By Richard Murphy FCA of Tax Research UK
When Jolyon asked me to contribute to a discussion in tax and self-employment I reflected on two things. The first is my own experience as a self-employed person, which given my own temperament was probably the only real option ever available to me. The second was the advice I have given to many hundreds (if not more) clients over many years on these two related issues. The result was that I realised, first, that the decision to be self employed has, in many cases, no relationship to tax at all. And, second, that because of the real number of variables involved in the tax decision making process when it comes to self-employment questions anyone who suggests that rational, tax based, decisions are taken is, at best deluding themselves either before the event (if they’re a professional adviser with a more expensive product to sell) or after the event if, by chance, savings worked out as hoped.
What the aim of this blog is, then, is to show just how many variables there really are in this decision process and to show how irrational it is to focus upon any of them for the vast majority of people (98% +) who earn less than £100,000 or so of taxable income each year (i.e. those for whom a focus on increasing net income might be of significantly greater use). In the process I also show that almost no Laffer effect could be reliably predicted for those with the option of self employment earning below £150,000 whilst those earning above that sum in reality face a choice of varying flat rates of tax, making Laffer implications impossible to measure independently of any choice on rate substitution, which is likely to have much bigger impact.
If it gets a bit technical on the way I don’t apologise. What I do instead suggest is that it really is time that we had professional advisers in this country who helped businesses make more and create more wealth instead of concentrating on a spurious goal of tax minimisation (which is, as I show, itself meaningless because what it means varies at different income levels, some of which will only be known well after the time when decisions need to be made). In other words, a debate about self employment and tax makes sense, but only in the context of considering all the variables that might be relevant in the equation that relates the issues. And by equation, I mean equation.
There are, of course, issues relating to the tax differentials between the two bases for taxing the income of people in the UK that might have impact on an individual’s tax decision making and on national tax yield but this is not, I suggest, a binary choice of either / or employed versus self employed status.
Firstly because this is not the only choice available: there is also the option of incorporating as an alternative mechanism for running a business which in turn gives rise to at least three alternative tax rates, being those on corporate retained income, corporate distributed income via dividends and corporate distributed income via salary, and these three options are all stated before the potential to divert income to others (not considered further here, but a very real factor in much tax planning at the point where it very definitely interfaces with tax avoidance) comes into play.
Secondly, tax payments and so yields are not just impacted by tax rates. The interaction between income and state social security payments, both taxed and untaxed, also has an impact on effective tax rates, whilst the capacity of the taxpayer to save in tax enhanced ways (ISAs, pensions, VCTs, etc) has to be taken into account, as too does the capacity of the chosen mechanism for declaring income to facilitate tax evasion, the offset of expenses incurred in relation to work related activity and even the opportunity for recategorising income as gains need to be taken into account.
Do all this and something like the following, simplified, equations, come into operation when considering effective tax rates, assuming that:
B = Tax base
P = Non-discretionary allowances
U = Untaxed social security payments
W = Taxed social security benefits in period
A = Discretionary allowances
V = Evaded
X = Expenses
S = Tax relieved savings in period
G = Capital gains
R1 = Employed tax rate
R2 = Self employed tax rate
R3 = Corporate savings rate
R4 = Distributed corporate tax rate
R5 = IR35 tax rate
Z = Capital gains tax rate
T = Tax paid
F = Effective tax rate
Y = Gross pre tax income
F = Effective tax rate
N = Net income
After which it follows that
T = (B-A-V-X-G)Rn + GZ
Where n = 1 to 5
And B = Y – P – U
And A = S – W
And F = T / Y
And N = Y – T
The question that then needs to be asked is what a person’s objectives might be in the above equations, and whether or not that objective remains consistent at all points in the income cycle or for all people at any point in that cycle.
It is also important to note that given the extensive range of variables and rates noted (even assuming national insurance and income tax rates are merged) and that the tax rate R is in in many (but not all) cases not an independent variable in this equation as it varies with the outcome of the expression (B-A-V-X-G), then the variables prioritised for ex ante decision making will almost certainly represent estimated data at the time a decision is taken since in practice in a real world situation the value of many (but not all) variables will only be known after decisions on tax status (even assuming that is unchallenged) have been made. It has to be stressed therefore that real world optimisation of any chosen outcome in this equation is nigh on impossible. Wise people should, and would, recognise this fact.
Despite this a rational economist (a term not necessarily synonymous with a wise person) would say that the decision a person should make is to maximise N, which is net income. But economists do not understand human beings, and many real people will for wholly rational reasons not do this, because they have other intellectual and emotional objectives (see The Courageous State) or simply do not prioritise income as the most important thing in life, and so income maximisation is not just a constrained opportunity for some (which it can be for others), it can also not be a choice in the sense that a person simply satisfices in this area.
