Brexit: Could there be a legal challenge to trade negotiations?

Sometimes the stream of  Brexit hysteria in the Daily Express yields the odd interesting nugget. Last week the paper reported that the European Commission wants to “torpedo” the Brexit negotiations by putting “a legal lock on discussions about the UK’s access to the single market, meaning that the issue cannot be brought up during the negotiations.”

The source of this story is Ryan Heath’s Politico column, in which he reports on a conversation with “a senior Commission source”:

There may be a few months where the parties are not really talking to each other. [If] the U.K. says we want to discuss tariffs and the [location of] the European Banking Authority and the space program, and what happens to [Britain’s European Commissioner Julian] King … [the EU’s Brexit negotiator Michel] Barnier will have a simple answer: ‘This is not in my mandate to negotiate with you.’

Barnier will not be legally allowed to negotiate on trade, on customs, on whether the U.K. can still participate in the Horizon 2020 research program.

In other words, there will be a legal barrier to discussing trade. The only negotiations allowed will be those about the separation agreement.

There is nothing here that the EU trade commissioner hasn’t already said. Last summer, Cecilia Malmstrom insisted that, under EU law, the EU can only negotiate trade agreements with third countries. Therefore the UK must become a third country before it can talk trade with the EU. In other words, it must leave the EU before it can do a trade deal.

She hasn’t changed her tune on this since. If the Express’s Nick Gutteridge had read one of his own articles from earlier this year, he would have found this quote from Ms Malmstrom (my emphasis):

First of all they have to formally invoke the Article 50, the letter of divorce. Then the European Council will discuss that and based on that they will give a mandate to the Commission to negotiate.

Then, if they do leave as the prime minister has said the internal market and also probably the customs union, there will have to be all the exit procedures and then there will be a trade agreement between us and the United Kingdom which would be negotiated after they have left.

When she says a deal can be negotiated in two years, she’s talking 2021, not 2019.

She said it again earlier this month:

If she is right, the triggering of Article 50 next week will take us straight to trading under WTO rules two years from now.

Luis González García of Matrix Chambers thinks she’s over-egging it though:

Can the UK negotiate a trade agreement with the EU while being a member of the EU?

According to the EU’s Trade Commissioner, Cecilia Malmström, the answer is no. In a recent interview she said, “There are actually two negotiations. First you exit, and then you negotiate the new relationship, whatever that is.” Her position seems to favour a strict interpretation of Article 50. This interpretation may be supported by the fact that a formal trade deal between the UK and the EU would be in conflict with the EU rules and practice in the negotiation and conclusion of trade agreements.

But in my opinion nothing in Article 50 prevents the EU from initiating formal trade negotiations with the UK during the withdrawal process. Article 50 (2) provides in the relevant part that

A Member State which decides to withdraw shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union.

This formulation requires the EU to conclude a withdrawal agreement with the UK, taking into account the framework of the trading relationship between the withdrawal Member State and the EU. What could be included in the “framework” is unclear but it seems to me that the spirit of Article 50 envisages the adoption of an instrument setting out the new rules which would govern the bilateral trade relations between the UK and the EU, including the technical aspects of a future trade agreement which could only be concluded once the UK has formally exited the EU.

This paper from Sussex University comes to a similar conclusion:

Article 50(2) TEU addresses the content of the withdrawal agreement. It is open-ended, stating that ‘the Union shall negotiate and conclude an agreement with [the UK], setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union.’ This does not preclude trade talks forming part of the Article 50 TEU withdrawal agreement or taking place in parallel. In practice, as Article 50 TEU has never been implemented before, legal debates about whether the UK faces restrictions in pursuing trade talks are highly politicised.

In other words, there’s a bit of posturing going on here and the law isn’t really clear.

The European Parliament’s committee on constitutional affairs seems to agree, arguing that, in practice, it is very difficult to disentangle the two agreements:

The treaty provision establishing that the withdrawal treaty will be concluded in a manner “taking account” of the future relationship is also a challenge in several aspects. This implies that the content of that future relationship should be known not only at the time of the signature of the withdrawal agreement but, ideally, from start of the negotiations. The greater the level of understanding on the future relationship, the easier drafting the withdrawal agreement will be.

