Hammond is right to break the Conservatives’ National Insurance pledge

Philip Hammond’s decision to raise National Insurance contributions (NICs) for self-employed people has been the most eye-catching and controversial aspect of the budget. No less captivating for a Liberal Democrat has been our party’s response. Lib Dems are understandably keen to hammer the Tories for breaking a manifesto promise. And MPs have been quick to paint themselves as the defenders of entrepreneurs and small business people (though patronising them as “White van man” is probably unwise).

For all that, the Chancellor’s policy is right – though it goes only a tiny way to treating all workers equally and fairly. Let us look first at the tax break and then deal with some objections.

  • Employees pay class 1 national insurance at 12% on earnings from £155 to £877 a week and 2% on earnings above that. The weekly sums are supposed to equate to £8,060 and £43,000 a year.
  • Employers also pay 13.8% on top of what the employee pays. Despite the myth that “employers pay” and that this comes out of profits, this is a tax on employed people’s wages. This is the biggest part of the injustice in the tax system and the chancellor has not touched it.
  • Self-employed people pay class 4 national insurance at 9% on profits between £8,060 and £43,000 and 2% on profits above £43,000.
  • Self-employed people also pay class 2 national insurance at a flat rate of £2.80 a week if they earn over £5,965 a year. So silly is this policy that George Osborne killed it (from April 2018). Interestingly, as part of that it was announced that class 4 national insurance would be increased to compensate, so there is some cover for Mr Hammond’s move.
  • Those incorporated as companies are able to take their income as dividends rather than salary, and so avoid NICs altogether.

Two things are obvious from this. Firstly, the self-employed pay a marginal rate of tax that is 2% lower than an employed person on what one might call (using an Income Tax analogy) “the basic rate”, and they totally avoid the 13.8% “Employers” NICs. Secondly, they get to offset some business costs against income (e.g. a telephone line; part of their rental or mortgage costs).

This is unfair. Two people should not be taxed differently for the same job (imagine a contractor and an employee working side-by-side) or even for different jobs paying the same amount. And the directors of a company should not pay lower rates of tax than their employees. It also distorts the decisions people make – for example, encouraging them to choose self-employment rather than a job for tax reasons rather than more substantial reasons.

There are two counter arguments. Both are wrong.

The first is that entrepreneurs are risk-takers and innovators whom the government should incentivise through the tax system. I disagree. There is plenty enough incentive being self-employed, and if the deciding factor is that you get better tax treatment when self-employed you’re making the choice for the wrong reasons. It is also not true that most small businesses are especially creative. In fact many self-employed people are just consultants who want to minimise their taxes. The government is right to stop this absurd subsidy.

The second is that the self-employed do not have access to some of the state benefits that employees get and so should not pay as much. This would be fair if true, but it is largely mistaken. Firstly, most of what NIC (supposedly) pays for is available to all: the biggest is the state pension; 16% goes to the NHS; the self-employed get Statutory Maternity Pay. Both Statutory Sick Pay and holiday pay are funded by employers. It does not make any difference if you are an employee or self-employed: the money you charge for services pays for your holidays and sick pay, as well as your salary. Self-employed people can’t treat all their fees as hourly income and then complain that they don’t get holiday pay. If there are any major welfare gaps they should be closed; as it is, but the self-employed would anyway still be paying far less tax due to avoiding “Employers” NICs.

I cannot deny that it has warmed my heart to see my fellow Liberal Democrats decrying a Tory tax increase. I hope that we will continue to fight for lower taxes for working people. But we also have a proud record of arguing for tax justice. It is unfair that employees have paid more tax than the self-employed for years. It is right that the government should try to fix that.

* Tom Papworth is a member of Waltham Forest Liberal Democrats

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18 Comments

  • I’d just prefer to hammer the pensioners – they voted for Brexit, they should pay for it.

  • The Tories used the threat of tax increase, and specifically NI increase, as a reason not to vote Labour in 2015. It may be seen as hypocritical for Lib Dems to be arguing that so easily breaking a manifesto pledge is the wrong thing to to but the error would be in not speaking up. A change of policy such as this should come with a pretty detailed explanation about why there was a need for change otherwise we left in a world where the public can be mislead about a parties intention without any implications from it.

    The second point would then be about whether it is right to increase tax in this way. The ways in which we tax people are needing to get increasingly complicated (how many news outlets used the image of Uber when talking about self-employment tax rises despite also reporting on the October 2016 court ruling that they are workers?) and tweets about this change meaning middle earners are now going to pay more tax than amazon are shocking; however you are right in saying that tax justice is far more important than previously ill-thought out election promises.

  • Eddie Sammon 13th Mar '17 - 4:31pm

    This is where I agree and where I disagree:

    I agree:

    Raising Class 4 to 12%, in theory, would be equalising direct NIC rates between the self-employed and the employed. The Chancellor is only going to 11%.