In that case can it be assumed that another objective (either tax minimisation, or tax rate minimisation or marginal tax rate minimisation, and all could be set as goals) make sense? Maybe, but probably only if you are an accountant, lawyer or large corporation so remote from normal human objectives and conflicting interests that such a proxy for rational behaviour is even considered a priority. That said, precisely because so few accountants and lawyers do have much idea how to maximise income, even if that was a client’s actual objective (and I never in my practising career heard a client say it was) I am quite sure those professional people do adopt one of these tax related proxies for rationality instead, in the process hoping to hide their inability to offer business advice or even listen to their client’s stated preferences.
However, this may be quite irrational behaviour on these professional people’s part. The evidence for the importance of any of these tax related goals is limited. Well over 80% of all people working in the UK choose to be employed even though this is likely to increase their tax rates (R1 is greater than R2 which is greater than R4, for example, almost invariably and across most income ranges) and reduce opportunities for evasion, expense deduction and conversion of income into lower taxed gains. Either all of these people are economically crazy or there is something else at play here.
Even when self-employment is chosen as an option the likelihood that a person will risk tax minimisation (legally or illegally) is low. HMRC think that more than 40% of all self employed people under declare income on their tax returns. I believe, in addition, that the number making returns compared to those who should do so is significantly understated. But there still remain a substantial number who, nonetheless, do declare their income reasonably accurately whilst every year financial advisers suggest billions in available tax reliefs are not used by those who had opportunity to claim them. So even though tax advisers may think tax minimisation is a priority the reality is that the evidence does not support that fact.
This is not to say that tax does not impact on behaviour; it very clearly does. But, first of all, this evidence suggests that it may have relatively little impact on the decision to be self employed or not. In addition, the impact it may have might vary considerably depending on the values and priorities given to different variables in the equations noted at varying points in the income profile. So, for example, at some points the impact of the marginal tax rate (I could start expressing these variables mathematically but will resist the temptation to do so for risk of alienating most readers) will be very high. This might be especially true when there is a significant withdrawal of social security benefits (W). At other points this may arise because of the withdrawal of non-discretionary allowances (P). At other points the impact of rate substitution (R4 for R2, for example) might justify a reduction in net allowances (actually, in this case an increase in real costs with advisers, who do, I suggest, motivate much of this decision for that reason, by the way). And so on.
But with all these options, is the tax profession really able to advise rationally without either broadening its skill base or the adoption of bogus proxies for rationality (already noted). That is the first question?
The second question is whether we are in fact asking the right questions of tax design and our reaction to it when faced with all these options. That would have to be the subject of another blog. I suspect the answer is that at present we are simply failing to understand the real reasons for tax design when thinking on this issue. We are being blinkered in our focus on tax paid to the social dimensions of tax design.
And third, let me raise the question Jolyon Maugham has asked me to consider when writing this blog, which is where is Laffer in all this and, indeed, the issue of progressive taxation in all this? The only sensible answer I can give is, that to a very large degree, neither is anywhere to be seen at all. Firstly that is because much of the decision making that impacts the decisions noted has to be taken before facts, including income, are known. Therefore the impact of rates is assumed, and not known. Second it is because some residual factors, e.g. use of tax deductions for pensions can be used ex post to vary outcomes, and third, and most important, tax is just not that important to the vast majority of people, self employed or otherwise to go through all the necessary decision making processes (which might explain the appeal of evasion to some).
But perhaps, fourthly, and most importantly, over the income ranges where tax rates on earned income, however derived or recorded, vary significantly (i.e. at levels broadly speaking below £100,000 and definitely below £150,000) tax is not by a long way the most important factor in determining choice on employment versus self employment and so net income outcome. Work availability, career choice, social priorities, personal risk preference and a host of other factors will impact the decision much more significantly over this income range, not least because many within the income bracket of £150,000 or less will think they need most of their income to live on or to compulsorily save for a pension. Serious tax planning only happens at higher income brackets where more significant discretionary funds are available and in that case Laffer plays no effective part at all in the UK as rates are then flat, if albeit, substitutable (which is where planning comes into play, with most impact being the fact that R1 > R2 > R3, and this creates a regressive tax regime for many).
So what conclusion do I reach? There are several.
The first is that tax professionals over-emphasis the importance of tax to others.
The second is that tax optimisation, taking into consideration the variables I note (and there may well be others, but they only complicate matters further) requires, firstly, perfect knowledge of the future that none of us possess and secondly analytic ability to consider a a range of variables so complex most would not try to resolve the issue in any rational way.
Thirdly, in the face of these first two factors tax professionals try to sell pre-packaged solutions (e.g. incorporation as a route to national insurance minimisation) without ever being fully aware of its potential implications for the client whose interests they may not have properly noted. The chance that this is because such pre-packaged solutions enhance adviser income cannot be overlooked.
Fourth, if there is one variable designed, above all others to impact in N (net income) in the equations noted above it is Y (gross, pre taxed income) and it is time that the accountancy profession, in particular, reframed its thinking about how to help clients maximise this rather than minimise tax.