What seems desirable is that the withdrawing state has a clear projection of the future relationship when negotiating the withdrawal agreement, and that both agreements are negotiated in parallel. Ideally, when the rights and obligations deriving from the Treaties for the UK and its citizens extinguish, as agreed in the withdrawal agreement, the transitional provisions and/or the new partnership provide for a clear legal framework so there is as little legal vacuum as possible.

As does Steve Peers, professor of EU law at Essex University:

Since the UK is going to be in a different situation, it could be argued the normal rules can’t really apply and the UK should be able to have informal trade negotiations that could be enforced from the day it leaves.

All very sensible. It’s in all countries’ interests to reach some sort of trade deal after Brexit so why would anyone want to put a legal block on trade negotiations?

The trouble is, common sense seems to be in pretty short supply at the moment and we don’t really know what the law says because none of it has been tested. As the BBC’s fact-check concluded:

Under current EU rules, EU countries cannot make separate trade deals with individual member states or non-EU countries. However, there is no legal precedent for a country to leave the EU and renegotiate a trade agreement with the bloc. Legal experts say the UK could argue its official status has changed once it invokes Article 50, but this is largely hypothetical at the moment.

There are all sorts of competing interests in the other 27 countries. Any one of them could bring a legal challenge if they thought there might be some advantage to be gained by holding up the trade negotiations. Even if they were not successful, what would happen to the timing of the negotiations? Would it be like a rugby game where the clock stops or would the 2-years keep running down while the court case was heard?

In normal times we would assume that someone somewhere in Whitehall was looking at this, discussing it behind the scenes with EU lawyers and making a contingency plan. But when a senior government minister can come before a Commons select committee and revel in his government’s ignorance and lack of preparation, these are clearly not normal times.

There is a great quote on one of those demotivational slides which is a warning to anyone about to embark upon a major change:

When the winds of change blow hard enough, the most trivial of things can become deadly projectiles.

This may be one of those trivial things. Let’s hope it never gets much of a wind behind it.


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Brexit likely to hit Leave voting areas hardest

If people voted Leave to stick it to the metropolitan elite they might be disappointed. A piece of research published in Regional Studies journal this month found that London is a lot less dependent on EU trade than most other parts of the UK. Furthermore, the regions that voted strongly for leave tended also to be the same regions whose economies were most dependent on the EU.

The researchers used data from the World Input–Output Database to calculate the share of each NUTS-2 region’s economic activity that is dependent on trade with the rest of the EU. They then mapped this against that region’s Leave vote.

Figure 1. Relationship between the NUTS-2 regional votes for leave and the regional gross domestic product (GDP) share due to consumption and investment demand in the other European Union countries, 2010.

Note: R2 = 0.31.

 

They then did the same with the share of wages.

Figure 2. Relationship between the NUTS-2 regional votes for leave and the regional wage-income share due to consumption and investment demand in the other European Union countries, 2010.

Note: R2 = 0.23.

 

The findings suggest that the economies and wages in the high Leave voting areas are far more likely to be adversely affected by the UK’s exit from the EU. This is counterintuitive, to say the least. The dominant narrative since the referendum has it that London reaped the benefits of EU membership while the rest of the country has seen precious little.

But, as the authors of the paper point out, London is one of the few truly global cities in the world. Because of its international connections it exports goods and services all over the world. Therefore, even though it exports more to the EU than any other region, as a percentage of its total GDP, the value of those exports is much smaller than in other parts of the UK.

While London’s financial services engage with markets all over the world every day, most of the firms in the rest of the UK’s regions tend to engage with European value- chains rather than genuinely global value-chains. The share of UK domestic GDP which is accounted for by EU demand has remained remarkably stable between 1995 and 2011, although its composition has changed due to the UK’s increasingly complex integration processes with EU global value chains.

[A]lmost every part of the UK outside of London has become more, not less, integrated with the EU over recent years, with the major exception being London. On the other hand, London has benefited from inflows of human capital more than any other city in the world and the majority of these human capital injections come from Europe. Yet, these EU-dominated inflows help London compete globally rather than just across Europe. In contrast, the rest of the UK tends to compete on more of a pan-European scale.

In short, London’s economy is globalised while the economies of other regions are Europeanised.

The report’s appendix breaks down the findings by region and sector but I have summarised them and sorted them as a league table here. There are a few surprises near the top but Inner and Outer London are the least EU dependent of the lot. East Yorkshire and North Lincolnshire, one of the areas with the highest Leave voting majority, also has one of the highest dependency on EU trade.

