Will Workers Pay The Employer National Insurance Contributions Rise?

31 October 2024

Ander Iraizoz, Oxford University Centre for Business Taxation

The Chancelor announced an increase in employers’ National Insurance Contributions (NICs) in the Budget on October 30th. This has brought the complex question of tax incidence to the forefront, as some see this as breaking Labour’s pledge not to increase taxes on "working people". While it may sound like businesses should pay the employers’ NIC burden, economists have long argued it is not that simple. When employers' NICs increase, companies’ demand for labour decreases, which puts downward pressure on wages. So, how much of that extra tax can be expected to be passed onto workers? This blog draws on the latest research findings on tax incidence to address that question.

What are National Insurance Contributions and how have they changed?

NICs are the UK’s second-largest source of tax revenue, making up about one-sixth of the total. Levied on labour income, NICs allow contributors to qualify for state pensions, jobseeker’s allowance, and other benefits. Unlike income tax, NICs are paid by both employees and employers, although at different rates. 

In the recent Budget, employee contributions remain steady at around 8% on earnings. However, employers’ NICs will see a substantial increase, predicted to raise an additional £24.5 billion. This increase has two main components:

1. Lower earnings threshold: The earnings level at which employers start paying NICs decreases from £9,100 to £5,000.
2. Higher NIC rate: The employer NIC rate rises from 13.8% to 15%.

While these changes may appear to place a larger burden on employers, the real question is whether this cost will ultimately be passed on to employees. This is especially relevant here, as the average employer NIC rate rises more sharply for lower-income employees than for higher-income ones.

Conventional wisdom: Workers ultimately bear most of the burden

Economic models suggest that the legal assignment of NICs is irrelevant to who ends up bearing the cost of them. Instead, what matters is the elasticity of labour demand and supply, or how sensitive the decisions of employers and workers are to wage changes. Since firms' demand for labour is generally more elastic than workers' supply of labour, conventional wisdom suggests that most of the burden of NICs will be shifted onto employees through a drop in wages. For instance, when the UK adjusted employers’ NICs in 2021, the Office for Budget Responsibility (OBR, 2021) assumed that workers would end up bearing the cost through lower real wages in the medium term.

Empirical evidence: A more nuanced view

Recent empirical research has nuanced the conventional view on the incidence of NICs in certain contexts. Benzarti (2024) reviews recent studies using quasi-experimental designs and administrative data, which show departures from the standard theoretical model of tax incidence in the short to medium-term.

Evidence shows that in the short-term, increasing employer NICs does not immediately affect wages, as firms face challenges to lowering posted wages – nominal wage rigidity. Studies from the UK (Adam et al., 2019) and France (Lehmann et al., 2013) found that employers did not immediately pass NIC increases onto workers. Additionally, when employer NICs changes applied to specific groups - based on age (Saez et al., 2019) or cohort (Saez et al., 2012) – firms did not adjust wages for identical jobs, suggesting that fairness concerns may also affect the incidence of NICs.

How do businesses then manage the additional labour cost of higher NICs? Research by Benzarti and Harju (2021) in Finland shows that firms responded by altering their labour input choices, substituting low-skilled workers with high-skilled ones and reducing investments. These adjustments show that, even with limited wage effects, employer NIC may still affect workers through reduced employment opportunities.

Therefore, while theoretical models suggest that workers will bear most of the cost, empirical evidence shows that firms may absorb a significant portion in the short term. There are four important considerations to keep in mind:

1. Short-term vs. long-term effects: Most empirical studies focus on the short-term, so workers may still face wage cuts in the long run.
2. Impact on prices: Even under limited direct wage cuts, workers’ real incomes may fall if companies raise consumer prices. 
3. Employment decisions: Higher employer NICs could influence firms’ employment decisions, which may especially affect low-income employees as their labour costs have increased disproportionately.
4. Differential business impact: NICs may affect businesses based on employment size, not profitability, potentially affecting labour-intensive firms.

Are there better business tax policies?

If the government’s goal is to increase revenue from businesses, it's worth considering whether alternative tax policies might be more efficient. In a policy paper and a blog, Michael Devereux has argued for taxing excess profits—profits above the minimum required rate of return. Such a tax would target economic rents and could raise revenue without affecting workers or distorting firms' employment decisions.

Conclusion

In sum, while employers' NICs are legally imposed on businesses, workers can be expected to be affected by an increase in employers’ NICs. Empirical evidence suggests that in the short term, firms may bear more of the burden than previously thought, but over time, workers are likely to face wage cuts or job losses. Reflecting this, the OBR forecasts that workers will bear around 60% of the NIC increase initially, rising to 76% in the medium term (OBR, 2024). Exploring alternative tax policies, such as taxes on excess profits, could offer a more balanced solution for raising revenue without harming labour markets.

References

Adam, Stuart, David Phillips, and Barra Roantree. 2019. "35 years of reforms: A panel analysis of the incidence of, and employee and employer responses to, social security contributions in the UK," Journal of Public Economics, 171(C): 29-50.

Benzarti, Youssef. 2024. "Tax Incidence Anomalies," NBER Working Papers 32819.

Benzarti, Youssef, and Jarkko Harju. 2021. “Using payroll tax variation to unpack the black box of firm-level production.” Journal of the European Economic Association, 19 (5): 2737–2764.

Lehmann, Etienne, François Marical, and Laurence Rioux. 2013. “Labor income responds differently to income-tax and payroll-tax reforms.” Journal of Public Economics, 99: 66–84.

Office for Budget Responsibility (OBR). 2021. “Economic and fiscal outlook - October 2021”

Office for Budget Responsibility (OBR). 2024. “Economic and fiscal outlook - October 2024”

Saez, Emmanuel, Manos Matsaganis, and Panos Tsakloglou. 2012. “Earnings determination and taxes: Evidence from a cohort-based payroll tax reform in Greece.” The Quarterly Journal of Economics,127 (1): 493–533

Saez, Emmanuel, Benjamin Schoefer, and David Seim. 2019. “Payroll taxes, firm behavior, and rent sharing: Evidence from a young workers’ tax cut in Sweden.” American Economic Review, 109 (5): 1717–1763.