Fifth, if Laffer effects are so unlikely to be measurable in any scenario likely to be considered, why do we worry about them?
Sixth, given the substitutability of tax rates right across the income spectrum considered here (effectively from almost zero to infinity, if you wish) the chance that the Laffer effect will ever have impact at the rates available (bar short term shifting as seen with the 50p tax rate) is very low indeed, and to extrapolate from short term income shifting to long term behavioural impacts of tax is a step that no one should take.
Seventh, the impact of the integration of tax rates with tax spending (i.e. how rates are impacted by benefits and allowances and reliefs as well as indirect tax benefits of government spending) is always understated in a discussion of the sort I have attempted here. In reality tax and spend are part of an integrated whole process and not to be seen in isolation of each other.
Last, given all those factors, shouldn’t we realise that tax is not designed solely for revenue raising purposes but for any other social and economic reasons as well and that all we are looking at is the reaction to those various deliberate and often intended consequences of that design process with too limited a lens when we consider tax rates in isolation? Many people, from my experience, choose not to do so, thinking that tax is, as I said at the outset, of overstated importance in their decision making processes and that they really would prefer that their advisers take more nuanced approaches.
Waiting for Godot 
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“Despite this a rational economist (a term not necessarily synonymous with a wise person) would say that the decision a person should make is to maximise N, which is net income.”
No, I’m afraid not. An economist would argue that the individual will aim to maximise utility.
“But economists do not understand human beings, and many real people will for wholly rational reasons not do this, because they have other intellectual and emotional objectives (see The Courageous State) or simply do not prioritise income as the most important thing in life, and so income maximisation is not just a constrained opportunity for some (which it can be for others), it can also not be a choice in the sense that a person simply satisfices in this area.”
Meaning exactly that. Utility being that blend of self-worth, leisure, income and everything else that best suits the desires of that individual.
Seriously Richard, if you want to have a pop at economists it really would be worth understanding what economists say before having that pop.
“In that case can it be assumed that another objective (either tax minimisation, or tax rate minimisation or marginal tax rate minimisation, and all could be set as goals) make sense?”
All sorts of things contribute to utility. And the essential point is that utility functions are personal. So it’s whether it makes sense to the individual making the decision or not.
“Either all of these people are economically crazy or there is something else at play here.”
No, they have different utility functions.
“HMRC think that more than 40% of all self employed people under declare income on their tax returns. I believe, in addition, that the number making returns compared to those who should do so is significantly understated. But there still remain a substantial number who, nonetheless, do declare their income reasonably accurately whilst every year financial advisers suggest billions in available tax reliefs are not used by those who had opportunity to claim them. So even though tax advisers may think tax minimisation is a priority the reality is that the evidence does not support that fact.”
Again, different people have different utility functions.
This is a seriously wondrous argument:
“Serious tax planning only happens at higher income brackets where more significant discretionary funds are available and in that case Laffer plays no effective part at all in the UK as rates are then flat, if albeit, substitutable ”
Laffer effects come from the interaction of the income and substitution effects. They do not depend upon whether marginal tax rates are rising, falling or flat. They depend upon the interaction of those two effects. Whether or not I work that 59 th hour in a week still depends upon what my marginal tax rate is, whether that is higher, the same, or lower, that the tax rate I faced on my 58 th hour of work (or even on the 60th).
I should note that Richard has written a little more about his blog post here http://www.taxresearch.org.uk/Blog/2014/09/30/tax-self-employment-and-laffer-a-little-bit-of-theory-and-a-lot-of-condemnation-of-practice/
Tim
You may live in a world where you are familiar with your utility but let’s get real here and note that this is not the case beyond your very little bubble.
Even economists do not believe what you’re saying. If they did none would talk about profit maximisation, but as a matter of fact they do. And the question I was looking at related to business where this is always the deemed objective for behaviour by that profession.
So, candidly, your argument does not stack and simply amounts to an ad hominem straw man attack.
I was reviewing current debate using its current terms of reference and the success criteria it uses and in that context what I am saying is wholly appropriate unless, of course, you can find that piece of company law that requires a company to maximise its utility and those directors who say they do that for their wider stakeholder group without being accused of failure of fiduciary duty and those advisers who advertise that they are utility maximisers. I wish more existed, and I am arguing they should, but that does not undermine my case, it reinforces it, and makes a mockery of your criticism.
Richard
I thought the absence of employers’ NI was a factor in the decision to go self-employed but since tax rates are the same for the employed and self employed I don’t see how tax rates can be much of a factor.
