The unjustified under-taxation of the self-employed

The self-employed are undertaxed relative to employees. That’s a simple statement of fact.

But let’s first be clear what this doesn’t mean. That doesn’t imply that people who work for themselves are any less virtuous than people who work for firms. It doesn’t belittle the economic contribution of these five million or so British workers. Nor does the statement contain any judgement about the rate of tax that employees pay, whether it’s too high or too low.

Yet that statement of fact – that the self-employed are currently privileged in the tax system with the gap adding up to around £ 5bn of foregone revenues a year – is evidently a hard message for many people to digest. Impossible even.

The Treasury’s low-key cancellation of a planned bit of national insurance tax relief for this group of workers last week was loudly condemned by the Federation of Small Businesses and bewailed by the TaxPayers’ Allowance even though, had the move gone ahead, it would have increased the overall tax gap between the self-employed and the employed still further.

“The Tory party is meant to be the party of low taxation and the friend of the ambitious. This U-turn fails on both counts,” sniffed the Tory backbencher Jacob Rees-Mogg. Are we to infer from this statement that company employees, all 27 million of us, who do not benefit from this lower rate of tax, are to be considered unambitious? The consequence of the tax gap is that employers have a major incentive to hire people as temporary contractors rather than taking them on full-time, even when they’re effectively doing the same job. Plenty of people who are self-employed today, particularly in the gig economy, would prefer to be employed.

Yet even Labour’s shadow chancellor John McDonnell, who has frequently bemoaned the casualisation of the British workforce in recent years, called the Treasury’s reversal a “betrayal of the self-employed”.

Another consequence of the tax gap for the self-employed is that, as more people are employed in this way, total tax revenues from employment dwindle. This is something the Office for Budget Responsibility has highlighted as a threat to the public finances.

If less tax comes from the self-employed, there’s a strong likelihood that, with public services clearly in need of a funding boost, ministers will end up increasing the income-tax burden on the employed. In this sense, one might say that the Treasury’s originally planned tax cut for the self-employed would have been a betrayal of the employed. Some don’t seek to deny that the self-employed are undertaxed, but argue that this is necessary to encourage people to become entrepreneurs, or to compensate the self-employed for the fact that they don’t get paid holidays or company pension contributions. But leaving aside the pretty dubious economics inherent in these claims, trying to accomplish these kind of goals through a distorting tax gap is a terrible way to do it.

What we have here is an example of the dysfunction of our political system when it comes to tax.

Newspapers don’t understand the subject, or choose not to understand it. They create a stupid slogan such as “White Van Man tax” in response to an attempt to close the gap. Cynical politicians – from both main parties – pander to the slogan, even when it undermines their broader agenda.

Ministers panic. Broadly sensible attempts at reform put forward by civil servants are hastily reversed, as happened last year. Then there’s a furtive attempt to undo some of the damage of the reversal, which is in danger of making matters worse because it is not part of a comprehensive and coherent reform of the whole cripplingly-complex system.

The traditional liberal faith is that good arguments and good information will have a tendency to drive out the bad varieties. It’s a faith that is being brutally tested. The Institute for Fiscal Studies has carefully explained the issue of the £ 5bn-a-year self-employed-employed tax gap and its adverse consequences clearly and frequently in recent years. Its director, Paul Johnson, did so again on the BBC’s Today programme on Friday.

The government-commissioned Taylor Review of modern working practices last year argued unambiguously that “treating different forms of employment more equally in the tax system would be fairer, more economically efficient and support better quality work”.

Perhaps one glorious day the message will finally penetrate. But for now we’re forced to contemplate a miserable vista of wilfully ignorant news organisations, ideologically obsessive pressure groups and political opportunists shoring up a tax status quo that hurts the people that this same crew purport to be trying to help.

#InstituteforFiscalStudies #nationalinsurance #selfemployment

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