    But:

    It needs to be made clear that 100% of the cost of Employer’s Class 1 (the 13.8% rate) is not passed onto the employee. This is the suggestion from graphs and tables of taxes that the Treasury, Resolution Foundation and IFS have been producing and is as wrong as saying that Corporations pay 100% of the cost of VAT. The cost is split, because the tax is levied onto someone else.

    The direct taxation on dividends 1-((1*(1-corporation tax))*(1-dividend tax)) is actually higher than income tax + Class 1 NICs for the employed for higher and additional rate tax payers. Dividends are no longer a method to avoid much tax, unless you count lots of the Employer’s Class 1 too.

    On expenses: many employer’s get these paid for. Employees don’t have to chip in for their seat in the office, so this is not really a big advantage for going self-employed unless you punish the law-abiders for the crimes of the ones falsifying expenses.

    I also disagree with this idea that tax equalisation must always mean more taxes. I’d rather cut NI on employees to equalise treatment, rather than trying to tax and cut our way to prosperity too much.

  • Tom Papworth 13th Mar '17 - 4:35pm

    Thank you both for commenting.

    Rob, I’d prefer not to ‘hammer’ anybody; I’d rather see taxes fall rather than rise. It is a fascinating insight into our current debate about ‘austerity’ that there is much talk about the spending-cut side of austerity but very little about the tax-raising side, which is just as ‘austere’.

    Having said that, it is true that pensioners have been the only age group for whom real incomes have risen since the recession. There is inequity there, to be sure.

    DJ, I suspect you are right that “It may be seen as hypocritical for Lib Dems to be arguing that so easily breaking a manifesto pledge is the wrong thing to” do. Having not only done so ourselves but also defended it on the very grounds that it was “the right thing to do”, we are more likely to attract ridicule than respect. This despite the fact that the conservatives have, themselves, been hypocritical, having criticises us for breaking a pledge just two years ago.

    I hope above I have made a decent fist of providing “a pretty detailed explanation” of why a “change of policy such as this should come”. It is simply unfair to perpetuate the existing inequity.

    I agree that a fundamental, root-and-branch re-examination of how we raise tax is long overdue. But it is also very hard to do in practice (for an example of doing it in theory, see the Mirrlees Review). Nonetheless, Hammond’s policy is an (imperfect) attempt to eliminate a distortion and simplify the tax system. That should be welcome.

  • They could have equalised the rates by dropping NI and giving a boost to the workers. Now they’d either be faced with more cuts or increasing other taxes if they did that. Personally an increase in Income tax would be my preferred option.

  • Tom Papworth 13th Mar '17 - 4:44pm

    Eddie, I agree (as I hope my last paragraph hinted) that it would have been preferable for the Chancellor to ‘equalise down’ rather than ‘equalising up” – I’d like to have seen a NIC cut for employees too. And I agree that the chancellor’s move didn’t go far enough (though it is 11% next year and 12% from 2018, IIRC). I also agree that the impact of expenses is not huge; I agree that self-employed people should be taxed on the surplus after expenses.

    I don’t think you are right about Employers’ NICs, however. Ultimately, these are merely another part of the ‘Tax wedge’ between what employers pay to employ somebody and what the employee takes home. Strictly speaking the tax is 13.8/113.8 of the nominal salary, rather than simply 13.8%, as I implied above – I thought I’d avoid getting into that so as to keep it simple. But the tax still ultimately reduces employees take-home wages and allowing the self-employed to avoid it is the largest single inequity in the tax treatment of the two groups.

  • Eddie Sammon 13th Mar '17 - 5:20pm

    Thanks Tom, yes I agree a bit of equalising down would be good too (bit of both is realistic). I’m not sure how much Employer’s NI raises but I think it needs to be phased out or we need to introduce a “Contractor’s NI” rate, levied onto the contractor, to get rid of the main driver behind recruiting people “on a self-employed basis”.

    We should also toughen up on the enforcement of employment contracts. The old guidelines used to say if you are only working for one entity on a regular basis and are not doing any of your own marketing activities then you are employed, not self-employed. Often the guidelines are right but they simply aren’t enforced.

  • Sorry Tom, maybe I’m being dense, but I really don’t see why the 13.8% NIC that I as an employer am paying is coming out of my employees’ wages. Are you assuming that if I didn’t have to pay this then the money would be used to increase their wages? If so, why? Maybe if I didn’t have to pay £1000 a month for the privilege of employing people I could afford to pay myself the same as I pay them; or perhaps I could invest in equipment to boost the company’s productivity. I’m not averse to paying tax, but such a hefty tax on employment seems to me to be perverse.

  • Nonconformistradical 13th Mar '17 - 7:48pm

    @Rob
    “I’d just prefer to hammer the pensioners – they voted for Brexit, they should pay for it.”

