If you’re going to avoid tax, and at some stage in your life you probably will, you’re likely to do it with your earned income. The reasons for this are pretty clear. Most people have earned income, the difference between tax rates on the employed and self-employed is huge, and the line separating those statuses is both blurred and shorn of logic and economic principle.
Meanwhile, issues around employment and self-employment have leapt to the head of the policy queue. The Office for Tax Simplification has started a review into employment status; the Royal Society of the Arts continues its wide ranging self-employment project; the Office for National Statistics has published a short but influential report noting both that self-employment was at its highest level in forty years and that average earnings from self-employment had fallen 22% since 2008/09; the think tank Centre Forum have described the difference in rates as “without compelling reason” and the leading tax academic Professor Judith Freedman has declared it a “crude tax subsidy” which we should “stop“. On the political front the Labour Party appears publicly to have committed to, in effect, abolishing sole trader self-employment in the construction industry.
What I mean to do in a series of blogs over the coming months is ask some questions about the differing tax treatments of employment and self-employment. What are the differences? How are they justified? How are they arbitraged? Why do employees and employers behave as they do? How does fiscal policy respond to these challenges? And does it respond well?
Where I get stuff wrong, and I will, please tell me. I’ll put the record straight and I’ll try to do it with good grace. If you’d like to contribute to the series, please let me know; the best discussion is a heterodox one.
However, the starting point is probably to observe that, and how, employment and self-employment are taxed differently.
For the sake of simplicity, I consider the situation of an individual, I round to the nearest ’00, I aggregate all taxes on earned income (so not just income tax but also both employers’ and employees’ national insurance contributions. These are, if you like, roses by other names), and I assume no deductible expenditure.
Looked at in this way (and focusing on the position of the typical worker with no other income) the total tax burden on different slices of income (in 2014/15) for the employed and the self-employed (in parentheses) is as follows:
0-8,000 – 0% (0%)
8,000-10,000 – 22.7% (9%)
10,000-41,900 – 40.2% (29%)
41,900-100,000 – 49% (42%)
100,000-120,000 – 66.6% (62%)*
120,000-150,000 – 49% (42%)
150,000+ – 53.4% (47%)
*This band is attributable to the removal of the nil rate band by £1 for every £2 one earns over £100,000.
A few points will immediately be gleaned from the above:
(1) if you were designing a tax system you wouldn’t start here;
(2) no one would describe our rates as smoothly progressive;
(3) no one could describe our rates as particularly progressive;
(4) there’s a huge difference between rates of tax on employed and self-employed income.
(5) whither, now, the Laffer curve?
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