Tax and the self-employed

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.

screen-shot-2017-02-14-at-16-28-40But 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.

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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.

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Furthermore, the more people are paid, the wider the differential becomes.

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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).

And:

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.

But there’s a problem with all this. Most of the self-employed are already earning a pittance as it is. The collapse in their earnings since the recession has been severe.

screen-shot-2017-02-15-at-09-49-55

Chart via Resolution Foundation, Living Standards 2017

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.

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seFOIblog0

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.

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6 Responses to Tax and the self-employed

  1. Jim says:

    The self employed don’t get the same benefits as the employed – no holidays, no holiday pay, no sick pay, no redundancy money, nothing. If you don’t work, you don’t get paid, simple as that. What the f*ck should I pay the same tax as en employee but get less benefits?

  2. Patricia Leighton says:

    This is quite a fair report and does illustrate that the main ‘winners’ are employers, especially of low paid allegedly self-employed workers. It should also be borne in mind that the costs to the freelance/self-employed are not just in terms of the way they work. Even renting a flat, getting a loan is often most difficult and usually hugely more costly if you are self-employed. It is vital to shift the fire away from lower paid yet vulnerable self-employed people on to often large, often multi-national tax avoiding companies like Uber and Amazon to ensure, one way or another that they pay up. Just look at the data on Uber, in terms of the deductions(25% at least) by Uber from income, the costs borne by drivers and the dividends paid to US based share holders of a company ‘doing what’?

  3. Jason Kitcat says:

    A really good blog pulling together lots of threads in the self-employment debate at the moment. As Crunch (my employer) were partners with the RSA on the report you cite “The Entrepreneurial Audit” I thought I might throw in a few points:

    – The report proposes equalising NI for workers regardless of status in return for up-lifting what the self-employed can expect from the state e.g. adding paternity and adoption allowance eligibility for the self-employed.
    – The report also proposes a number of possible reforms to employer’s NICs which combined with the above recommendation would remove much of the incentive from employer’s cost savings by pushing workers into false self-employment.
    – Other recommendations cover issues from business rates to home working to late payments; so it’s a pretty broad piece of work.

    As an aside: Completely aligning tax burden between the employed and self-employed is a tall order for as long as the regulatory burdens are greater on the self-employed: Tax filing, Company House filing, insurance etc.

    The larger, perhaps cultural point, is that we risk getting lost in a debate around a very small sub-set of the self-employed: Those being unfairly treated, those in disguised employment etc. Those issues need to be dealt with, no doubt. But what the RSA’s work is about is supporting those seeking genuine self-employment which still, by all reasonable accounts, makes up the vast majority of this fast-growing sector.

    As you say, existing legislation is already sufficient (when properly applied) to block the worst cases. But what can we do for the many who want to run their own business in pursuit of meaningful work and reasonable incomes? The RSA report is a contribution to that debate which affects the many in genuine self-employment. https://www.thersa.org/events/2017/02/the-entrepreneurial-audit

  4. Keith says:

    Old hat this. Mirrlees et al proposed the unification of income tax and national insurance years ago.
    This integration would allow all tax payers to have a personal allowance so all direct tax was progressive. The treasury however seems determined to ignore all the people who have ever studied taxation in designing the system!

  5. Thanks to the author of this blog for a great summary.

    Jason Kitcat comments that..

    “The larger, perhaps cultural point, is that we risk getting lost in a debate around a very small sub-set of the self-employed: Those being unfairly treated, those in disguised employment etc. Those issues need to be dealt with, no doubt. ”

    And that …

    “The report also proposes a number of possible reforms to employer’s NICs which combined with the above recommendation would remove much of the incentive from employer’s cost savings by pushing workers into false self-employment.”

    “remove the incentive”? I mean, really? If only the self employed were paying more tax, then employers wouldn’t bogusly employ them then, is that the logic? I hate to state the blindingly obvious, but employers couldn’t care less what rate of NICs you’re paying when they’re bogusly self employing you. It still doesn’t hit their pocket, only yours.

    And I wonder, just what makes you think the Govt will embrace these incentives?!

    The NIC tax changes (effective April 2018) and the minimum income floor and the surplus earnings rule and rules around transitional protection in Universal Credit all clearly demonstrate the real contempt this Govt now holds the self employed in. As far as they’re concerned the low paid self employed just aren’t trying hard enough to increase their profits and Govt is tired of ‘subsidising’ them. This reform to national insurance contributions is not about helping the self employed for heaven’s sake. Get real !

    And when those on tax credits and any other benefits that are outwith Universal Credit right now are migrated, what a perfect storm will brew. Govt won’t give you benefits, and employers won’t give you any of those proper (paye) jobs. Really good to see Frances O’Grady keeping cite of the reality though https://www.thersa.org/events/2017/02/the-entrepreneurial-audit

    • Jason Kitcat says:

      Hi @rentrebel,

      I think you misunderstood my point…

      I totally agree with you that disreputable employers already seeking to avoid their NIC obligations with false self-employment of their workers aren’t going to be motivated by changes to employee NICs.

      But the RSA report suggests changes to NICs at both ends. The proposed changes at the employer end would remove the incentives for disguised employment as the NICs would be the same to the employer regardless of whether the worker was employed or self-employed.

      In my view the rules are already there to be clear on what is genuine self-employment and what isn’t. There is a lack of enforcement, my hope is the recent tribunal and court judgements will help nudge this along. But as Frances O’Grady acknowledged this all relates to a small number of workers compared to the overall self-employment segment. What can government do to support the genuine self-employed? That’s an important questions which applies to more people than ever before.

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