There’s a further twist, though, because the London economy, say the report’s authors, has become detached from that of the rest of the country.

Indeed, the extent to which the London economy is largely disconnected from that of the rest of the UK is observed in the WIOD inter- regional data. Further examination of the detailed interre- gional data8 shows that for all other UK NUTS-2 regions, demand from London only accounts for between 0.7% and 4% of their local GDP.

For all non-London UK regions, the share of their local GDP which is accounted for by the EU demand is greater than the share which is accounted for by demand from London.

It is not surprising that EU markets are more important to UK regions than London markets, given that the EU markets are some 33 times larger than the London markets, and only slightly further away from most of the UK regions than London.

In other words, the economies of many regions are more dependent on trade with the EU than they are on trade with London. Therefore, London’s resilience after Brexit might not help the rest of the country much at all.

We don’t yet know how far Brexit will disrupt trade with the EU. That depends on the terms the government is able to negotiate. Whatever happens, though, there will be more friction in our trade with the EU which will increase costs and reduce the competitiveness of the UK’s exports in the EU. Those regions whose economies are most integrated with the rest of Europe and whose incomes are most dependent on it are likely to suffer disproportionately.

The trouble is, many of these areas are also more dependent on public spending than London. They are therefore likely to lose more from the deterioration in tax revenues and the resulting squeeze on public spending in the wake of Brexit. high Leave voting areas tend to receive a greater proportion of their household income from social benefits. The last thing they need is faltering business revenues.

Brexit is therefore likely to further increase the share of the country’s tax paid by London. Those advocates of devolution who say that they want their region to keep more of its money might want to think about that. Regionalisation might mean London keeping more of its money too and, unless other regions can find new sources of revenue outside the EU, they are likely to find paying for their public services gets even more difficult than it is now.

There will be hard times ahead for many parts of the UK after Brexit. How hard depends on what happens over the next two years. London is likely to fare better than most though. The London elites, by which I mean the real elites with investments and high six figure salaries, not the cycling beardy hipsters, will be just fine. Whatever else people thought they were voting for when they put their crosses in the Leave box, those who wanted to punish rich Londoners will be the first to be disappointed.

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Special report: Bongobongoland

This week’s special report focuses on the extraordinary situation in Bongobongoland. Once considered one of the world’s most stable and well-governed states, its rapid slide into reactionary autocracy and the increasingly erratic behaviour of its rulers has shocked the world. The speed and scale of this geopolitical disaster has left Bongobongoland’s allies wondering how things could have turned so ugly so quickly.

Bongobongoland was badly damaged by the global recession in 2008. Relative to the size of its economy, it took a bigger hit than most of its neighbours. Nevertheless, after a shaky start, the country appeared to be slowly but steadily recovering. Or so everyone thought.

The trouble began with an obscure dispute over membership of a regional trade body, about which few people cared and even fewer understood. However, these arguments soon became wrapped up with wider economic grievances and resentment against migrant workers from some of the country’s poorer neighbours. This led to a political crisis in which the prime minister, a member of the patrician tribe which had run the country for centuries, was forced to resign.

In the ensuing chaos, power was seized in an almost bloodless coup by the daughter of a holy man from the country’s prosperous southern provinces. Hopes that this might stabilise the situation were quickly dashed by the appointment of highly controversial characters to three of the country’s most senior ministerial posts.

The first, an itinerant jester and storyteller, famed for his colourful interpretations of the country’s rich oral history, had no government experience other than as headman of the country’s largest town. His appointment as foreign minister was greeted with dismay in the world’s capitals and was taken as something of an insult by the country’s allies. The new minister’s crude humour did not translate well to the diplomatic arena. In a few short months, his crass remarks and jokes about foreigners severely damaged the country’s reputation abroad. A nation once known for its deftness in international diplomacy is now a laughingstock in the world’s embassies.

Almost as bizarre was the second appointment, a medicine man from the country’s far north who had served under the previous regime before being forced out amidst allegations of cronyism and expense fiddling. Since his rehabilitation, his main contribution seems to have been a series of outlandish and unworkable plans that have served only to draw yet more scorn from the country’s neighbours.

The third appointment, a former soldier turned sugar trader, known as something of a maverick, is perhaps too straightforward his own good. His admission that the government had no idea what to do about the most serious issues facing the country and had made no contingency plans was refreshingly honest but didn’t do much to calm the nerves of business leaders.

