Please note the charts on this page have not been updated for March 2021 forecast due to a software issue. We will endeavour to update them as soon as possible.

Taxes on different forms of personal income provide the biggest source of revenue for government. In 2019-20 National Insurance Contributions (NICs) raised £145 billion. That represented 17.5 per cent of all receipts and was equivalent to £5,100 per household and 6.5 per cent of national income.

The main reason that NICs are the second biggest source of revenue (after income tax) is that personal income makes up the majority of total national income. NICs are 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.
  • For the self-employed, it is paid via the self-assessment (SA) system. This is mostly class 4 NICs, which is related to self-employed earnings above a certain threshold, but a small amount is the flat-rate class 2 NICs which also covers some self-employed people with lower incomes. 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.
  • Other smaller sources of NICs include Class 3 (voluntary payments for those wishing to add to their NICs record), statutory payment deductions (mostly related to statutory maternity pay), personal pension rebates, state scheme premiums, investigation settlements and repayments.

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

NIC receipts are, unlike most taxes, paid into the National Insurance Fund and are notionally used to pay for state pension and other contributory benefits, where an individual’s past payment record has some influence on the size of payments they receive. A small amount is notionally directed to the National Health Service (NHS), although this only makes up a small proportion of NHS funding. As such, in some presentations of receipts, NICs are counted as ‘social contributions’ rather than taxes.

  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 NICs 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 (EFOs).

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 taken from the Personal Tax Model.

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 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 several 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, were skewed towards the lower end.

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

The coronavirus outbreak and the public health measures taken to contain it has led to a significant decline in economic activity, and hence receipts in 2020-21. With the level of earnings expected to be permanently lower than assumed in our pre-pandemic forecasts, NIC receipts are also expected to be significantly weaker.

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  Policy measures

Since our first forecast in June 2010, the government has announced a number of 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 (an initial estimate in our March 2017 EFO indicated a yield of £5.9 billion). 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. Thresholds for employee NICs were raised by more than inflation for 2020-21 in the March 2020 Budget.
    • The introduction of a  ‘employment allowance’. This gives a NICs-free threshold at the business level, taking the smallest employers out of employer NICs. The allowance is £4,000 in 2020-21. A number of exemptions apply.

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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 2019 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 2019 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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