The absence of employers’ NI for members of LLPs (a fact which surely Richard is aware of as he is himself a member of an LLP) has led to many hybrid LLP/corporate structures in which senior management within a group of companies cease employment and become instead members of an LLP. The savings can be significant and the planning is being done largely because of these savings. Provided the members really do have say in the running of the LLP and their LLP share of profits is proportional it can hardly be called an abuse of the system. Many of these individuals are earning salaries well below the £150k (the level at which Richard thinks serious tax planning starts) and an immediate example that tax rates (for employers’ NI is a tax in all but name) can affect behaviour.
Obviously these decisions were taking in the real world without the advantage of algebra.
Hi Andrew, The impact of employers’ NI on the employed and self-employed has been examined here Separately, although I have no difficulty with attacks on Richard’s arguments, can I ask that you confine the attacks to that. I will invite readers to recraft future posts – including from him – that seem to me (in my editorial discretion – such sublime power!) to cross that line. Thanks.
Richard, the difficulty with many of your writings is a lack of clear citations to others’ work, particularly the work you are seeking to rebut.
So you make a statement like:
“a rational economist… would say that the decision a person should make is to maximise N, which is net income”
without any indication of which economists make such a claim. I am not sure there are any.
A full analysis of the tax treatment of employed vs self-employed is indeed complex and fact-dependent. However the employer NIC position is very straightforward indeed. I frequently see it driving decision making – with high paid employees in some sectors demanding to be treated as self employed, and low paid employees in other sectors being required to be treated as self-employed.
There is nothing really that anyone can add to Tim Worstall’s comments on Utility or the interaction of the Income and Substitution Effects or indeed Richard’s [edited] re-imagining of them. Instead I can question the world Richard presents to us.
Why has Richard chosen to frame his piece around a mostly false “choice” of employment or self-employment?
“Well over 80% of all people working in the UK choose to be employed” he says. No they don’t! An employee provides service to an employer who chooses to employ him or not; there is no “choice” involved for the large majority of people, save perhaps the employer! By contrast there is a very real choice between self-employment and incorporation for those whose position and trading/professional relationship with whoever is engaging them provides for them not be classed as employed.
For these people – and not just their tax advisors – tax considerations most definitely DO play a considerable part in their plans, as they should. Richard is well aware of this and has himself written articles in national newspapers explaining the benefits of incorporting your domestic staff.
I am frankly astounding by the claim that maximising income (or should we say minimising tax?) is not a major objective of his clients: “and I never in my practising career heard a client say it was”.
Never? Richard must have been the most sheltered of advisors [edited]. The claims of his own blog suggests the contrary:
– a claimed tax gap in excess of £100 billion
– comprising mostly of the shadow economy, i.e. cash-in-hand
– the consequent need to shift HMRC’s compliance activities from avoidance to evasion (with the accompanying need to challenge the vested interest of ‘white van man’)
– the marketing of highly agreesive and abusive personal tax schemes such as film partnerships, aimed directly at taxpayers who are extremely focused on reducing their tax bills
– the 40% of returns that are to a greater or lesser degree understated.
So, does tax really influence the decision to be self-employed or not? In as much as an individual truly has a choice, clearly it does, consciously and usually expressly. Richard’s career is testament to this truth. As to how it influences it, well we’re back to the Income and Substitution effects and the Laffer curve for that.
Hi Jolyon
As your article on employers NI makes clear, the overall burden on the employed is higher and as I see every day, this impacts on behaviour. Be it dividends instead of salary or (more specific to the argumen here) a decision to set up as a member of an LLP rather then set up a company and pay full salary.
The problem with Richard’s article is it is full of assumptions that he makes that back up his arguments but has no external references to back up his assumptions.
I know, for a fact, that tax rates (if one includes NI as tax) have influenced the actions of many of my clients and other individuals I see in business every day. I don’t work for Grant Thornton but here’s an example for anyone who doubts what I am saying – it took me a couple of minutes on Google to track down. If Richard’s argument excludes NI it’s not based in the real world and if it includes NI it’s just plain wrong.
Click to access FSG-Limited-Liability-Partnerships.pdf
Well, the general duty on directors of companies incorporated in the UK is now set out in Chapter 2 of the Companies Act 2006. http://www.legislation.gov.uk/ukpga/2006/46/part/10/chapter/2
In particular, under s.172, a director must “act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”, and have regard to a number of factors, including interests of employees, relationships with suppliers and customers, and impact on the community and the environment.
I suppose an economist might label the framework that that a director uses to reconcile those different factors and make a decision as a “utility function”.
To go back a step, what do we mean “choose” self-employment? Have 80% of people really made an active decision in favour of employment and against being self-employed? Certainly tax will be a factor when for example someone is setting up a new business. Avoiding employer NICs might be a factor (R2 rather than R1), but then so might the ability to retain profits in a company without paying 45% income tax and 2% NICs, and/or to take dividends (R4 rather that R2).
I think you’re focusing on the wrong question. You’ve looked at an individual who is deciding whether to be employed or self-employed; but in my experience that is not a question that can be decided by the person who’ll be impacted by the answer. It is therefore not a question that comes up in practice at all often.