    This one didn’t – don’t tar all pensioners with the same brush please

  • Nonconformistradical 13th Mar '17 - 7:51pm

    @David Becket
    “I would support the increase but for one factor. We have first got to sort out the Gig economy, and ensure that only those who want to be self employed are self employed.”

    I thought m’learned friends were at work on that – there have been several cases where courts have ruled people working in the gig economy should be treated as employees – involving I think a couple of Uber drivers, 1 or more Deliveroo drivers, a cycle courier and a plumber.

  • Neil Sandison 13th Mar '17 - 8:40pm

    There is a whole world of difference between being self employed with your own company and being your own “guvnor “Than being a an agency worker or an alleged franchisee on minimum wage locked into punitive contract or exclusive contract for an employer by another name.We have to redefine what is genuinely self employed and what is unscrupulous milking of the employment market we can then set tax rates that encourage genuine enterprise and punish employers who use loop holes to exploit their alleged self employed staff.

  • It would have been good if the LibDems had instinctively stood up for the smaller self employed earners. If ever there was an obvious constituency for a liberal party ….,

  • And, as many people are very well aware, whilst the employed pay tax and NI on all (or certainly almost all) of their earnings, it would be naive to suggest that all self employed people do the same.

  • Dean Crofts 14th Mar '17 - 8:59am

    Ok why do we want to punish the self employed? Especially sole traders who are earning probably less than the VAT threshold of £83K, as anyone would set up a limited company if turnover was more than this. These are the people we should be protecting and reducing taxation for!

    Self employed – mainly sole traders who pay class 4 NI – do not get the same benefits as employed people – no statutory sick pay, which last time I looked is higher than what self employed get on ESA. No holiday pay – self employed have to plan their holidays as if they ae not working they are not earning – if you are employed you are guaranteed 20 days a year leave with full pay.

    If we have to raise taxes to pay for public services then please let us as liberals look at indirect taxation and not taking money off people before they even earn it.

  • Tom Papworth 14th Mar '17 - 10:09am

    Hi Tony,

    That’s a fair question about employers’ NICs. It boils down to the fact that what you as an employer pay to employ somebody is not their nominal salary but the entire cost of employment. You will presumably employ anybody who is able to generate more revenue for you than they cost to employ – the surplus being your profit. Because your competitors could also employ them, the amount you pay will be bid up to the maximum you can afford to pay (i.e. the minimum profit you are willing to take).

    Employer NICS, like pensions, holidays and the desk they sit at, are costs of employing them that do not go to the employee. What is left is their nominal gross salary. There are further costs of employing them that do not go to the employee in the form of employee NICs and Income Tax. On paper the former set are paid by you and the latter set are paid by your employee, but in reality all taxes are a cost that reduce the amount that the employee takes home.

    You are right that a hefty tax on employment is peverse. Numerous economists have pointed out that employer NICs are an “employment tax” that increases unemployment because it makes some workers to expensive to employ. For the rest, it reduces their real wages. I would love to abolish employer NICs, but if that is not possible there should be equality between employees and the self-employed (or, if you prefer, between employers and the self-employing).

  • Tom Papworth 14th Mar '17 - 10:10am

    Neil Sandison,

    I agree with you in principle, but defining “hat is genuinely self employed and what is unscrupulous milking of the employment market” is hard if not impossible. The beauty of equalising the tax treatment of both groups is that it removes the bias in the system and means that there are no “loop holes to exploit”.

    John M,

    Actually the Lib Dems DID “instinctively [stand] up for the smaller self employed earners” (http://www.libdems.org.uk/national-insurance-hikes-budget-2017). My point is that taxes should be fair; “smaller self employed earners” don’t deserve any more sympathy than “smaller” employed earners. I would have preferred to achieve that by reducing taxes for employees, but that doesn’t change the fact that the tax system should be fair, which means it should treat employees and the self-employed equitably.

    Dean,

    As I note in the article, self-employed people get most of the same benefits as employees, and those which they do not are funded by the employers (and should, therefore, be funded by the self-employers). For example, statutory sick pay is paid by employers – it is only “statutory” in that the minimum is set in law – and employees are also eligible for ESA when they are sick. Holiday pay, again, is funded by employers from the revenues they generate and the self-employed should fund their holidays in the same way.

    This has nothing to do with “punish[ing] the self employed”. The “people we should be protecting and reducing taxation for” are surely everybody, and the poorest most of all, irrespective of their employment status. In that context it is worth nothing that this tax change is HIGHLY progressive – the lowest-earning 40% of self-employed people will be better off!

    https://media.guim.co.uk/dc085cd1706eca8960f7307e430fca85af349667/0_0_1210_895/1000.jpg

  • Richard Underhill 18th Jun '17 - 10:41am

    Hammond is well educated, but if he wants to be Prime Minister he should watch his language. “Egregious” is described as ‘archaic’ by Chambers Twentieth Secretary (1964).

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