Shortly after their appointment, the trio were embroiled in an unedifying squabble over government resources, with each one demanding that his rivals’ departments be broken up, and a row over who should have the use of a 17th century palace some 40 miles from the country’s capital.

The regime’s hostile rhetoric and adversarial approach to its neighbours has been matched by a strident reactionary authoritarianism at home. Backed by a press egging it on to ever more extreme policies, the government has viciously attacked the judiciary and loftily dismissed its critics as enemies of the people. In spite of this, the regime has very little opposition. The country’s parliament is supine and the regime’s opponents are disorganised, cowed and ineffectual. The official opposition, led by two sexagenarians steeped in the mythology of 1970s liberation struggles, has made little headway and has proved unable to mobilise popular support. Oddly, rising discontent seems only to result in increased support for the government.

The only serious opposition to the regime is in the far north, where long-standing resentment threatens to flare into open revolt. The chieftains of the far north have threatened to declare independence before but, despite the government’s dismissive reaction, many observers believe that this time they might pull it off. The secession of the northern province would deprive the country of what’s left of its oil reserves and would be a severe blow to its prestige.

In parallel to these developments there appears to have been a cultural shift in the country. Within the last year there has been a sharp rise in xenophobic and racist abuse which has sometimes spilled over into violence. There have been reports of people being attacked, and in one case killed, simply for speaking a foreign language. Initially it was thought that these incidents were confined to the remote areas of the country but recently there have been reports of similar incidents in the capital. There is some evidence that this hostile atmosphere is driving foreign workers away. So far, no formal warnings have been issued but expatriates and foreign visitors have been advised to remain vigilant at all times and to avoid speaking their own languages in public.

Matthias Bloggs, professor of anthropology and an expert on Bongobongoland, pointed out that it wouldn’t be the first time that a seemingly open and progressive country had fallen back into reactionary authoritarianism.

“Western liberals tend to assume that all societies will become more open and pluralist,” he said, “but look at pictures from Iran and Afghanistan in the 1970s and compare them to 2017. They looked more modern 40 years ago than they do now.”

He continued, “There are clear parallels between Erdoğan’s Turkey and Bongobongoland; the aggressive majoritarianism, the claim that an election victory means they can push aside all opposition, the attacks on the judiciary in the name of the ‘will of the people’ and a contemptuous dismissal of national minorities. Both regimes trade heavily on nostalgia and a stylised view of history, recalling the glories of long-vanished empires. Doublespeak is typical of such regimes, for example, imprisoning judges in the name of freedom or using the term ‘repeal’ to describe a measure which will increase executive power.”

But it is the sheer speed of the country’s fall from grace that has surprised Professor Bloggs.

“Eight or nine years ago, this country was seen as a stable anchor during the financial crisis. Its finance minister was highly regarded by the IMF. Nowadays even its friends are exasperated by the behaviour of some government ministers. Their language and attitudes are those of the football terraces not the embassy or the conference room. They are even talking about tearing up international treaties. It’s absolutely astonishing.”

Bongobongoland’s currency has already taken a hit and its economic forecasts are worsening. There are fears about what might happen if its trading relationships sour and it finds itself locked out of its export markets. The country has already been criticised for money laundering and opaque financial engineering. In its desperate search for cash, it might turn itself into deregulated bucket shop, where anything goes and anyone with money is welcome. That, in doing so, the country might become a pariah state seems not to worry its leaders unduly.

This sudden retreat into nationalist isolationism has left observers shocked and baffled. As Professor Bloggs remarked, “This is a once powerful and prosperous country turning its back on the rest of the world for reasons that no-one can quite understand. It has gone from beacon to basket-case in a few short years. It really is most extraordinary. I’ve never seen anything quite like it before.”

Disclaimer: This preposterous story, with its tacky colonial stereotypes, is purely a work of fiction. Any resemblance to real places or to persons living or dead is purely coincidental.

Update: A report from the FT’s correspondent yesterday:

 

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A star-studded Future of Work event

A quick plug for the CIPD’s Future of Work event later this month. The context is the CIPD’s Profession for the Future initiative, part of which is the need for HR professionals to be more aware of the megatrends shaping the economy and the future of work.

