What are employer national insurance contributions and what would raising them do?

Rachel Reeves has hinted she plans to put up the tax in the budget but some businesses have voiced concerns

The chancellor, Rachel Reeves, has dropped heavy hints that she plans to increase employer national insurance contributions (NICs) in her budget at the end of the month, and on Tuesday Keir Starmer twice refused to rule this out. But what exactly is the tax and would increasing it break the Labour party’s election manifesto promises?

What is national insurance?

National insurance is similar to income tax but is paid on earned income only – so it does not apply to dividends from shares, interest from savings, rental income from property or money from pensions.

NI contributions are made by workers and, if they are employed, as well as by their employer and are based on an individual’s earnings. While employees do not pay NICs once they reach state pension age, employers continue to pay them after that point.

Self-employed workers also make contributions based on how much money they are making from their work.

How much do employers pay?

Employers pay NICs for most workers earning more than £9,100 a year. The sum they pay is the equivalent of 13.8% of the employee’s earnings above that threshold, so for an employee earning £30,000 the employer would pay NICs of £2,884.20.

The contributions do not come out of the employee’s salary, but are paid on top of that. Currently employers do not pay NICs on payments they make into their employees’ pension pots.

The thresholds for paying NICs are higher for employees aged under 21 and apprentices aged under 25, while an employment allowance is available to small employers to reduce their bill.

What might change?

The chancellor is reported to be considering an increase in employer NICsby changing the rules so that employers have to pay them on the money they put into their workers’ pension scheme.

If this was introduced at 13.8% of current pension contributions, it has been suggested that it would bring in £17bn a year to the Treasury. According to the Resolution Foundation thinktank, the state would need to pick up the tab for public sector employers’ extra payments, reducing the haul to £12bn.

The advice firm Hargreaves Lansdown says an employer paying the minimum contribution of 3% of salary into the pension of someone earning £35,000 a year would face a cost of £119.06 a year if the NICs rate was 13.8%.

It says that if the government did not impose the whole 13.8% but went for just 2% of pension contributions, the cost to employers would still add up. In that scenario, it would be £17.25 a year for that same employee.

Raising the rate at which employer NICs are paid could also bring in more money. An increase of one percentage point, to 14.8% of earnings, would bring in £8.5bn in 2025-26 and more in each of the following years.

What will this mean to workers?

On the face of it most workers will be unaffected as the rates of national insurance they pay will remain unchanged, unless there are separate moves to alter that.

But some commentators have warned there could be an impact on employees as firms seek to claw back their extra costs. According to a survey for the Association of British Insurers, almost half of employers that pay more than the minimum into their workers’ pensions will consider reducing their contributions if they have to pay NICs on them.

This would both limit their bill and give them money to pay the extra charge.

For the employee above, an employer paying 5% of salary into their pension scheme would face a bill of £198.44 a year at a rate of 13.8%, says Hargreaves Lansdown – two-thirds higher than if they made only minimum contributions into the pension.

Some have suggested employers could ultimately reduce wages or increase them only slowly to cover the cost of pension contributions they have to make.

And workers who are involved in salary sacrifice schemes to increase their pensions may see this option closed. In these schemes, employees reduce their salary by a sum that is paid into their pension scheme. Both the employer and employee reduce their NICs as a result, so employers currently have an incentive to offer these arrangements. If that is removed, they may decide not to.

Would a change break a manifesto promise?

The Labour manifesto contained the promise that the party would “not increase taxes on working people, which is why we will not increase national insurance, the basic, higher, or additional rates of income tax, or VAT”.

Whether a change to employers’ NICs contravenes this may depend on whether you regard it as a promise to not increase national insurance paid by workers, or to not increase national insurance full stop. Paul Johnson, the director of the Institute for Fiscal Studies, believes it is the latter.

How have employers reacted?

Business lobby groups have said they would face higher day-to-day running costs that could force them to cut back elsewhere.

UK Hospitality, the body that represents the hotel, restaurant and leisure sectors, said staff costs represented their biggest business expense and many firms may need to reduce staffing.

Describing the move as “a tax on jobs”, the chief executive Kate Nicholls, said: “Hospitality businesses are much less able to stomach yet another cost increase, when they’re already managing increases in other areas like wages, food, drink and energy.”

Higher employment costs could feed through to higher prices in the shops, pushing up inflation and further slowing wages growth, which is already cooling.

What could it mean for the wider economy?

The Bank of England has said it wants to see more slack in the labour market before it cuts the cost of borrowing from 5%. Policymakers in Threadneedle Street have argued that a shortage of workers is likely to push up wages at a faster pace than expected, increasing the pressure on inflation.

By reducing the demand for workers with higher NICs, the government could give the Bank of England the incentive it needs to cut interest rates more quickly.