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Will the next government deliver fair taxation for self-employed?

by LLB Finance Reporter
16th Oct 23 12:53 pm

With taxes at an all-time high and the country gearing up for a general election, Dr Kevin Caraher of the University of York’s School for Business and Society believes that it is finally time for the two main parties to consider a more progressive taxation system – particularly one that provides a more equitable outcome for self-employed people in the UK, who have rarely been in a more precarious position.

Together with Dr Enrico Reuter, he explores possible solutions for a fairer tax system that still delivers the returns the country needs, but questions whether either party will have the political will to deliver the change that’s so clearly needed.

Cast your mind back to March 2020, and the grim news that most of us would be confined to our homes for an indeterminate period, the result of the deadly Covid-19 pandemic. For the country’s employees, the furlough scheme was a quick and immediate way of making sure they didn’t fall through the financial safety net.

For those working for themselves, as sole traders, company directors or as part of the gig economy, the situation was far more precarious. For a while, it was a question of ‘would-they-wouldn’t-they?’ get any help, and even when they did, many of those categorised as self-employed were ineligible to access it.

This dire situation highlighted what the self-employed have known for many years – that despite contributing £303 billion to the UK economy (2021 figures), they have far less financial protection and rights then their employed counterparts.

There is an argument that the benefits of self-employment – lower headline tax rates, more freedom, more earning potential – outweigh the risks of uncertain income and less access to benefits if needed. However, in recent years this argument has been negated somewhat by income disparity between the two groups.

The Family Resources Survey (FRS) recorded that median income fell by 22 per cent for the self-employed from 2008/9 to 2012/13 as opposed to employees who over the same period saw earnings drop by only 5 per cent. Furthermore, the poorest 20 per cent of self-employed workers earn a quarter less than the poorest 20 per cent of employees, and 30 per cent of households with one self-employed worker (and no other earners) are actually in poverty.

Dr Kevin Caraher, lecturer in Social Policy at York University’s School for Business and Society and expert in self-employment, says that a semi-progressive taxation system in the UK is undermined by the National Insurance system. In a chapter called Employment, Self-employment and Taxation written for a recently published book Taxation and Social Policy, he and colleague Dr Enrico Reuter argue that workplace taxation as a whole tends to favour the better-off, particularly in the case of National Insurance Contributions (NICs).

“The overall progressive quality of the taxation of paid income is undermined by a number of factors,” they write, “not least that employers are also liable for NICs, which in effect can be regarded as a tax on employment and a key impediment to any future proposed merger of income tax and NI.

“First and foremost, though, NICs do not rise once an individual reaches certain levels of income as with the higher income tax rates. Instead, employee NIC rates drop by 10 percentage points, thus largely reducing the overall increase in taxation that is caused by crossing into the higher income tax rate of 40 per cent. The effect is similar with profits from self-employment, even if the reduction in NICs is only 7 percentage points.”

Dr Caraher admits that the relationship between employment, self-employment, tax and NICs is ‘highly complex’.

“We don’t have a particularly progressive tax system,” he says, “and the progression that is built in is undermined by the NI system which self-employed people benefit from, but do not have the same range of services that employed people get. So there is in-built inequity.”

Dr Caraher’s comments come in the wake of a report by the Fabian Society, which calls for parity for the self-employed on key rights and entitlements, including better sickness and maternity/paternity support, and easier access to the Universal Credit system. The report is squarely aimed at the Labour party, in the presumption that it may well form the next government. Labour has championed better financial conditions for the self-employed, but hasn’t come even close to talking about a ‘root and branch’ reform of the current income tax system to truly cement such improvements.

“The Fabian Society report is trying to raise the self-employed to a similar level to employed people under the benefits system,” he says. “But I question whether there is the political will to turn round and say, ‘we’re going to give these benefits to 5 million people, but we will have to charge all of you more money to do this’.

“The reasons the Fabians are interested is that there are floating voters for Labour among the self-employed, along with the issue of equity. But you cannot tinker around the edges; you need a full-on systemic change of the tax system to make it more equitable. Incremental change taking place undermines that, because you just add an extra layer of complexity on to an already complex system.

“We argue in the book that you can either try to change the tax package as it is, or you change the way you make other taxes, like property tax. How about taxing people who own mass tracts of land and wealth? That is an easier way to raise revenue to bring up the self-employed.

“I would suggest there isn’t the political will within Labour to make such progressive changes. The Fabian Society report is more of a pitch to the self-employed than a solution to be offered. It’s nice research but, disappointingly, it is unlikely to lead anywhere.”

As we’ve seen in recent times, not least with the debacle of then-Chancellor Kwasi Kwarteng’s mini-budget and the subsequent fallout that ended Liz Truss’s premiership, talk of taxation is a hot political potato that no-one particularly wants to handle. Yet a recent report by the Institute for Fiscal Studies states that Britain must either face higher taxes or accept a deterioration in public services and the welfare state.

The IFS also agrees that root-and-branch reform of the system is be needed to reduce the economic pain that higher levies would involve. This, it adds, is because every one of the UK’s principal taxes is flawed.

Add into the mix elements of the media that pour condemnation upon any party or organisation that dares to suggest tax reform which might punish higher earners, and you have a situation in which there is a kind of paralysis, where no-one wants to blink first.

“How, in this economic climate, do you create a revenue raising package that doesn’t look punitive to the greatest number of people?” Dr Caraher says. “Everyone is hit with something and it’s incredibly difficult to find a way of doing this without making waves. Yet you need to make those waves to make a fairer system work.”

Is there a solution, one that an incoming Labour government could adopt in its first few months in office while support is riding high? Dr Caraher says that raising NICs above the upper earning limits to align with income tax would need to be accompanied by ‘a range of other measures’ to alleviate its negative social and political consequences. These might include a larger number of income tax bands or a more fine-grained system of tax allowances to reflect the circumstances of individual households.

“One could ask whether there are not richer pickings elsewhere in tax reforms,” he writes, “that ensure income from employment or self-employment is treated more favourably than income derived from assets, such as wealth or land, reforms that would not only help to address shortcomings in government revenue and distributional problems but would also prioritise productive activity over the interests of rentiers.

“These, however, would be reforms of a truly radical nature, running counter to the decades-long trend of the British political economy towards rentier capitalism.”

And therein lies the problem – a political system that favours so-called ‘trickle down’ economics and the subsequent soothing in vested interests instead of a tough, yet grown-up conversation about who we are as a society and, more importantly, how we finance this society.

Labour has the opportunity to change this taxation dynamic but, as Dr Caraher predicts, they don’t currently appear to have the political courage to do so.

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