While that may all sound pretty obvious and uncontroversial, the record of the professions in the corporate world hasn’t been particularly good of late. This time last year hardly anyone was talking about the rise of populism and almost no-one expected Trump to become President of the USA or the UK to leave the EU. My data for this is purely anecdotal but many British organisations still seem to be in shock about Brexit and haven’t really worked out what to do about it. Very few of us saw it coming. We’d chosen to ignore politics for the past couple of decades so politics jumped up and punched us on the nose.

Developing our capacity to understand socio-economic and political trends is therefore  something most of us could benefit from. As part of London CIPD’s contribution to this process we are running this great event on the Future of Work. I say great because look at who we have lined up to speak – a panel of economists, commentators, think-tankers and HR professionals.
Andy Campbell – HCM Strategy Director, Oracle – Andy has been with Oracle for 20 years and describes himself as an HR evangelist. He’s the man behind the HR in 2017 report, deep within which you will find a quote from me about robots taking our jobs. You  can read Andy’s blog posts here.

Frances Coppola – Regular contributor to the FT, Forbes, the Guardian and the BBC – Frances is a banker turned singing teacher and financial commentator. You may have seen her on the BBC’s business programme at some ungodly hour of the morning. You’ll find her work in a number of publications but her personal blog is well worth a read too.

Conor D’Arcy – Policy Analyst, Resolution Foundation – Conor is one of that  bunch of bright people at the Resolution Foundation who publish reports on the economy, living standards and the labour market with astonishing frequency. His many reports and articles can be found here.

Kate Griffiths-Lambeth – HR Director at Charles Stanley and non-exec NHS director – A lawyer turned HR professional, earlier this month Kate became the first female member of the Executive Committee at Charles Stanley, the world’s 15th oldest financial services business. Kate’s blog Leading Light is a thought provoking read.

Sarah O’Connor – Employment correspondent, Financial Times  Sarah joined the FT in 2007, just in time for the financial crisis. A dirty shoe economist, one who gets out and talks to people rather than just looking at spreadsheets, she has written extensively on the changing nature of work.

The event takes place on 28 March in Hatton Garden. It is free to CIPD members. There is a small charge for non members but it’s not much more than the price of a central London pint.

Further details and a booking form are on the CIPD’s Eventbrite page.

This promises to be an informative and lively discussion. Of course, I will be there too but don’t let that put you off.

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Bad on top of bad

The self-employment NI increase grabbed most of the headlines last week, so the general state of the economy didn’t get much of a look in. It was very similar this time last year when all the headlines were about the sugar tax and no-one noticed that, as the FT’s Chris Giles put it, the OBR had forecast lower growth forevuuuh! The OBR had effectively called time on the recovery and said that our economy would bump along at 2 percent growth for the rest of the decade.

It is a sign of how far our expectations have fallen that last week’s budget was accompanied by headlines about improved GDP forecasts. It is true that the OBR’s outlook for this year is better than their forecast in November but that’s about it. They now expect growth to be well below 2 percent for the rest of the decade. In one year, the forecast has gone from mediocre to rubbish. This helpful chart by the Resolution Foundation shows the deterioration.

Institute for Fiscal Studies Director Paul Johnson explained:

One rather remarkable comment from the OBR is that:

“Cumulative growth over the forecast as a whole is slightly weaker than in November, as we now believe the economy was running slightly above potential at the end of last year”

That’s an economy, recall, in which GDP per capita is still barely 2% above its 2008 level. That’s nine years to grow as much as it would normally grow in one. What the OBR is saying is that despite that truly dismal record all of the productivity – and with it earnings growth – we would normally expect has been lost forever. This remains the big story of the last decade – a decade without growth, a decade without precedent in the UK in modern times.

And on the outlook for pay he was almost lost for words:

Of course in all this what really matters to people is what is happening to their incomes. Income and earnings growth over the next few years still look like being weak. On current forecasts average earnings will be no higher in 2022 than they were in 2007. Fifteen years without a pay rise. I’m rather lost for superlatives. This is completely unprecedented.

Or, at least, unprecedented in modern times. As the Resolution Foundation noted, you have to go back to 1810 to find a time when average pay across a decade was lower than it was in the previous one.

The problem here is that Brexit has piled bad on top of bad.

As the Resolution Foundation’s Matt Whittaker showed in a report last month, while the recession was worse than any of the downturns we have seen since the Second World War, the recovery has been much weaker and slower. Usually we expect a bounce back after a crash but this time it hasn’t happened. In the past, smaller crashes followed by bigger booms meant that we pretty much made up for lost ground. This time we’ve had a big crash followed by a much smaller recovery, leaving a hole in our economy.

