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Tax and the dilemma of the self-employed
October, 26th 2016

Britain’s self-employed workers have caught the attention of policymakers, not least because their ranks are swelling while their incomes are shrinking. They account for 15 per cent of the workforce but earn less on average than 20 years ago. A debate rages over whether (and how) the government should intervene to support these workers, many of whom are happy, some of whom are not. Yet no one wants to deal with a more intractable problem — tax.

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There are plenty of reasons why the self-employed workforce has grown 45 per cent since the millennium. Technology has made it possible for more people to pursue the independent careers they want. Older workers have used self-employment to sell their expertise and control their own path into retirement. Unemployed people have become sole traders as an alternative to life on jobless benefits. Some businesses have hired independent contractors because they want more flexibility; others to avoid giving employee rights like the minimum wage.
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But no list is complete without a recognition that the tax system incentivises self-employment over regular employment. The dilemma for policymakers is what to do about this without hurting the very people they want to help.

Employees pay a higher rate of national insurance contributions (NICs) than self-employed workers. Employers, meanwhile, have to pay NICs on employees’ wages, but not on the money they pay to self-employed contractors. So the employer who chooses a self-employed contractor over an employee pays less, while the contractor takes home more. The exchequer is the loser, to the tune of about £2.85bn this year.

You could argue this tax break is justified because it promotes entrepreneurship. But the proportion of self-employed people who employ staff of their own has dropped from 23 to 11 per cent since the turn of the millennium. The proportion who work more than 40 hours a week has dropped from 51 per cent to 35 per cent. If this is entrepreneurship, it is not the go-getting, job-creating entrepreneurship to which politicians usually allude.

Alternatively, you might say the self-employed should pay less tax because they are less secure and shoulder more risk. But if policymakers are worried about employers classifying workers as self-employed to avoid giving them protections, then a tax break that incentivises this behaviour seems perverse.

As the tax law specialist Jolyon Maugham points out, it is already costly to provide employees with sick pay, holiday pay, pension contributions and the like. You do not want a tax system that provides bosses with another financial incentive to structure their businesses so that they do not have to bother.

In an ideal world, we would have a system that treats employment and self-employment equally. But there is no easy way to get there. Scrap employers’ NICs and you say goodbye to £70bn revenue. Raise contributions for the self-employed and you impose a tax increase on millions.

Yes, some of these people earn a lot, but the Social Market Foundation estimates that 45 per cent earn less than the national living wage of £7.20 an hour. It might seem more palatable to make employers pay contributions when they hand money to the self-employed. But they would probably share this cost with the contractor, so the self-employed would end up with less money either way.

As Theresa May, the prime minister, embarks on a review of workers’ rights in a changing economy, she might be tempted to avoid the tax question altogether. But even without a simple solution to hand, it is better to face up to the problem than to pretend it does not exist.

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