It won’t have escaped your attention that the way in which we work is changing. A number of narratives have sprung up around those changes.
There is an optimistic narrative that celebrates the opportunities for self-actualisation that a more fluid work environment delivers. There is a narrative around how everyone can benefit from the chance to tailor the supply of our labour as we choose. There is a narrative that identifies the negative impact of less secure models on working on individuals whose skills leave them with low bargaining power. And there is a corresponding narrative that decries the exploitation of those individuals.
Each is true – and none is universal.
What I’d like to do is identify some regulatory levers a Labour Government might pull to bring more of us within those positive narratives. But to do that, I need to start by identifying a less common narrative.
The arbitrage advantage
The line between employment and self-employment describes the difference between a contract whereby you provide services to another and a contract of service. Are you in business on your own – or are you in the service of another?
If you are in the service of another, that other must provide you with a safety net, one which corresponds to your service. There are regulatory obligations of minimum pay, of security, to treat you fairly and share risks with you. If you are in business on your own, those burdens fall on you.
So for the employer, an important consequence of employing someone is that you carry the cost of providing that safety net. Contracts for services do not carry those costs.
This same line in the sand – between employment and self-employment – that dictates availability of this safety net also carries profound tax consequences. Putting £100 of pay in the pocket of a basic rate employee can cost an employer (after tax and National Insurance) £167. Putting that same £100 in the pocket of a self-employed worker costs her engager £141.
In a competitive, labour intensive, high volume, low value added industry that £26 represents a saving far more profound than any that might be delivered by a real-life competitive edge. When taken together with additional costs imposed on employers of providing the safety net it is overwhelming.
Disruptive new technologies that enable different modes of working are creating new opportunities for businesses to compete. Sometimes they deliver pure efficiency advantages. But they also create opportunities to arbitrage regulatory weaknesses.
And the successes we celebrate as victories for new technology are very often – usually I would say – the product, in whole or in part, of regulatory arbitrage. Our narratives might ignore it but we live in a world where, as Stephen Sondheim crisply put it, the Princes are Lawyers.
This is an indubitable fact. And it is true not merely of labour intensive businesses – although it is upon those that I focus here.
And arbitraging these advantages channels vast amounts of money – tens of billions of pounds – into the pockets of the arbitrageurs. And it channels that money from the rest of us. From businesses that don’t enjoy those arbitrages and are outcompeted. From individuals denied that safety net who faces lives of financial uncertainty and breadline pay. And from taxpayers and those who rely on public services who together fund that lost £26.
A properly functioning regulatory environment fosters and rewards real innovation. Ours acts actively to reward poor labour practices and burden shifting. By creating market distortions it rewards the very behaviour it should discourage.
How should Labour respond?
The problem of outdated regulatory frameworks extends beyond the workplace. But it is the workplace I want to focus on here.
Sometimes it will be appropriate to impose the burden of providing a safety net on those who use labour. And there are good reasons to encourage entrepreneurial behaviour through the tax system: real entrepreneurs – unlike arbitrageurs – deliver wealth to us all. I start from these principles.
The history of the dividing line – employment or self-employment – is measured in centuries rather than decades. The quality of the safety net that is its consequence ebbs and flows with different Governments. But the line that dictates whether or not it is available has in recent times remained broadly static. It has not moved as the ways in which we work have changed. It derives from the (wrong) question ‘are you in service?’ rather than the (right) question ‘should we impose upon your engager the obligation to provide a safety net?’ It looks to a formal question ‘does this contract look like a contract of employment?’ rather than a functional one ‘how does this relationship actually function?’ And it is found in judge-made law, which Government cannot adjust as circumstances change.
It is not the right line.
If there are circumstances where the burden of providing a safety net should fall on employers those circumstances must be dictated by a principled analysis of when it is appropriate to impose it. You can only conduct that principled analysis by replacing the present test with a statutory test; a statutory test that looks to functional questions rather than legal ones. And which, unlike the ‘in or not in service question’, you can adjust as the world adjusts.
A sensible functional test looks in particular to whether there is an ongoing relationship between an individual and an other. And to the intensity of that relationship (hours a week). And imposes the burden on the counterparty whose business it is financially to profit from that individual’s labour.
Such a test would, of course, disrupt some business models – but it would protect others and create more. Labour should not be afraid of these consequences.