To compensate for a crash like this we would have needed much stronger GDP growth.

 

So the catch-up didn’t happen.

Still, this time last year things were beginning to look up. Per capita GDP was, at last, back to its pre-recession level and wages were rising again. We even thought that average earnings might get back to their pre-recession levels by the end of the decade. Now that looks hopelessly optimistic.

It could be worse still. Earlier this year, the EY Item Club produced a report based on the assumption that the UK would leave the EU without a trade deal, a scenario that is looking ever more likely by the day. It forecast growth of 1.3 percent, 1 percent and 1.4 percent for the next three years, making the OBR figures look rosy in comparison.

Whatever happens, leaving the EU will slow the recovery down. We don’t know by how much and for how long, only that it will. You can’t change the assumptions on which businesses have been built for the past forty years without damaging the economy. Just as we were beginning to claw our way out of the stinking pit that was the Great Recession, we have decided to embark on an economic experiment that will impede our escape and might even drag us down again. To quote Ozzy Osborne, ‘Crazy, but that’s how it goes!’

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Self-employment: who’s dodging the tax?

Are lots of people going self-employed to avoid tax?

That suggestion comes through in the reporting of the widely expected increase in national insurance for the self-employed. The Independent, for example:

‘dramatic increase’ in number of people registering as self-employed to cut tax bill

And that was the general tone of the chancellor’s speech:

People should have choices about how they work, but those choices should not be driven primarily by differences in tax treatment.

He then went on to quote the example from the Institute for Fiscal Studies report:

An employee earning £32,000 will incur between him and his employer £6,170 of National Insurance Contributions.

A self-employed person earning the equivalent amount will pay just £2,300 – significantly less than half as much.

Such dramatically different treatment of two people earning essentially the same undermines the fairness of the tax system.

Employed and self-employed alike use our public services in the same way, but they are not paying for them in the same way.

The lower National Insurance paid by the self-employed is forecast to cost our public finances over £5 billion this year alone.

That is not fair to the 85% of workers who are employees.

This is a remarkable shift in rhetoric. Until recently, the self-employed could do no wrong. They were the grafters, the backbone of Britain and the lifeblood of the economy. That all began to change when the idea of equalising tax on employees and the self-employed was trailed, raising questions about whether it is fair that the self-employed pay so much less in tax than employees. Almost overnight the self-employed have gone from being the backbone or the lifeblood to being tax dodgers who are not paying their way.

It caused a right stink and the government already seems to be back pedalling. Nevertheless, the idea that the self-employed are avoiding paying their fair share seems to be taking root.

There are good reasons for equalising the tax treatment of employees and the self-employed but the suggestion that a significant number of people have chosen to become self-employed for tax reasons is some way wide of the mark. There will be some, of course, but the data on the earnings of the self-employed over recent years should quickly dispel the idea that these people are minted.

Let’s look at that example from the IFS report again. The title of the chart is slightly misleading. What it shows is not £40,000 of income but £40,000 cost to the employer. The employee in this example would not consider himself to be earning £40,000, but the £36,000 or so he receives after the employer has paid the employer NI. Out of this, he then pays around £8,400 in tax and employee NI. The self-employed worker pays roughly the same in tax and NI as the employee, while the contractor working through a company pays a little less but neither are paying employer’s NI. The overall tax paid for the two non-employees is therefore less than that for the employee.

If the employer, having decided to use self-employed workers rather than employees, pays them the entire £40,000, they’d be laughing. It is more likely, though, that the employer would pocket most of the NI saving. He might pay the contractors a little more than the employee for doing the same job but probably not the full £40,000. There are some cases where contractors earn more than employees but, for the most part, the earnings of self-employed people are generally much lower than those of employees.

The data on self-employment incomes suggest that the self-employed are earning significantly less and that the gap has widened as the number of people in self-employment has risen, as the Resolution Foundation’s recent analysis of DWP and Family Resources Survey data shows.

HMRC data released earlier this month tell an even more astonishing story. The total amount earned by the self-employed in 2015-15 was £87.5 billion. That is £900 million less than what they earned 7 years earlier in 2007-08. That’s straightforward cash, not real terms. So despite there being over 700,000 more people with self-employment income, they managed to earn almost a billion less.

