James Heywood is a Senior Researcher at the Centre for Policy Studies.
While the Government’s response to the economic impact of the Coronavirus crisis has mostly been warmly received, it was widely accepted that the self-employed were the elephant in the room.
This is not simply down to neglect by the Chancellor, who has actually done his level best to do right by the self-employed, recognised that more needed to be done for them, and has now announced sensible solutions.
But the confusion over the issue speaks to a wider problem with the way our labour market and tax and welfare systems work. We still tend to operate on the assumption that almost everyone is an employee, pays PAYE and earns a steady wage each month, but this increasingly does not reflect the modern UK workforce.
Over the last two decades, the number of self-employed people has increased by 54 per cent and now stands at five million. Nearly one in three of the net jobs created since 2000 have been people becoming their own boss. Now, for every five employees there is one self-employed person.
More people working for themselves is a great thing both for them and for the economy, and many value the freedom and flexibility it brings. A lot of the growth in self-employment has been a result of technological changes which have made it easier for people to set up business in their backroom with little more than a laptop.
However, the phenomenon also poses major challenges for policymakers. As shown by the Coronavirus crisis, self-employed people are particularly vulnerable to sudden fluctuations in business and it is not as easy for the government to help them as it is for a normal employee. More widely, there is an ongoing debate around the gig economy and employment rights, and the self-employed have also been largely left out of the wider success story on workplace pension saving and auto-enrolment in recent years.
There are also anomalies in the tax system which are overdue reform. As the Chancellor said in his statement: “it is now much harder to justify the inconsistent contributions between people of different employment statuses. If we all want to benefit equally from state support, we must all pay in equally in the future.”
Self-employed people pay a nine per cent rate of NICs compared to the 12 percent paid by employees (and the latter’s employer also pays NICs on their wage bill). This lower rate is meant to reflect the more generous State Pension entitlement enjoyed by employees but, under the new State Pension introduced in 2016, Class 4 NICs entitle you to the full amount ,just as Class 1 NICs paid by employees do.
Some can gain from setting themselves up as a limited company and taking their income as dividends. I personally know of people who have joined large, established companies and have been told by their colleagues on arrival that they should set up as a contractor, like everyone else in the office, meaning they can do the same job at the same desk but save themselves and the company thousands in tax. The Office for Budget Responsibility has previously calculated that the tax benefit for an employed person earning £30,000 of incorporating themselves as a company would be £3,300 per year.
Some people and companies can exploit the tax system to pay far less than their fair share while making no greater contribution to the economy than they would doing the same job with employee status. Not only does that make little economic sense, it also means the authorities end up being unnecessarily suspicious of genuine sole traders who are driving growth, for example through the controversial IR35 compliance rules.
There is a strong case for the tax system to reflect the risks involved in running your own business and the reduced entitlement to employment rights and some state benefits, but this should be proportionate and well-targeted and should take into account the heterogeneity of the self-employed population.
As the Institute for Fiscal Studies have pointed out, the tax advantages enjoyed by some are unfair on ordinary employees doing effectively the same work. The tax benefits of being self-employed or an owner-manager should be geared towards incentivising investment and innovation, and should reflect genuine value added relative to normal employment.
As an indication of how confused things are right now, it is currently entirely possible for someone to be classed as a worker under employment law but as self-employed for tax purposes. We need to think seriously about how exactly we want to define self-employment – how we can ensure that it does not expose people to insecurity and exploitation, and how its status should be recognised by the tax and welfare systems in ways which are fair on other taxpayers and provide economic benefit. There are millions of people working for themselves who are driving growth and increasingly form the backbone of our economy. If we can manage this in the right way, we can maximise the benefits of modern technology and working practices.