Taxes on different forms of personal income provide the biggest source of revenue for government. In our latest forecast, we expect National Insurance Contributions (NICs) to raise £131.0 billion in 2017-18. That would represent 17.6 per cent of all receipts and is equivalent to £4,700 per household and 6.4 per cent of national income.

The main reason that NICs is the second biggest source of revenue (after income tax) is that personal income makes up the majority of total national income. NICs is only levied on the labour income (the wages and salaries of employees and earnings of the self-employed) element of personal income. Different types of NICs are paid by employees, employers and the self-employed. In all cases, earnings are no longer subject to NICs when a person reaches the State Pension age.

NICs revenue is collected in a variety of different ways:

  • For the majority of employees, it is paid via the pay-as-you-earn (PAYE) system and is known as ‘Class 1’ NICs (including the Class 1A/1B element paid by employers). The amount of NICs to be paid is calculated by the employer and transferred directly to the tax authorities (HMRC). This is also known as being deducted at source. It means the individual does not need to deal directly with HMRC and that the tax is paid promptly. We expect 93.4 per cent of NICs in 2016-17 to be raised through the PAYE system.
  • For the self-employed, it is paid via the self-assessment (SA) system. This is mostly Class 4 NICs, but a small amount is Class 2 NICs for those with smaller amounts of self-employment income (Class 2 is set to be abolished in 2018-19). The amount of tax to be paid is calculated by the individual and declared on a tax return sent to HMRC. Tax returns and associated payments are completed after the tax-year has ended – in most cases in the following January (so January 2018 for the 2016-17 tax year). We expect 2.2 per cent of NICs in 2016-17 to be raised via the SA system.
  • Other smaller sources of NICs include Class 3 (voluntary payments for those wishing to add to their NICs record), statutory payment deductions (related to statutory maternity pay), personal pension rebates, state scheme premiums, investigation settlements and repayments. Taken together, we expect 4.4 per cent of NICs in 2016-17 to be raised from these sources.

For most employees income tax is also deducted at source while the self-employed pay income tax via SA.

  • Latest forecast

    Our latest fiscal forecast was published in November 2017. NICs receipts are set to rise by 0.1 per cent of GDP between 2016-17 and 2022-23. This is more than explained by a rise in the effective tax rate. Most of this is due to our assumption that productivity and real earnings growth will pick up (although to still historically subdued rates), which will mean that more income is subject to tax at the higher employer NICs rate. The process by which the effective tax rate rises as earnings grow faster than the pace at which tax thresholds are increased is called ‘fiscal drag’. It is less important in the NICs system than the income tax system because its structure is less progressive. Earnings over the ‘upper earnings limit’ are taxed at 2 per cent for employee NICs, rather than 12 per cent for earnings over the ‘lower earnings limit’.

    More detail on our latest forecast and how it was revised relative to our previous forecast in March was provided in paragraphs 4.41 to 4.49 of our November 2017 EFO. We describe income tax and NICs together in our EFOs, given the similar underlying drivers of each.

    Expand to read the extract from our November 2017 EFO

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  • Latest monthly data

    The monthly profile of NICs receipts is relatively stable across the year, with a pick-up in March related to end-of-year bonus payments.

    Over the first seven months of 2017-18, NICs receipts have risen slightly faster than our full-year forecast (4.4 versus 4.0 per cent). It is too early to judge whether these trends will persist over the rest of the year, but the weakness in NICs in the first half of 2016-17 relative to the second half is likely to be flattering the year-on-year comparison.

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  • Forecast methodology

    Forecast process

    The OBR commissions forecasts of NIC receipts from HM Revenue and Customs for each fiscal event. The forecasts start by generating an in-year estimate for receipts in the current year, then uses a model to forecast growth in receipts from that starting point. We provide HMRC with economic forecasts that are then used to generate the tax forecasts. These are scrutinised in a challenge process that typically involves two rounds of meetings where HMRC analysts present forecasts to the Budget Responsibility Committee and OBR staff. This process allows the BRC to refine the assumptions and judgements that underpin the forecasts before they are published in our Economic and fiscal outlooks.

    Forecasting models

    The Class 1 NICs model uses the same approach as the PAYE income tax forecasting model. The forecast is generated by estimating year-on-year changes in receipts using the last full-year figure as a baseline. Our forecast for wages and salaries growth (decomposed into growth in earnings and growth in employment) is the key driver of the forecast.

