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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14 Responses to Self-employment: who’s dodging the tax?

  1. sdbast says:

    Reblogged this on sdbast.

  2. david says:

    damned if they do and…..

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

    Yes they are. Self-employed and employed workers both face the same income tax on identical income. Income tax, along with other general taxes, fund public services. Or put another way, public services are funded from general taxation, not by National Insurance Contributions (NICs).

    National Insurance Contributions (apart from a 20% sequestration introduced by Gordon Brown for the NHS) do not fund public services. Instead NICs fund contingent benefits such as pensions, sickness and maternity benefits, and Job Seekers Allowance and similar. The largest part of annual NICS paid by workers is transferred to OAPs as state pension. Workers who are paying these NICs accrue an entitlement to receive a state pension in their old age provided thay have made 10 years or more of contributions. It’s unpoplar to say this, but National Insurance was intended to be an insurance scheme and still retains many of the features that make it so.

    Those who argue that NICs are just another tax and that, consequently, there should be equalisation of tax treatment between the self-employed and employed, should also be calling for equalisation of tax treatment between earned incomes and unearned income. Strangely, the silence coming from tax commenatators and economists is deafening.

    Of course, the case for not levying NICs on unearned income (savings income, dividends, rent from property, etc) is that the recipients of such income can not claim contingent benefits or qualify for a state pension. So to defend a favourable tax treatment for unearned income recipients, the commentariat relies on the defence of the National Insurance scheme being insurance, not a tax. How convenient!

    To the extent that NICs do fund public services (20% of NICS now go to the NHS, which is a public service, thanks to Gordon Brown’s reluctance to raise income tax), then a fair tax system should require unearned income to bear a pro-rated National Insurance contribution in respect of the element used to fund the NHS. Not one commentator or “think tanker” has raised this point.

    Last but not least, the commentariat seens to have swallowed hook, line, and sinker the claim by Hammond that Osborne’s abolition of class 2 NICs will make low income self-employed workers better off. This claim is erroneous. Class 2 NICs currently cost the poorest self-employed worker £2.80 per week. This contribution buys the self-employed worker access to the state pension at an accrual rate of approximately £6 per week in retirement. It is very good value in investment terms. But of couse, the poorest self-employed worker will now be denied access to this favourable scheme. Abolition of class 2 NICs in 2018 will leave those self-employed workers who are below the class 4 thresholds high and dry in respect of providing for their old age through the state pension (let alone a private pension). Of all the measures the Blair government took to alleviate poverty, attaching pension rights to class 2 NICs was one of their finest. But, of course, only support for class 2 abolition is offered by the great and good and the commentariat for the withdrawal of this vital lifeline for the poorest among the self-employed.

    • Sue says:

      I am affected by the abolition of Class 2 contributions as somebody who only earns about £6000 a year from self-employment. In all the comments since the budget,,this is the first one I have read which has highlighted the issue of people like me. My only option now,if I want to continue accruing entitlement to state pension is to pay voluntary Class 3contributions @ over £14pw,which is a huge jump from £2.80. The double whammy for me is that I’m one of the women who has had her state pension age raised from 60 to 66 and I have continued to work to make up for the delay in receiving state pension.

  4. Dipper says:

    do you have stats for dividends paid by the self-employed to themselves? The remuneration picture isn’t complete without that. And what about the self employed cycling their companies to get entrepreneurs tax relief?

  5. Hammond might have told us all how Class 4 will level the playing field exactly, before talking of increases?! It currently still buys you zilch.

  6. John says:

    It was obvious Hammond was being economical with the truth when he said ‘An employee earning £32,000 will incur between him and his employer £6,170 of National Insurance Contributions.’
    What he somehow overlooked was the breakdown between how much of that is paid by the employee and how much by the employer.
    This makes it cheaper for employers not to have employees.
    It also means that unionised labour reduces as a proportion of the economy.
    That is unless self-employed individuals join trade unions – unlikely.
    This policy is an attack on trade unions and the Labour Party.
    The Tories think they are so smart – but they really are stupid.
    Serves them right – getting into a political mess with their stupid ideas.

    • Blissex says:

      «Hammond was being economical with the truth when he said ‘An employee earning £32,000 will incur between him and his employer £6,170 of National Insurance Contributions. What he somehow overlooked was the breakdown between how much of that is paid by the employee and how much by the employer.»

      100% of both NI contributions is paid by the employee. The “above the line” 13.8 of NI “employer” contributions, just like “employer” private pension contributions, is pure dissembling with the purpose of fooling gullible workers into the illusion that they have shifted part of their tax or pension burden onto employers. For employers what matters is the total cost of an employee and how much they must withold each month for HMRC, not the misleading labels used to itemize each line.
      Then there is the difficult issue of tax incidence, but that is not affected at all by having several misleadingly different labels for the same thing.

  7. Francis says:

    In the long run the incidence of employer’s NI and employee’s NI will be the same, surely?

  8. Dipper says:

    A small tip of a very big iceberg here. Rick has been reporting assiduously on the self-employed/employee split and this tax rise seems to be another step in the road.

    Self-employed have fewer rights and fewer benefits. Paying lower taxes is compensation for the risks. If tax is the same then there is less benefit to the individual of being self-employed.

    Meanwhile UK is leading the way in driving down employee remuneration to drive economic growth. The gig economy is removing employee rights, and our (historic) fully embracing Freedom of Movement to source lowest cost Labour from across the EU (and outside) and to avoid the expense of training workers has resulted in our being the only leading nation to have simultaneous economic growth and reducing wages (see https://twitter.com/paul1kirby/status/837411180213846017).

    This puts the Tories in a difficult situation. The notion that reducing regulation will ultimately lead to an increase in wealth across the classes is at the core of conservative philosophy and is manifestly being disproved. The nation has just voted to remove one peg of the economic construction – freedom of movement – and if this doesn’t result in wage increase then surely other forms of protest will follow. May’s controlling instincts are at odds with much of her parties intellectual inheritance. How the self-employment vs employment balance plays out will be very interesting.

  9. Philip says:

    Back-pedalling rather than back peddling…

  10. Blissex says:

    «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.»

    Too bad that such an employee would be fooled by quite intentional mislabeling.
    Anyhow the big deal is that as “The Economist” noted it used to be that typically the self-employed were opted-out of a large chunk of the state pension, and that matched low NI contributions. Last year the state pension was largely equalized between employees and self-employed, so there is a very argument to equalize the total level of contribution.

  11. Pingback: “Self-employment: Who’s dodging the tax?” – Terence's Museyroom

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