The business population statistics give a similar picture. Even though there has been a huge growth in the number of one person businesses, they have a smaller market share now than they did in 2007. There are a lot more people fighting for a share of a much smaller pool.

The story becomes even more remarkable when you look at the change in the composition of the self-employed since the recession. Most of the net increase has come in occupations which you would expect to be more highly paid. Yet, at the same time, earnings have fallen through the floor.

Source: ONS

That said, the earnings of employees in the groups have taken a hammering since the recession too, so pay rates for the self-employed have probably followed them downwards.

Chart via Resolution Foundation

The Department for Business Innovation and Skills looked into the earnings of the self-employed a year ago. They noted a significant increase since the recession in the number of self-employed people working fewer than 30 hours a week. As the self-employed population has increased, the hours per person have fallen.

This suggests that a number of things may be happening. As the Resolution Foundation and the RSA found, there are all sorts of reasons why people are going self-employed. Sometimes it’s for lifestyle reasons or to have more control over the type of work they do. Some of the newly self-employed in professional occupations may be maintaining their day rates but just working fewer hours and therefore earning less. Undoubtedly some have chosen to sacrifice earnings for autonomy and lifestyle. At the same time, though, there is some substitution of employed labour by employers going on, such as the drivers who are told they are self-employed when they are not really. What none of the many reports and analysis of the rise in self-employment have suggested, though, is a significant move to self-employment for tax reasons.

Of course, the drop in earnings could be due to the self-employed being a load of dodgy Del Boys who hide their earnings. There is no doubt that some of this goes on but it always has. Why would the newly self-employed be that much better at tax dodging? In any case, many of those in managerial and professional occupations who represent the bulk of the recent increase in self-employment, sell to businesses and bill electronically, so there is less scope for hiding turnover. It would require superhuman fiddling capability to make nearly £1 billion disappear.

There may be a few people who find it more tax efficient to do the work they used to be employed to do as self-employed contractors.For most people, though, self-employment means a fall in earnings. Sometimes that is voluntary, sometimes not. But whatever else is behind the post-recession rise in self-employment, a tax wheeze isn’t it.

Where there is a tax saving, of course, is on the employer’s pay bill. After the budget, the IFS re-drew its chart based on the proposed changes.

Here, the self-employed person and the owner-manager are paying more NI but there is no additional cost to the employer, so the incentive to use more self-employed labour hasn’t gone away. Unless, of course, employers increase the day rates to compensate self-employed workers for the extra tax they are now paying. (Is that hollow laughter I hear from my self-employed readers?)

The Resolution Foundation has been one of the cheerleaders for the NI increase on the self-employed but their position is more nuanced than some of the reporting suggests. Here’s director Torsten Bell:

[T]he real debate about tax and the self-employed lies not in the National Insurance individuals directly pay but with the fact that firms pay 13.8 per cent employer National Insurance for everyone they employ, but nothing if they use self-employed labour. How to close that huge gap without causing wider problems is what our limited capacity for anxiety should really prioritise.

Indeed!

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Time to come clean about health spending

I was out of the country when the Office for Budget Responsibility published its Fiscal Sustainability Report, so I have a vaguely plausible excuse for missing it. That said, it sounds like it didn’t attract much comment. As you might expect, the FT and a couple of others covered it but, as Michael says, there wasn’t the usual hullabaloo. Which is surprising because its long-term forecast of public debt was worse than the one in the last report eighteen months ago. A lot worse.


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Chart by Michael O’Connor

The reaction to this, or lack of it, is a sign of how far politics has shifted in the past couple of years. A few years ago, The Debt was the biggest story around but Brexit has eclipsed it and with the OBR’s report being released on the same day as Theresa May’s speech it was never going to get much of a look in.

But, as Michael says, if, as most newspapers insisted every year, the level of debt forecast by the OBR was ‘unsustainable’, then this new projection must be super-plus-unsustainable!

So what has made the OBR debt forecast so much worse? Has there been a sudden deterioration in public finances?

As you can see from Michael’s’ chart, the public debt is a little higher than where the OBR thought it would be 18 months ago, mainly because tax revenues continued to disappoint. But that isn’t the main reason for the change. What is behind the soaraway debt forecast is a change in the way the OBR has assessed the likely increase in health costs.