    HMRC’s Personal Tax Model (PTM) – a micro-simulation model based on a survey of taxpayers’ liabilities – generates forecasts of marginal tax rates (MTRs) and effective tax rates (ETRs), taking account of reliefs, allowances and our assumptions on differential earnings growth. The model then applies the MTR forecast to extra income arising from earnings growth and the ETR forecast to extra income arising from employment growth.

    Future changes to the tax system (announced as Budget measures) and other ‘off-model’ factors (such as the effect on increasing incorporations) are also included in the forecast.

    The Class 4 NICs model uses a similar approach to the SA income tax model. Liabilities are estimated by multiplying taxable profits by the average effective tax rate. Outturn taxable profits are grown in line with relevant parts of our economy forecast. The average effective tax rate is forecast using an econometric model based on previous trends.

    Main forecast determinants

    The main determinants of our NICs forecast are those related to the tax base (in particular, employment and earnings growth) and those that are used by the Government in setting parameters of the tax system (notably CPI inflation). See the ready reckoners section below for more information on the effects of these determinants on NICs tax receipts.

    Main forecast judgements

    The most important judgements in our NICs forecast are related to the economy forecast that underpins it – most important of all being the outlook for employment and earnings growth. Alongside those, we need to make a number of other forecast judgements. These include:

    • In-year estimate – Our estimate for NICs receipts in the current year is determined by performance of receipts year-to-date, our economy forecast and any other indications from the HMRC model. The in-year estimate determines the base year from which we use our models to forecast receipts growth. For PAYE NICs, it implicitly reflects the average effective tax rate on wages and salaries.
    • Differential earnings growth – Given the importance of the shape of the income distribution for PAYE receipts, we allow for differential earnings growth across it when calculating the average and marginal tax rates for the forecast. The top-end of the income distribution is more ‘tax-rich’ as the average tax rate broadly rises in line with income, so this is an important judgement in the forecast. It is, however, much less important than for income tax.
    • Assumption on bonuses – PAYE NICs receipts are received disproportionately towards the end of the financial year, reflecting the tax paid on end-of-year bonuses. Our assumptions on financial and non-financial sector bonus growth drive our expectations of these end-of-year receipts. Again, this is much less important for NICs than for income tax.
    • Incorporations – Our PAYE, SA, NICs and corporation tax (CT) forecasts are affected by our assumption that incorporations will continue their rising trend. Employment income is taxed more heavily than profits and dividends, so when formerly employed or self-employed individuals incorporate, their tax bills generally fall. Among other effects, this reduces NICs revenue. (See Box 4.1 of our November 2016 EFO for more detail.)

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  • Previous forecasts

    NICs receipts were weaker than our initial forecasts, in part reflecting weak average earnings growth and despite strong employment growth. The distribution of incomes, notably for new workers and among the self-employed, has been skewed towards the lower end.

    Employment growth has surprised on the upside, but has not been sufficient to offset the effect of slower growth in earnings. Since the large downward revisions to our economy forecasts in December 2012 and March 2013, NICs receipts have been much closer to forecast.

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  • Policy measures

    Since our first forecast in June 2010, governments have announced 96 policy measures affecting our forecast for NICs. The original costings for these measures are contained in our policy measures database and were described briefly in the Treasury’s relevant Policy costings document. For measures announced since December 2014, the uncertainty ranking that we assigned to each is set out in a separate database. For those deemed ‘high’ or ‘very high’ uncertainty, the rationale for that ranking was set out in Annex A of the relevant Economic and fiscal outlook.

    Key NICs policy changes announced since 2010 have included:

    • The abolition of the NICs contracting-out rebate from April 2016. This was announced in Budget 2013 and our March 2016 estimate was that it would raise £5.6 billion in 2016-17. Around 50 per cent of this relates to public sector employers paying higher employer NICs.
    • NICs thresholds have generally been raised by inflation, with indexation moved from RPI to CPI from April 2012. The exception is that the threshold for employer NICs was raised by £21 above indexation for 2011-12 in the June 2010 Budget. This was designed to offset the ‘employer’ element of the 1 per cent rise in NICs rates from 2011-12 that had been announced by the previous Labour Government.
    • The introduction of a £3,000 ‘employment allowance’. This gives a NICs-free threshold at the business level, taking the smallest employers out of employer NICs. A number of exemptions apply.
    • Budget 2017 included a measure to raise the rate of Class 4 NICs from 9 per cent to 10 per cent in April 2018 and 11 per cent from April 2019. This measure was subsequently dropped before being implemented.