I have occasionally come across a self-employed person who has been offered an employment in a different role and wants to know what will happen if they accept (and quit their existing business), but that is relatively rare.
The two questions that can normally be decided (which you allude to but don’t really address) are:
1) Should I carry on as self-employed, or incorporate my business?
2) Should I engage this worker as an employee, or as a subcontractor; if the latter, directly or through a PSC?
The former normally comes down to running some business models to see whether the cost of running a company would outweigh the tax savings that might result. As you note, the tax savings will vary depending on the level of anticipated income, but it is trivial to run these scenarios – it is not nearly as complex as you make out, as most of the things you show as variables are in fact constants at any given time. Yes, they may change over time; but a little bit of sensitivity analysis deals with that: it’s basic spreadsheet modelling. The only area that I find people get badly caught out by changing rates is company cars, where the ratcheting of the rates makes huge differences over the normal term of a lease.
But people do in fact ask the question and pay attention to the answer. After all it normally comes down to two scenarios, and although the exact result of each depends on the values of the inputs in most cases a clear trend is established. When deciding between routes A and B you don’t need to know exactly how much tax you would save going down each, if it is clear that A is always going to save you more.
The second question primarily comes down to secondary NI, when you look at the cash tax position; but these days the climate has changed so far in the direction of presumption of employment by HMRC that in fact one ends up talking more about PAYE exposures and penalties than just the tax position. The commercial requirements dictate the answer that you will end up with, and most of the discussion is spent convincing the client that they don’t have as much freedom of choice as they think they do.
So in answer to “Does tax influence whether to be self-employed?”, the answer then is:
1) If you are looking at whether to be employed or self-employed in a particular role, the answer is yes – but this question only comes up rarely, and normally has to be determined in conjunction with the other party’s wishes (see (3) below).
2) If you are looking at whether to be employed in one role or self-employed in another, then the answer is yes – although in practice only if the gross incomes are relatively similar, as otherwise the taxpayer won’t ask the question, as they’ll assume higher gross income leads to higher net income
3) If you are looking at whether to employ someone or take them on as a consultant, the answer is a definite yes: you care about secondary NI, and PAYE regulations, and exposure to penalties
4) If you are looking at whether to incorporate your sole trade (whether or not you’ve actually started it) then the answer is a definite yes.
The other question, “Is tax the major influence on whether to be self-employed?”, the answer is very much “it depends”, and is a bit too large to be discussed here 🙂
Finally, I think you’re attacking a straw man when you say:
– “it really is time that we had professional advisers in this country who helped businesses make more and create more wealth instead of concentrating on a spurious goal of tax minimisation”;
– “tax professionals over-emphasis the importance of tax to others”; and
– “tax professionals try to sell pre-packaged solutions (e.g. incorporation as a route to national insurance minimisation) without ever being fully aware of its potential implications for the client whose interests they may not have properly noted”.
Do you have any evidence that these are representative of the profession as a whole? I do none of them: my firm is all about doing exactly what you propose, which is helping people get what they want out of life, based on a rounded understanding of their situation and goals. That could be higher net income, it could be more time at home and less in the office, it could be knowing that their children will inherit the company… a whole range of things.
If anything, the perception that decisions should be driven by tax comes from the clients (“Which company car should I buy?”), and I spend a lot of time disabusing them of that notion (“The one you want to drive”).
Yes, there are some areas where tax is an influence (buy now before AIA drops, be careful about selling the company for loan notes if you want to get Entrepreneur’s Relief, are you sure you want to give the family home away to your kids now?) but this is more commonly a case of avoiding pitfalls in the manner of doing things than it is one of deciding what to do in the first place.
Overall, I think you’re right to highlight that the question of tax impact on commercial decisions is a complex one. However, I think you’re wrong in your understanding of how that complexity affects the decision-making process itself, and of the role advisors play.
“You may live in a world where you are familiar with your utility but let’s get real here and note that this is not the case beyond your very little bubble.”
I’ve not said that I know what my utility function is. Nor have I said that each and every individual does nor even that any do. All that I have said is that economists say that what people attempt to maximise is their utility. Not, as you state, their income.
Whether or not people know and calculate it is irrelevant to that point. To offer an analogy. I’m not sure I know where my gallbladder is nor what it does. A doctor, such as your wife, would. But that does not change the fact that I have a gallbladder, it has a location and it does something. So it is with an economist and utility.
And to offer an explanation of maximising utility. You have often said that you prefer not to write on the weekends. There are better things to be doing with your sons, for example, that sit at a desk typing. That is you maximising, or at least satisfacting, your utility. Whether you call it that, whether you consciously calculate it, does not change that fact that an economist calls this you maximising your utility. This is what they mean by that phrase.
“Even economists do not believe what you’re saying. If they did none would talk about profit maximisation, but as a matter of fact they do.”
