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Rumours have it that the Chancellor will use his Budget tomorrow to raise Class 4 NICs for the self-employed – a sensible move that could strengthen self-employment in the long run. But he risks a backlash unless he commits his proposals to meaningful consultation. Tax reform without popular support is always short lived.

To raise or not to raise?

If yesterday’s reports are anything to go by, the government is not-so-secretly drawing up plans to raise National Insurance contributions for the self-employed, meaning they would pay an equivalent personal rate to employees.

Sole traders who work for themselves currently contribute 9% of their earnings above £8,060, whereas employees pay 12% of their earnings above the same threshold. And while employers pay 13.8% of their employee’s earnings in NICs, there is no equivalent tax levied on the self-employed.

Unsurprisingly, the suggestion of such a tax rise has been met with fierce opposition, including from business groups, a number of MPs and many in the tabloid press.

The Sun calls it a ‘white van tax grab’. The Daily Mail describes it as a ‘tax raid on the self-employed’. Even Jacob Rees-Mogg has chimed in, saying the move would ‘hit the entrepreneurial spirit and damage the economy and tax revenues in the long run’.

But is more equal treatment under NICs such a bad idea?

Three arguments for reform

A recent RSA/Crunch report argues that the tax discrepancy between the self-employed and employees leads to three core problems.

First, it creates incentives for bogus self-employment. Thanks to the tax gap, employers face considerable savings by treating their workers as independent contractors when they should be engaged as standard employees. For a worker paid the median wage of £27,000, this equates to a windfall in Employer NICs of over £2,600 a year.

Workers may gain from this arrangement in the short run – paying a lower personal NICs rate of 9% - but they stand to lose several important protections that may not be immediately apparent. This includes sick pay, holiday pay, maternity pay and employer pension contributions.

The second problem is that the NICs differential makes it difficult to call for more welfare protections to be extended to the self-employed. The Chancellor is unlikely to open up Statutory Maternity Pay or establish a Paternity Allowance for sole traders while they continue to pay less in NICs. Nor can we expect any softening of Universal Credit terms, under which the self-employed currently have a raw deal.

Third, the NICs gap puts pressure on the UK’s tax base, lowering tax receipts at a time when public services are at their most stretched. According to HMRC, the Exchequer lost out to the tune of £2.85bn in 2015/16 as a result of the self-employed paying a lower NICs rate than employees.

Three arguments against reform

What about the case against an uplift in NICs?

One argument is that the self-employed take more risks and drive innovation, and that this should be recognised in the tax system. But while this is true of some of the self-employed, it is certainly not true of all. Think of the majority of tradesmen and women – carpenters, electricians, welders – whose job is a predictable, if highly-skilled, vocation.

It is more sensible to reward risk-taking behaviour and innovative activities through targeted tax breaks. A good example is the Employment Allowance, which writes off the first few thousand pounds a business pays in Employer NICs, thereby directly encouraging them to take the gamble of hiring employees.

A second argument is that the self-employed are already struggling with low pay, and that a tax rise would push them further to the edge. Yet this perspective misses the fact that it is the highest earners who benefit the most from the tax discrepancy. Someone on £15,000 a year gains just £63 in NICs savings, whereas another person on £60,000 benefits from £903, not including the £7,160 foregone in Em­ployer NICs.

A third argument is that self-employment is vital to a flexible labour market, giving people an easy outlet for work and thereby softening the impact of economic fluctuations. Ergo, the lower the taxes are on this form of work, the more dynamic our economy and the more likely we are to avoid spikes in unemployment during recessions.

I find this argument the strongest – but still not strong enough to explain the extent of the tax advantage open to people who work for themselves.

Legitimacy first, reform second

Taken together, there is clearly justification for some kind of reform to National Insurance. Yet if we are being honest, we would recognise that arguments are rarely won on a technocratic footing – one that assumes people will confront an issue on rational terms and have the time to absorb all the facts, arguments and counter arguments.

The Treasury, lobby groups and think-tanks can do all the number crunching they like, and make the most compelling technical case for reform. But if they are only talking to themselves rather than the outside world, then there is little hope for meaningful change.

Witness the outcome of the Mirrlees Review. Despite being one of the most far reaching and comprehensive investigations into the UK’s tax system, it barely made a dent on tax policy. Indeed, most of the sensible recommendations it put forward were ignored, including those of merging NICs and Income Tax, updating Council Tax bands and transforming Inheritance Tax.

Why? Because the Review had no legitimacy. And it had no legitimacy because it wasn’t underpinned by a robust public debate about the necessary trade-offs that would need to be made, who should win and who should lose, and what we even want our tax system to do for us as a society.

All of this points to the need for a thorough consultation on NICs reform before any changes are made.

In doing so, the government should work with business groups to consider the different options for an adjustment to NICs (and to taxes on incorporated businesses*), be honest about the trade-offs, make clear what people have to gain, and implement any chosen reform over a period of time to cause the least amount of disruption.

And if not?

Then the Chancellor may face his very own ‘pasty tax’ moment

 

*Any consideration of tax reform for the self-employed must also take into account the position of those who have incorporated their business. A NICs uplift will almost certainly create incentives for people to move from sole trader status to limited company.

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