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  • Ready reckoners

    ‘Ready reckoners’ show how our fiscal forecasts could be affected by changes in selected economic determinants. They are stylised quantifications that reflect the typical impact of changes in economic variables on receipts and spending. These estimates are specific to our March 2017 forecast and we would expect them to become outdated over time, as the economy and public finances, and the policy setting, continue to evolve. They are subject to uncertainty because they are based on models that draw on historical relationships or simulations of policy settings. More information can be found in the ‘Tax and spending ready reckoners’ spreadsheet we published alongside our 2017 Fiscal risks report.

    The table below shows that:

    • Changes in labour income have a large impact on NICs receipts. Staggered NICs thresholds mean that receipts rise (and fall) proportionately more than changes in labour income. NICs receipts are less geared towards average earnings than income tax, as a lower employee NICs rate is applied to earnings above the upper earnings limit.
    • The impact of changes in inflation on cash receipts depends on the extent to which inflation feeds through into higher nominal tax bases, in particular wages. Assuming that average earnings growth is unchanged, higher inflation would reduce NICs receipts. Higher thresholds – which are uprated in line with CPI inflation – mean that less income is taxed at higher rates.

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  • Other information

    A further breakdown of our income tax and NICs forecast can be found in our EFO supplementary tables.

    Model review

    In our 2017 Forecast evaluation report we set out the initial conclusions of our review of fiscal forecasting models. This section sets out the conclusions of our review of some of our income tax and NICs forecasting models.

    PAYE and NIC1 integrated payment model

    Income tax and ‘Class 1’ NICs paid through PAYE are the largest item in our receipts forecast, so while they are not particularly volatile relative to some taxes, even small percentage forecast differences can be material for our overall fiscal forecast. Our PAYE forecast model uses our earnings and employment growth forecasts to project the tax base from the latest base year and applies average effective tax rates (AETRs) derived from the ‘Personal Tax Model’ (the PTM, which we have reviewed separately). The model was extended to incorporate NIC1 payments in 2015, which had a number of advantages relative to the previous modelling approach (see our November 2015 EFO for more detail). Abstracting from uncertainty around the key determinants, the main fiscal forecasting challenge relates to the judgements that are fed into the model, in particular the current year receipts estimate and assumptions about differential earnings growth, which drive the shape of the income distribution that underpins the effective tax rate assumption.

    For PAYE income tax, the average absolute two-year ahead fiscal forecasting difference since our March 2012 forecast has been 1.7 per cent, which on a volatility-adjusted basis is lower than the average across our fiscal forecasts. The average difference has been negative at 0.2 per cent, smaller than average, with an equal number of March forecasts since 2012 under- or over-predicting receipts at the two-year horizon. NICs fiscal forecasting differences have tended to be larger and positive, although these mostly reflect differences from forecasts produced using the old model.

    We have agreed the following priorities with HMRC for development work over the coming year:

    • Improve the transparency of smaller receipts streams in the model (such as the tax on occupational pensions).
    • Exploit real-time information (RTI) data more to help inform key assumptions (such as the in-year estimate and differential earnings growth).

    Personal tax model (PTM)

    The Personal Tax Model (PTM) is a micro-simulation model based on a survey of taxpayers’ liabilities. This model calculates the average marginal tax rate on additional income by taking account of reliefs, allowances and our assumptions about inflation and any differences in earnings growth at different points in the earnings distribution. The model then applies these tax rate forecasts to income growth to generate a receipts forecast. The main forecasting challenge relates to the shape of the income distribution and the differential earnings growth assumptions that are fed into this model to project the distribution.

    The PTM model is a component of our overall PAYE income tax and NIC1 forecasts. The fiscal forecasting differences associated with these overall forecasts are discussed in relation to the PAYE and NIC1 integrated payment model.

    We have agreed the following priorities with HMRC for development work over the coming year:

    • Exploit real-time information (RTI) data to help inform the projection of the base-year micro data.
    • Develop a top-down representation of the underlying income distribution to provide a cross-check on the model outputs in order to facilitate forecast scrutiny.

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  • Boxset

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