Profit maximisation and utility maximisation are not the same thing. One refers to human beings, who have multiple desires. The other refers to an inanimate form of organisation where there are no desires at all: only a function.
“And the question I was looking at related to business where this is always the deemed objective for behaviour by that profession.”
Umm, no, you were looking at choices made by human beings. Those complicated beings with a number of desires.
“So, candidly, your argument does not stack and simply amounts to an ad hominem straw man attack.”
There is no ad hominem there. I do not insult you nor do I insult your argument. I point to several places where the arguments being put forward are in error. That simply isn’t ad hominem. Nor is it a straw man either.
“you can find that piece of company law that requires a company to maximise its utility”
You were, above, examining the decision to be self-employed or not. That is about the motivations of an individual. Thus utility is in play. Insisting that I must now point to mentions of utility in company law really is a straw man.
I wish I had the time and patience to debate some of the points here, but since Andrew has so eloquently made a lot of the points I would make, it maximises my personal utility to endorse his comments.
I would only underline Andrew’s point that RM’s characterisation of client/professional interactions is often the polar opposite of his (and my) experience. Very often clients come to us with the sole stated aim of reducing tax, and it is we who raise the other (non-tax) issues which should be factored in to their decision-making. While I don’t dispute that the tax professional caricature RM paints so vividly has some basis in reality, it is not (from my experience) a fair portrayal of the profession as a whole.
In reading this piece, I’m reminded of two things. Firstly Jeff Wayne’s War of the Worlds, which observed that “the chances of anything coming from Mars are a million to one… but still they come”. And secondly, the humble bumble bee, which so the urban legend goes, is unable according to the laws of science to fly, but still does.
Richard spends a very long time proving to us that nobody considers tax in deciding whether to be employed or self-employed. But he’s missed the most obvious point of all – and which other commentators here have pointed out – which is that people clearly do consider tax. Some explanation for Richard of why his theorising isn’t borne out in the real world is needed. Sadly it’s not provided. For an article which spends so much of its time criticising the work of economists for not being based in the real world, it’s a pity that it concludes something which is itself readily falsified by real world observation.
Take IR35 [edited] it exists only because HMRC found that people were claiming to be self-employed when the facts showed that their business relationship more closely resembled employment. What could possibly lead them to pretend to be self-employed if not tax?
Then there is the recent campaigning by HMRC on false self-employment in the construction sector. In seeking to move from employment to self-employment, the former employee is giving up certain entitlements to benefits. So why would they do this, if not for the tax benefits?
Then there are umbrella companies, which are marketed as providing a tax benefit for the employee who wants to become a contractor.
For Richard’s analysis to stand up, it at least needs to recognise that, for all his theorising, the real world does contain many examples of people who appear to have considered tax as part of their decision to structure as self-employed rather than employed. So his inputs are wrong and/or his argument is wrong and/or his conclusion is wrong. We know, just because we looked at the world around us.
Some of this debate reminds me of Dr Johnson’s riposte to Bishop Berkeley and the theory of immaterialism, thus no material objects. Johnson kicked a rock and cried out, “Thus I refute Berkeley”.
Some commentators have kicked the metaphorical rock by appeals to looking at the world around us. Yet surely it is quite possible to look and still not disagree with the view that the issue of employment status is a matter of relative indifference to the vast majority of the working population.
If that is so, then we can turn to that rock and examine how robust it is and will it stand up to kicking. I think it undeniable that the amount of tax paid (or is it “suffered”?) matters to many people. But so do other things, like flexibility, ease of hiring/firing, security of contract, inheritance, employment rights (eg paid holidays, sick pay, etc), and more.
I am always a little wary of formulas that try to explain human motivations. Perhaps this is a case where any shortcomings in the formula actually generate that helpful discussion on the nature of the rock, its size, and all those messy aspects of the real world that can derail any theory.
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What is bizarre here is that a bunch of tax professionals have said that the world is the way they think it is and that tax matters because they tell people it does.
And no one has addressed the fact that what I sought to demonstrate is hat this view is only sustainable on the basis of knowledge no one has
In other words, a logical analysis shows that the tax advice most accountants give cannot be justified on the evidence that they have available but they give it anyway and because they almost all do think the outcome justifies their action in the first place.
[edited]
Why not address the question using facts [edited] as I sought to do?
It’s not “only sustainable on the basis of knowledge no one has”. It doesn’t need precise knowledge.
If one can say that if business profits are say £200k then structure A will result in higher net income than structure B will, and that under structure A the client will keep more of every additional pound, then one can safely say that structure A will be better from a tax perspective – even if one can’t exactly quantify the amount of benefit because one can’t exactly predict the business profits.
One can then point out the sensitive areas – that this would not be the case if the top rate of tax goes up to X%, or if secondary NI goes up to Y%, or if the CT rate changes to Z%, or the IHT NRB changes, or whatever.