This would not merely be right. It would also enable the manifesto promise that under Labour people who are employees will have a safety net. The class of individuals who continued not to benefit from that safety would shrink. And it would also be composed of individuals whose mode of working was more akin to being, in reality, in business on their own account. The sorts of individuals less in need a safety net.
And there may also be a good case for the State to step in where the test fails to identify a functional employment relationship. In his Conference speech Corbyn indicated Labour might venture down this road. He was right to do so
– indeed Labour might travel further.
I turn next to consider how we use the tax system to encourage entrepreneurial behaviour.
Remember that £26? As things stand, the dividing line between those who pay it and those who do not is, again, the question whether the individual is legally ‘in service’. And we collectively give a multi-billion subsidy – officially around £3bn per annum – to the self-employed and those who engage them.
If you think it odd that we today encourage entrepreneurship by reference to a line drawn in a long ago world; if you are surprised that the engagers we subsidise are those who do not provide safety nets; if you find it a remarkable coincidence that the line we use to encourage entrepreneurship is the same as the line we use to dictate whether there is a safety net then… well, you are in good company.
Labour should abolish the subsidy.
It is poorly targeted and damages legitimate competition. The saving would fund the modest costs of improving the safety net for the self-employed. And a better safety net would itself enable more risk taking. But the saving would also fund the cost of a tax relief, targeted at basic rate taxpayers, and that encouraged entrepreneurs and not arbitrageurs.
I shall not write here about the mechanics of abolition: that is a discussion for another place. Nor shall I further outline what that tax relief might look like. The question how to encourage entrepreneurship through the tax system is a broader conversation but I may later write on the principles which might guide that conversation.
Follow @jolyonmaughamNote: this is the second of the series of pieces stemming from this Manifesto.
Waiting for Godot 
Reblogged this on lawmice.com and commented:
Thoughtful and nicely written
This is very interesting.
Just two points though.
1. Where does the engager’s cost of £141 come from? Surely, the engager’s cost is £100?
2. HMRC already insists for some self-employed workers that they be treated as employed for income tax and National Insurance purposes.,(Self-employed lecturers are a case in point). Whether this group enjoys the protections of employment law is moot. They probably don’t, given the contract they have with their engagers.
Anyway, I am very pleased (and surprised) that these issues have been raised.
As well as looking at the question of tax incentives to employ workers with a proper safety net, whether directly or via contractors/self-employed, I’ve always been struck by the way our law allows for the protection of limited liability for entrepreneurs setting up companies, with no compensating duties towards the welfare of their workers.
I crudely imagined a couple of years ago addressing this by a simple amendment of the Companies Act – “Companies and their employees” http://wp.me/p1DwQc-g
Thanks Andrew. Interesting piece!
J
Thanks for another interesting and thoughtful piece.
Three comments.
1. I assume the £26 is due to differing rules on National Insurance. If so, is it possible to end that differential by the more radical step of abolishing NIC and merging it with tax? I know that has its problems, especially the presentational side for politicians and some implementation issues (especially for pensioners who do not pay NIC on their pensions income but did pay NIC when employed). But it would be a big simplification and make it easier to set up in business, as well as avoiding the chance that any new rules on “engagement” would face legal challenges or questions of interpretation that might require legal judgements.
2. To the extent the £3bn is a subsidy that is reflected in lower prices then any changes will potentially increase prices? And if not expressed as lower prices will this not show up as increased profits, wages (probably executive), or dividends – any of which are taxable. so there might be an impact there as well?
3. Given Osborne’s cherry-picking of policies is there anything in what you propose that he could not simply pilfer?
Thanks Ian.
1. The £26 is different rules on NICs, yes. Merging NICs and IT doesn’t solve that problem per se – you still have to work out what you’d do as part of the merger.
2. The effects of removing the differential are complex and would depend on who bore it – individuals, engagers, or customers. Of course, it would improve competition which would drive down prices.
3. I’d be delighted if Osborne cherry picked some of these ideas. He has pilfered some before and I hope he carries on doing so.
And arbitraging these advantages channels vast amounts of money – tens of billions of pounds – into the pockets of the arbitrageurs. And it channels that money from the rest of us. From businesses that don’t enjoy those arbitrages and are outcompeted. From individuals denied that safety net who faces lives of financial uncertainty and breadline pay. And from taxpayers and those who rely on public services who together fund that lost £26.
It does not channel that money from the rest of us. Most (around 97%) of the value of innovation is not arbitraged away by the producers, it falls to consumers. Or voters, as they are sometimes known.