This is not due to the ageing population, which the OBR factored into its previous estimates, but to other factors such as increasing demand and healthcare costs rising faster than inflation.  These assumptions were set out in a report last September, Fiscal sustainability and public spending on health, which would have formed part of last year’s FSR had it not been cancelled because of Brexit. The report notes that, even before the pressures of an ageing population, healthcare spending rose more quickly than GDP in most developed countries.

Michael illustrates the point with an example from the BBC’s Hospital series:

The BBC series “Hospital” that’s running at the moment has some great examples of this. For example in Episode 5, 18 year-old Deborah is saved because new developments mean that sickle-cell disease can be cured with a bone-marrow transplant from a donor who is only a 50% match rather than as previously requiring a 100% match. This means that of all the young people with sickle-cell, more can now be treated and will be treated, pushing up spending. Though the state can put into the other side of the balance the prospect of a healthy tax-paying life for Deborah! At the other end of the age-spectrum, the programme showed new procedures for heart-valve replacement for people who are too old and frail for traditional open-heart surgery, increasing the proportion of people within an already increasing pool who can be treated (and thus doubly increasing the number of operations that could take place).

In other words, because we can, we will. As more procedures become possible, more people will want them. Today a professor will sit on the breakfast TV sofa describing a new operation, tomorrow people will be beating on their GP’s doors demanding it. In a health service free at the point of use, innovation doesn’t reduce cost, it increases it.

Add to this the relatively high cost of medical equipment and of wages in healthcare. As the OBR comments:

Health care is a relatively labour intensive sector. For example, the King’s Fund found that staff accounted for around 70 per cent of a typical hospital’s total costs and that this proportion had grown over time.10 Cost and price pressures have generally been stronger in the health sector than in the rest of the economy, while productivity growth has tended to be lower. According to the so-called ‘Baumol cost disease’ theory, real wages in the health care sector have to keep pace with the rest of the economy in order to attract and retain staff, but slower productivity growth means that additional input would be needed to achieve the required improvement in care per person. As a result, the cost of health services will rise relative to other sectors of the economy.

Taking all this into account, much of the rise in health are costs in recent years hasn’t had as much to do with an ageing population as the headlines might suggest. For example, during the last financial year much of the increase in spending was due to other factors.

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Once you add in these extra cost pressures, the projections for health spending go through the roof. In the chart below, the green line is based on the assumptions the OBR used in its previous forecasts. The Central projection is the one used in calculating the increase in debt shown on Michael’s chart above. Even the ‘lower cost pressures’ scenario is still higher than the OBR’s previous forecasts.

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Now of course, these are only projections and these days it’s deeply unfashionable to take economic forecasts at all seriously. Who knows what will happen to the economy a decade or so from now? Nevertheless, what the FSR does show is just how sensitive the UK’s fiscal position is to changes in healthcare spending. Even before the most recent report, healthcare spending was the variable with the most impact on the UK’s debt trajectory. It dwarfs everything else, be it pensions, immigration or changes in interest rates. As Michael says, even the various migration scenarios don’t have anywhere near the same impact as the change to health spending.

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Chart by Michael O’Connor

Even if the OBR is only half right it is highly likely that healthcare spending will outgrow the economy from sometime early in the next decade. It is unlikely that efficiency savings will do much to mitigate this. The National Audit Office has expressed doubt about the ability of the NHS to deliver the sort of productivity improvements that would be needed to offset its financial problems and has suggested that some of the efficiency targets might even have made things worse.

Unless people are willing to accept rationing or to pay for more healthcare at the point of use, the only way to stop the NHS either falling over or pushing the fiscal deficit ever higher is for us all to start paying more tax.

Chris Giles reckons now is a good time for the chancellor to come clean with us about this:

Since Mr Hammond wants to leave big tax reform until his Autumn Budget, he can nevertheless use the evidence of strain in public services to prepare voters for paying higher taxes in future. Naturally this is difficult. The Conservative government was elected on a promise not to raise income tax, national insurance or VAT rates, but if it can ditch a manifesto promise to keep Britain in the EU single market, it can also think again about how best to fund public services.

As the Social Market Foundation said in their report on health funding just before Christmas, people see healthcare as the top public spending priority and have done so fairly consistently for the last three decades.

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If anything is going to persuade the public of the need for tax increases, it is the pressure on NHS finances and the need to keep it properly funded into the next decade. Given recent developments and the worsening of NHS trust finances, it might be a good idea to have an honest conversation with the voters sooner rather than later.

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