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!