In missing out the interests of the consumer, you ignore the work of Schumpeter and Nordhaus, amongst many others.
http://www.nber.org/papers/w10433
As Schumpeter presciently said in 1942: “Intellectuals tend to have a negative outlook of capitalism, even while relying on it for prestige, because their professions rely on antagonism toward it.”
Take some bete noirs of the left:
Uber – yes it disrupts the Taxi industry, and yes, maybe Uber’s owners will get rich (though that is not certain), but what they provide is a lower cost of transport, with predictability, no tipping and greater availability to consumers generally.
Amazon – certainly puts book shops out of business (as did the end of retail price maintenance) but it also provides lower prices on a range of items, including books (but also cloud services) to millions of consumers who would otherwise have to pay more, or go without.
Wal-Mart – the Walton family has made $100 bn or so from Wal-Mart, a tidy sum indeed. But the innovation they brought to the retail market has benefited consumers by far more – around $5 trillion over 20 years.
There is little dispute that Wal-Mart’s price reductions have benefited the 120 million American workers employed outside of the retail sector. Plausible estimates of the magnitude of the savings from Wal-Mart are enormous – a total of $263 billion in 2004, or $2,329 per household.
http://www.forbes.com/sites/timworstall/2016/01/11/walmarts-asda-shows-why-and-how-walmart-itself-is-so-beneficial/
Entrepreneurs aren’t different from arbitragers, in most cases they are same people and organisations. It makes no sense to encourage one and not the other.
Protecting a small group of incumbents against the interests of innovators and consumers does not seem to me to be a good way to win those consumers’ votes.
Since the analysis is lacking, any proposed policies based on it will be similarly so. Equalising NI rates may well be sensible, but this does not prove the case.
Leaving aside the £26, the dividing line is between those companies which do provide a safety net for their workers and those which don’t.
The French offer a potential solution: the state provides the safety net (sick pay, maternity pay, redundancy pay, pension saving, etc.), not the companies. For companies, this puts them all on the same footing: whether large, small, or one-man bands. For workers, this makes all jobs equivalent: young women no longer have to choose employers based on who offers the most generous maternity pay; workers with long-term minor illnesses no longer have to choose employers based on who offers the best sick leave. This would also go some way to addressing the gender pay gap: freed from having to choose motherhood-friendly employers, women might be able to rise further in their careers. (Or not; but at least they’d have more choice.)
Yep. Look carefully and you’ll see an “if” at the relevant place.
But whether or not you’re right is kind of secondary to the question what the electorate might be persuaded to vote for – and I’m not sure that a broad extension of the state safety net is an especially viable political proposition.
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I have seen someone mentioning of lack of workings to justify the £26 figure.
To put a net amount of £100 in the pocket of a basic rate employee, the employer will need to find a little more than £167. The gross wage is a shade over £147, added to which is 13.8% employer Class 1 NICs (about £20), and the employer also deducts 20% income tax and 12% employee Class 1 NICs (about £29.40 and and £17.60 respectively).
A similar self-employed person with an income at the basic rate level pays 20% income tax and 9% Class 4 NICs (both of which the person pays themselves, out of the gross amount they receive – plus minimal Class 2 NICs of £2.80 per week, ignored here, and soon to be abolished). To end up with £100 in their pocket after tax, the self-employed person need to charge a fee of just under £141 (with tax of just over £28 and NICs of nearly £13 to pay). Also ignoring VAT.
No doubt some people prefer the life of a freelance contractor, and there is a good reason for real self-employed persons paying less tax and NICs as they have to bear the risk o failing to fund work and have to fund their own retirement provision, holiday pay, and any subsidised “benefits” that an employer might provide (car, health insurance, etc). But is £26 the right amount. And surely some who claim to be self-employed are really employees.
A related issue is the number of small busineses trading through small companies, paying the director/shareholder a small salary, with the rest paid out as dividends. Should the legal structure (employee, self-employed, incorporated) change the amount of tax that someone pays?
There’s double counting in your second paragraph (you’ve counted both the gross wage (ie including tax and NICs) and the PAYE deduction). I think my calculations are right.
Have I? I thought my calculation was getting to the same £26 difference you mentioned!
In round terms:
* employer funding requirement of £167, less £20 employer NICs. Gross wage £147.
Less PAYE £30 and employee NICs £17. Net income £100.
