It would seem that The Times is being used by HM Treasury on a quite regular basis now for kite flying tax reforms. The latest is implicit in the article linked in thus tweet from Paul Lewis:
Self-employed people who pretend to be a company do pay less tax, says IFS. As do self-employed sole traders because NI rate lower (9% not 12%) up to £50,000 and no employer's NICs (13.8%) either. Sounds like a Budget preview that will alarm many to me! pic.twitter.com/k5idf5bCO2
— Paul Lewis (@paullewismoney) January 31, 2021
This is something I have been writing about since the 1980s, and on this blog about since 2007. A relatively recent discussion gave rise to a succession of attacks suggesting I was wrong to suggest there was an advantage for those being paid by dividends, but it is absurd to claim otherwise. The IFS (acting comfortably within their micro territory here) offer a surprisingly large estimate of the tax lost.
The real question is whether much will be done to address this? The link noted above suggests a remedy I suggested that certainly appealed to the Treasury when it was written, because I was told that they took it seriously back then. However, events overtook matters and the recovery from the economic crisis of 2008 prevented action at that time. The fear of forcing contractors out of work when the economy was vulnerable was too great.
I strongly suspect that nothing will happen on this issue in March for the same reason. Simply, the economy is too vulnerable for such a reform right now. That there would be a backlash would be a fact compounded by the fact that many who ran companies in this way have been denied access to almost any of the Covid support schemes if unable to work. Reform would add insult to their already perceived injury. The consequence is that the risk of an embarrassing climb down if reform was announced would be very high.
But, as with wealth taxation, I think that the chance of a consultation beginning is high. There is a long running imbalance here that needs to be addressed.
However,I do not believe that the problem is solved by shoe-horning the consultant into conventional employment or PAYE employment in their own company. Subject to a genuine consultancy existing those engaged in this activity are not employees. But nor too, come to that, are they people who deserve to be taxed as if making a return to capital, which is what happens in their own companies.
There is a difference in the economic risk that a genuine consultant takes when compared to an employee and it would be absurd to pretend otherwise. Reform has to reflect economic reality and ensure that it is taxed fairly, I still think my 2007 proposal has merit. What is certain is that without genuine innovation this problem will not be solved.
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Richard, I think the penultimate sentence should read ‘Reform has to reflect economic reality’? Wouldn’t normally point out an autocorrect typo but this one is crucial, I think?
Thanks
It is autocorrect, of course, and it is so hard to edit something minutes after you have written it. You read what you think you wrote.
Having worked for 20+ years as an IT consultant using a LTD company it pains me to say this but the solution is completely simple.
Scrap all NIC and tax earned & unearned income alike.
It makes no sense to punitively tax productive labour. Your economy needs more workers and less rentiers.
This is not to say that all contractors would be paying 50% on income.
The current tax regime is loaded onto the middle class with high marginal rates of taxation that are in no way justified by the current economic situation.
Your tax pays for nothing. It is destroyed on receipt.
The fiscal purpose of taxation is the control of inflation. Of which we have none.
There is no justification for the current levels of taxation on 99% of taxpayers.
I would start by immediately raising the current tax threshold to £36k and I would keep raising it periodically until I started to see a real rise in inflation.
I think your claims are too sweeping
Taxing unearned income the same and introducing an investment income surcharge to equate to NIC on unearned income is wholly appropriate
I think there needs to be a step back in all of this and think about where we want to be.
The tax system for workers needs to be looked at more closely than simply comparing self employed, limited company directors and regular employees.
(as an side, the IR35 debacle (which is at the heart of Arctic Systems in your 20007 piece) was wrong from the outset and what is happening today continues to be wrong in that contractors are largely going to have to work through umbrella companies from March / April. That works for client and umbrella company but not for the worker. The real issue is that if someone looks smells and feels like an employee then they should be employed by the client and get the benefits of that employment. Similarly agency workers should acquire proper employment rights across the board.)
What is needed is some modelling of the interaction between the benefits system, employment, self employment and limited companies – to find the effective net income positions of each of these groups. I think that those on benefits should be able to live in reasonable housing and not go hungry or be cold (i.e. not in poverty). Those in employment ought to be better off than those not working and those who take risk (self employed and limited companies) should be able to gain a bit more to accommodate that risk.
From that a tax system could evolve which works for all.
The proposals as kite flown in the Times serve only to have the working population of moderate means squabbling amongst themselves and that serves only to allow the rich a free pass once again.
In the meantime cutting employment taxes: employees and employer NI makes much more sense. Plus possibly increasing the 2% employee NI on earnings over £962pw.
A lot to agree on there
The IFS are incorrect that the exchequer losses money it might otherwise gain.
The object of making life hell for contract programmers was to force them into the arms of the big consultancies, where, as permies, they would pay less tax (before they would earn a lot less) and the difference in fees to the client would be taken as profit by the employer and would be paid out to shareholders as…. dividends.
This has always been about crushing independent workers and forcing them to labour for “the man”.
It was never about “unfair” taxation.