That then allows the client to assess the risks and make an informed choice based on tax implications.
All you have done is assert that complete and perfect information is required before any decision can be made, which is clearly not the case.
“Why not address the question using facts as I sought to do”
Richard, I cannot see any facts in your blog. You have argued almost exclusively on the basis of your own assumptions.
Where you do stray close to a fact, you are wrong. 80% of people do not ‘choose’ to be employed as that is not a choice readily available, as anyone involved in employment status enquiries would know. The withdrawal of personal allowances above £100k makes the suggestion that it is only “broadly” below £100k that tax rates vary significantly a nonsense.
But I’m open to argument. Why not list the top 5 facts from your blog that you believe most strongly support your argument?
Andrew Jackson: you make the precise error I say practitioners make i.e. They assume facts they cannot know and advise on them
Andrew Carter: read what I have written and the formulas I have suggested and the assumptions required to make them work and say what is wrong with them. I thought all are logical. In the narrative I have to summarise to keep within blog constraints: this could easily have been a 30 page paper. But stop nitpicking a minor issue wholly allowed for in the formulas (if you read them and if you were clairvoyant and so could apply them) and instead deal with the substance of what I have written which is that a) Y is the most important variable but is not known and accountants do not advise on it and N is a post event fact that cannot be predicted and with regard to which as a result accountants cannot give sound and predictable advice so that c) Laffer cannot impact – not least because when real options are available rates are flat but substituable
Why argue with something I did not say when you should argue with what I did say?
Richard Murphy: I assume that the tax system will be broadly similar next year to how it was this year, with the main changes being to rates and allowances. I assume that the business will make profits in line with forecasts. I assume the client will still be alive next month. I assume no asteroids will have collided with the Earth in the next year or two and destroyed all sentient life.
You are right, I cannot *know* all these to be true. But my clients can take the uncertainty into account in making their decisions.
You have simply reasserted that complete and perfect knowledge is required for decision-making, and that to advise without perfect knowledge is inappropriate.
Well, to be frank I do not *know* whether my house has burnt down since I left it this morning – it is perfectly possible that it is ablaze as I write. Given this lack of solid information, it occurs to me that I might be better off sleeping in the office. Would anyone advising me to go home instead be giving me inappropriate advice, given that cannot *know* I have one to go to?
“Y is the most important variable but is not known and accountants do not advise on it and N is a post event fact that cannot be predicted and with regard to which as a result accountants cannot give sound and predictable advice so that c) Laffer cannot impact”
Y most certainly can be known. In consultancy situations or any situation where those that control the income are deciding how it is distributed. Indeed Y is often a precise figure actually suggested by an accountant. N can then be calculated. It’s part of the advisory process and I have advised many many clients what their N is going to be. I would expect any accountant to be able to work out N having suggested Y!
Many on here have tried to argue with what you did say, most more elegantly than I. You have so far failed to respond to those arguments.
Everyday thousands of accountants are advising on business structures which include the tax/NI outcomes of different structures. Did you even look at the GT flyer? I doubt there’s a top 50 firm in the country that isn’t doing similar work.
Quite frankly the only way your argument works is that people in the real world are making decisions which they think they are making using tax as a factor but in fact they don’t really know why they have made their decision. You really would need to be clairvoyant to know that.
Richard Murphy again, following up your reply to Andrew Carter: A few years ago, I was offered a new job. When deciding whether or not to take it, I weighed up the impact of the change of salary (Y in your formula) plus the change in commuting costs (not in your formula) to determine what the effect would be on my net income (N in your formula).
Of course the commuting costs were just an estimate: petrol prices and consumption vary a lot, and the other car costs are even harder to estimate. Also, although I knew the salary on offer in year 1 I had no assurance of what it would be in later years. So I could be confident about none of the variables in your formula.
I consulted my wife to get her opinion about whether I should take the job. What I didn’t realize was that she should never have expressed one! She didn’t know exactly what the change in our disposable income would be, so how could she possibly have given me any useful guidance?
I shall be having words with her tonight. Possibly by phone, from my car – I don’t know whether my house exists, so I’m not sure whether I should be going back there; and as no-one else does I’m not taking any advice on the matter.
In fact, as a brief addendum, if you look at the GT brochure you’ll see the precise amount of Y doesn’t matter. Under the LLP structure, N is going to be higher and that’s why clients sign up to it. They are offered two spots on the Laffer curve and make their choice accordingly. How much clearer could it possibly be?
Jolyon – I suppose as host you have to stay neutral during this exchange of witty banter? It must be frustrating. I suggest you ‘nod’ as you type your reply to this post if you agree with Richard and shake your head if you disagree. No one will ever know.
I dunno. There will be occasions when I feel like I have a dog in the fight. Just not sure that I do in this one. In all honesty, I don’t have clear sight of why it matters whether Richard is right or wrong.