* self-employed fee £141. Less self-assessed income tax £28 and NICs £13. Net income £100. (This also ignores “wholly and excuisively” deductible expenses too, of course, without the “necessarily” condition added on top as it is for employees.)
* difference is £167-141 = £26.
No?
Apologies. Either clumsily read or written. Doesn’t matter – we’re on the same page… Thanks.
Not sure I’d agree that it’s for the Government to compensate for the risks – and lack of employee benefits – attached to self-employment through the tax system. I’d think the self-employed should do that with higher rates of pay.
But I agree that legal structure should be irrelevant. That’s a slightly separate issue but one that I’ve proposed a solution to here https://waitingfortax.com/2015/12/04/tax-loss-business-and-personal-service-companies/
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My comment may be a little unsophisticated, but, when one compares the situation of employees and the self-employed, one should not overlook that great unmentionable, the cash-in-hand economy. When I see a white van, hoho (!), I think of that aspect of the British economy. Mine is simply an outsider’s view and I can summon up no statistics about it. I remember hearing about one retail business which had three cash tills. Two, apparently, were for the tax man and one was for the proprietor. There may be a limit to what a government can do in what is meant to be a free country.
The whole problem here assumes that contractors and employees would both get that same £100. We’ll come back to that, though. The £141 in many circumstances would actually be £100 (or £120 if the supplying company is VAT-registered, which could actually be reduced back to £100 with VAT-offsets at the other end of employer-co’s business). However, getting back to my first sentence, the real point should be that the employed and the self-employed wouldn’t be getting the same anyway. An employed person, with the safety nets and benefits of sick pay, holiday pay, training, redundancy, etc. would be on a lower rate than the risk-taking self-employed, who wouldn’t be paid for no-shows (sickness, holiday, training, etc.), will potentially have to provide their own PI/PLI cover and can be discarded at a moment’s notice.
The risk-taking self-employed person deserves a higher reward, I’m sure we’d agree. Only a fool would argue against that. IR35 and all its ramifications, such as business entity tests seems to attempt to solve one problem by looking at something else entirely. Businesses engage service providers for a variety of reasons, but typically this would be one of short term resource requirement, a freeze on permanent headcount but a need to get work done, maternity cover and so on. Only some of these engagements are a wilful attempt to avoid NICS contributions, which is where the “taxpayer misses out”. But IR35 seeks to trap all people by looking at the supervision, direction and/or control (SDC) rule rather than looking at the rights of the individual as part of that engagement. Anyone asked to do a piece of work for someone else will at some point be subject to one of S, D or C. This is wrong. Let’s not regard the self-employed as a tax-dodger. They go into business for themselves because they like variety, because they are less risk averse and more confident in their skillset and experience and because they like being their own boss.
Of course, part of what I refer to here is more skilled contracting in engineering, construction, IT, health, education and other industries where short-term specialist skills may be required. Irrespective of day rate, though, you will potentially catch both those that need protecting and those that want to be rewarded for risk with the same net. The reality is that some people are naturally more risk averse than others. These same people will then complain when a contractor is paid twice as much as them. Nothing to stop them doing it, apart from maybe the contractor is a highly-skilled SME and the complainer is not.
In terms of protection, you could argue about a minimum hourly rate below which all service providers need to be in the service of either the employer or an umbrella company or maybe a service provision agent of some sort (e.g. Office Angels, Mitie, etc) to afford them that protection and also boost the coffers of HMG with the additional NICS contributions. The skilled contractors would also contribute significantly. George Osbourne seriously got his maths wrong in what perhaps turned out to be a trial balloon. A skilled professional on, say £75,000 per annum in service of an employer may charge £500/day for their services on the freelance/contractor market. The salaried professional would contribute c£24k to the public coffers (plus whatever the employer contributes via NICS) while the freelance equivalent would contribute over £36k in Corporation Tax and VAT and knock on revenue from engaging other services (accountancy, insurance and other professional costs), filing annual returns, boosting the economy with more travel and so on. The new dividend tax rules will increase that contribution, while still rewarding the risk-taker accordingly. What is concerning is the intended clampdown (read abolition) on tax relief for travel and subsistence expenses for freelance workers (those in service get reimbursed in full), which would further curtail freedom of movement within the UK and impinge on our country’s ability to deliver projects.
I don’t see that there is a single silver bullet for this issue but we certainly shouldn’t punish those who strive to make the country all it can be.
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