I am not sure I agree with that
But I accept it is possible
The basic contention is that someone should be subject to similar levels of tax, whether they set themselves up in business as a self-employed person, or set up a company and then either pay themselves either a salary or dividend or a mixture of the two, or leave some of the cash in the company and ultimately sell their shares to realise a capital gain. The differences in tax treatment are unfair and difficult to justify.
The IFS published a chunky report about this last week and an accompanying presentation. https://www.ifs.org.uk/publications/15272 https://www.ifs.org.uk/publications/15280
In short it means that people who have benefitted from the lower rates of tax on dividends and on capital gains, or who pay less NICs than employers and employees do on salaries, will pay more. There will be losers and they will complain bitterly, especially as the Conservatives promised not to raise the rates of income tax, NICs or VAT in their last general election manifesto.
But perhaps a majority Conservative government can get away with this sort of proposal (e.g. doubling CGT rates, and raising the rate of Class 4 NICs from 9% to 12% or more) when Phil Hammond had to abandon his relatively modest and incremental proposal in 2017, to increase Class 4 NICs by 1% in 2018 and another 1% in 2019.
Let’s see…
If only they would do the real reforms that are required
As with so many of your blogs this is thought-provoking even if I am pretty naive over taxation details.
Coming into this site, my interest was simply that of fairness: people shouldn’t be able to benefit (from lower taxes thus higher take-home) simply by being able to configure their income as dividends or capital gains. But your post has made me think about this, as had the recent experiences under Covid of friends who own small companies or work as contractors.
I loved your linked original post (though admit I am ignorant about LLP tax details) but it made me think that people need to have some tax benefit to compensate being outside the risk protection provided within the PAYE salary earning situation. Friends who are co-owners of a family retail business and take most of their income as dividends probably normally have tax advantages – but also take the risks of retail peaks and troughs, and of course are not currently benefitting from furlough like their employees. Another friend who is a contractor whose income ceased with Covid has not had the benefit of redundancy rights which an employee would have had. The taxation system somehow has to recognise that transfer of risk, but how you quantitate it I don’t know.
The risk transfer point is an interesting one. The contention appears to be that employees have legal rights that they can enforce against their employer, and so they should pay more tax as compared to a self-employed person with a similar income. Strange sort of legal right that requires you to pay more tax to access it, but anyway…
Income tax is essentially the same whether you are employed or self-employed – there are a few differences, such as deductibility of expenses and when the tax is paid under PAYE or under self-assessment, but in broad terms the rates and thresholds are the same.
The main difference is NICs – employer (13.8%, 13.8%) plus employee (12%, 2%) Class 1 NICs, versus Class 2 (flat rate) and Class 4 (9%, 2%) NICs. Employees pay more NICs than the self-employed, *and* the employer pays even more on top.
It is a strange sort of compensation for risk transfer which requires an employer to pay more to the government because the law requires them to give certain rights to their employees.
Self-employment also offers some advantages over employment- for example, deciding what work to do, and when, and how, and yet you rarely hear anyone suggesting that employees should be compensated (over and above the income of self-employed persons in similar roles) for accepting the burden of being told what to do by their employer.
I fully accept Andrew that my point wasn’t the solution, only a factor in the debate.
Although learning about MMT has muddied the water, there seems to me an implicit contract beween citizen and government: the citizen pays taxes and complies with rules, and the government provides universal benefits like education, healthcare, pensions, and a financial safety net of state benefits. I was thinking of a local friend who runs a small family-owned bookshop; her employees have benefitted from furlough while the shop is closed due to Covid while she has had less benefit. It might be wrong to relate that to the fact that she (probably) ends up paying less tax than she would as an employee, but the business isn’t so profitable that she normally gets rich on the profits.
Hi Jonathan. I accept, risk is a factor that is often raised and has some intuitive attractiveness – the self-employed bear more business risks than employees, and employees have more rights, and so the narrative goes the self-employed should pay less tax – but I’m not convinced it is borne out.
I am suggesting that there are benefits to set against the risks for the self-employed. And that the employer also pays for the privilege of granting the rights and for bearing risks that for some reason we have to incentivise the self-employed to bear themselves.
I’d not argue that the benefits are such that self-employed should pay more tax than the employed, but arguably there is a measure of compensation for the risks in factors such as the more generous rules on deduction of expenses, and paying tax yearly through self-assessment (twice yearly through payments on account) rather than weekly or monthly through PAYE. You don’t need to tilt the playing field so much with such stark differences in rates.
The question of state benefits is another interesting one. The self-employed qualify for the full panoply of public services just like everyone else – education, healthcare, pensions, etc. There are relatively few state benefits that require you to have been an employee: Jobseekers Allowance is one – however much Class 2 and Class 4 NICs you pay, you don’t get it.
You are right, the self-employed didn’t qualify for furlough. But many of them did qualify for the Self-Employed Income Support Scheme. For those who did, it was generous. Those who didn’t were often left with little to nothing, yet for some reason here we are nearly 12 months later and the government doesn’t seem to care, despite having had a long time to ameliorate the hard edges of SEISS. Universal Credit, and scarce and arbitrary discretionary funds, are nowhere near enough.
But there will be vociferous objcetions again if there is any proposal for the self-employed to pay more NICs. I doubt the government will really want to grasp this nettle.