In a few cases employees could make modest savings by taking part of their remuneration in the form of benefits, although the NI cost to employers of paying in cash or in kind is broadly the same.

Those who own their own businesses should seriously consider substituting much of their salary for dividends, which has long been known as an NIC-efficient means of drawing profits from their companies. There are however other considerations to weigh up and professional advice should certainly be sought.

Apart from that, it's a case of thank God the interest rates are low!

Updated: 08:51 Thursday, March 27, 2003