I have this feeling we are entering into Berkeley v Johnson, Round 2. And we seem to be having a rather testy series of exchanges. I think it was RH Tawney who once once said erring colleagues were not Adullamites to be smote hip and thigh. It has never struck me as an approach likely to change minds.
To me it seems as if Richard falls more into the Berkeley school, by arguing from first principles, whereas other commentators are in the pragmatic school of Dr Johnson, dragging in that rock based on their experiences with real clients. If we accept the validity of the axioms, and I fail to see how we can not agree on things such as the rate of tax (even if some might change with no warning, eg retrospective legislation), then I think we, logically, ought to accept the validity of real life experiences. In essence, they are just different kinds of facts.
This is particularly the case when we all accept that (some but how many?) people are clearly motivated by a desire to reduce/avoid/evade taxes, and the rate of tax on their remuneration/profits/gains is clearly one component in how their decisions on reduce/avoid/evade. How many people/businesses, whether there is a ‘tipping point’ in terms of gross pre-tax/NIC income, does NIC matter, and so on, form the elements under debate here.
In this connection the link below shows that an official body believes, for example, NIC is a factor in choices between employment and self-employment. http://www.taxjournal.com/tj/articles/nic-regime-encourages-false-self-employment-01102014.
Traditionally in matters like this we would engage in some research amongst a representative sample, either to test a working hypothesis (the axioms), or to get some data form which a hypothesis can be formulated and maybe retested. Given the possibly wide range of expertise from those who’ve made it this far down the Blog, can anyone say if there have been such studies? I’m sure I’ve read of work on what makes a successful “entrepreneur”, so assume there are equivalent studies on employed/self-employed
Where’s the gold star button on this WordPress thingy?
“Given the possibly wide range of expertise from those who’ve made it this far down the Blog, can anyone say if there have been such studies? I’m sure I’ve read of work on what makes a successful “entrepreneur”, so assume there are equivalent studies on employed/self-employed”
There have been a number of such attitude studies – (google “survey on attitudes and behaviour towards tax and compliance” for an example). From rule of thumb memory i think somewhere it says 20% of people think it’s OK to use tax planning to take advantage of loopholes. I’m always weary of ‘attitude’ surveys as we all know the right thing to say if asked but do we do it in practice?
Not sure about employed/self-employed studies – what makes a person a successful entrepreneur isn’t quite the same as why do some people be self-employed and others not – some don’t have a choice in view of their chosen job, some simply don’t have a choice. Still I’m sure there are some who ‘just love being their own boss’ (or whatever) although note you can be your own boss as employed director of your own company.
I still think Richard fails comprehensively in his arguments. What are his conclusions? (and in all honesty, these are just his opinions as he doesn’t prove any of them – there’s not a single fact in his blog)
First – Tax professionals over-emphasise tax – No we don’t, I am constantly using the ‘don’t let the tax tail wag the dog’ line. What we do is present the most tax efficient way of a client achieveing their aims.
Second – Tax optimisation requires perfect knowledge – no it doesn’t. Almost universally dividends are more tax efficient than a bonus. I’m sure you could come up with a contrived scenario where they aren’t but the world in general simply doesn’t require perfect knowledge to work.
Third – Tax professionals sell pre-packaged ideas without looking at all the consequences – Good ones don’t. They’d go out of business if they did. Some builders do crappy jobs, doesn’t mean all builders are crap.
Fourth – Accountants don’t look to maximise income for clients – There is a whole industry of business advice within the accountancy profession (“FD in a box” schemes are all the rage at present)- Richard’s view is 20 years out of date.
Fifth – Laffer doesn’t matter. Then why are hybrid LLP schemes so popular when the main variable is tax?
Sixth – laffer (again) only affects highest earners shifting income – again plain wrong – I recently advised on a mangement LLP strcuture where most were on around £70k. Besides, a £20k a year subbie prefers to be self-employed.
Seventh – tax and spending should be considered together. If you like Richard. That’s your opinion, you’re entitled to it.
Marks 0.5/7
Hi Andrew, Have allowed your post in its entirety. But it’s closer to the line than I’d like…
Seriously, I’m not wishing to cause any offence here. I really did try to phrase it in the right spirit. I re-wrote bits of it a number of time. Any bits in particular?
Thanks Andrew. I’m grateful to you – and everyone else – for making an effort. I do want to avoid weaknesses that bedevil discussions on other blogs. Re-reading, perhaps you’re further from the line than I’d indicated.
A real pleasure to read. Not my place to, but Jolyon could propose a vote of thanks to all for expressing entirely contradictory positions in such a cordial manner. Enjoyable. Perhaps tax is an issue when calculating the benefit of work, rather than the choice of the means used, but I agree with Richard, I also never really got any thing out of employment except perhaps some training which I otherwise would have had to find and develop myself. There is a degree of self reliance in self-employment which concentrates the mind and therefore the results, before tax, of course!