The report on self-employment by the Institute for Fiscal Studies (IFS) published earlier this month has stirred things up. The report found that, on a given level of earnings, typically, a self-employed person will pay less tax and NI than an employee. Not particularly controversial but the Freelancer and Contractor Services Association (FCSA) and the Association for Independent Professionals and the Self-Employed (IPSE) interpreted this as an attack on the self-employed.
I can understand why. Headlines about the gig workers’ tax advantage didn’t help but, to be fair to the journalists, the IFS press release contained the strapline “costly, inefficient and unfair”. It was likely that someone would interpret this as an accusation against the self-employed.
The IFS responded, saying:
We make no criticism of them or their behaviour. Rather, we are criticising government tax policy, on the basis of verifiable facts about how the tax and benefit system works and our analysis of why most of the reasons used to defend lower rates for the self-employed simply don’t hold. We invite all interested parties to read our report.
A good suggestion because it is an interesting read.
The first thing it notes is that the self-employed are still a small proportion of the workforce and those working through companies an even smaller one.
But their numbers have grown significantly since the recession and this trend will probably continue. The reports also points out that the increase in the number of owner-managed firms since 2007-08 has come entirely from one-director companies.
The trouble is, the self-employed, whatever legal form they use, are not taxed in the same way as employees. As this example shows, for someone paid £40,000 a year by a company, the exchequer gets a lot more from an employee than it does from the self-employed.
Furthermore, the more people are paid, the wider the differential becomes.
Rising self-employment is therefore a potential disaster for the public finances. As the IFS report says:
One reason for this sudden interest is that the Office for Budget Responsibility (OBR) has quantified the cost of the ongoing shift towards working through a small company. It forecasts that the rapid expected growth in owner-managed companies will lead revenues to be £3.5 billion lower in 2021–22 than if the small company population and employment grew at the same rate (assuming that the overall change in the size of the workforce remained the same).
HM Revenue and Customs (HMRC) estimates that the effective NICs subsidy to the self- employed relative to the employed exceeds the value of their reduced benefit entitlement by £5.1 billion, or £1,240 per self-employed person.
The report recommends aligning the treatment of different legal forms of work, thereby applying the same overall tax rate to income derived from employment and self-employment. It discusses a number of ways to do this but, by whatever combination of taxes, the goal is for the three £40,000 earners in figure 7.3 to each be paying around £12,000 to the exchequer.
From a fiscal point of view this makes sense. By equalising the tax paid, either self-employment will become less attractive both to workers and employers, or it will continue but the tax take will rise. Either way the government plugs what could be a nasty and widening hole in its finances.
So, while it is true that a self-employed worker earning £40,000 will pay less tax than an employee on the same rate, he or (increasingly) she is much less likely to be on £40,000 in the first place. As you go up the scale in Figure 7.4, you find fewer and fewer self-employed people, apart from a tiny cluster earning over £100,000.
HMRC figures suggest the mean annual self-employment income is somewhere around £16,000 but, as Michael O’Connor showed, when you remove the small number of £100,000 plus earners, the mean incomes of the rest are very low. Furthermore, while some of the self-employed have earnings from other sources, a lot of them don’t.
As the RSA reported earlier this month, almost a fifth of self-employed are in receipt of tax credits, compared to 10 percent of employees. The move to Universal Credit is likely to reduce this support for many self-employed people.
Against this background, making the self-employed cover their own employer NICs is a big ask. It is true, as the RSA points out and the IFS chart in Fig 7.4 shows, that the amounts for low earners are not very large but when people’s pay is already so low it could make the difference between staying in business and packing up altogether.
Again, from a macroeconomic perspective, that might be a good thing. Removing the marginal self-employed would mean that employers either had to pay more to the ones that were left or convert their contractor jobs back into roles for permanent employees. However, even if this worked it would take a while and, in the meantime, some people would be facing destitution. More generous benefits for those that had closed their businesses, at least for short-term, would be a necessary quid-pro-quo.
There’s another important point here though. Let’s be clear about who is doing most of the tax avoiding. Look closely at Figure 7.3 from the IFS report. It’s the employer who is saving the biggest chunk of tax by using self-employed workers. Furthermore, the employer is also avoiding holiday pay, redundancy or unfair dismissal liabilities, pension payments and training costs. All this becomes the responsibility of the self-employed worker. While some of the self-employed may gain a bit from their tax status, the most of the benefits of self-employment are going to the employers.
Calls for something to be done about this are the story of the moment. ONS figures out today showed that the number of self-employed workers is at a record high. Yesterday the TUC added its voice to those of the IFS and RSA, claiming that low-paid self-employment is costing the exchequer £2.1 billion a year, though pointing out that this is due more to severe low pay relative to employees than to tax rates. RSA boss Matthew Taylor, who is heading the government’s review of employment practices, attacked businesses for using self-employed workers to avoid paying tax.
They are right, of course. As I have often said, the rise of the PAYE-less, NIC-less, VAT-less and impoverished freelancer is everyone’s problem. The trouble is, trying to solve this by adding burdens to people already struggling to get by will have potentially devastating consequences for some. If we want to make it more difficult for employers to avoid tax and dump costs by using self-employed workers, we have to make sure the poorest don’t end up taking most of the hit.