After the government's U-turn on NI contributions, tax advisers are wondering if unintended consequences are the inevitable result of a complex tax code
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This article was first published in the June 2017 UK edition of Accounting and Business magazine.
It was a swift climbdown for the chancellor; after proclaiming the need for a fairer system of taxing work in his first and last spring Budget, Philip Hammond has been left to ponder his options and consider whether it is possible to tweak the national insurance and income tax systems so that tax policy does not drive business structure. A new government, with a new mandate and new manifesto commitments, could renew the debate.
The original plan was straightforward: increase Class 4 National Insurance contributions (NICs) paid by the self-employed to 11%, leaving a small amount of wiggle room to allow for remaining benefit differences between the employed and self-employed. By closing the gap, Hammond had hoped to take tax business structure out of the equation so that individuals who wanted to start up their own business did so purely because they were driven by an entrepreneurial spirit and not by the desire to reduce their tax bills.
The attempted raid on national insurance, combined with a cut in the dividend allowance, left many working in the so-called gig economy feeling as though they had just been branded as tax avoiders rather than the engines of economic growth.
However, in fairness to the chancellor, he had been given this steer by the RSA’s chief executive Matthew Taylor, who has been tasked by the government to chair a review of modern employment. In his Budget speech, Hammond said: ‘[Taylor] is clear that differences in tax treatment are a key driver behind the trends we are observing.’ Part of the Taylor review will focus on moving away from taxing forms of employment differently to taxing labour more consistently. As Taylor himself says: ‘The goal here is to reduce the incentives for business models and forms of employment driven not by productivity or the desire for individual flexibility but by the attempt to avoid paying tax or meeting employment entitlements.’
The Resolution Foundation agrees. In a recent report (A tough gig? The nature of self-employment in 21st Century Britain and policy implications), the thinktank argues that one of the key drivers of the growth in self-employment has been the tax advantages enjoyed by the self-employed.
But the foundation also observes differences in behaviour between those it describes as in ‘privileged’ work – for instance law, IT and management consultancy – and those it describes as in ‘precarious’ roles: cleaners, hairdressers and, of course, taxi drivers. By splitting those working in the gig economy into these two camps, the foundation argues that tax is a much bigger driver in the rise in self-employment among the privileged.
Of course, Hammond also had one very large eye on the revenue he thinks the government is missing out on as a result of the gig economy. By 2021-22, the chancellor had hoped his increases in Class 4 NIC rates to 10% from April 2018 and 11% from April 2019 would have brought in more than £2bn. But even here, the Treasury acknowledged that this might not have been the case, as the main uncertainty hanging over this figure related to ‘behavioural responses’.
And it is this ‘behaviour’ that is driving the debate. ‘The government doesn’t want tax to have a neutral effect on behaviour – they are continually tinkering,’ says ACCA’s head of tax Chas Roy-Chowdhury. ‘They can’t start with a clean sheet of paper so we will now always have an interaction between tax and political bias.’
Of course, there have been numerous occasions when tax policy has directly affected the way businesses structure themselves. When Gordon Brown was chancellor he famously introduced the 0% rate of corporation tax for the first £10,000 of profit from 2002 to 2005. As is well known, this led to a rash of incorporations. In 2002-03 (when the corporation tax ‘starting rate’ was reduced to 0%), just over 320,000 new companies were created, up almost 90,000 from just over 230,000 in 2001-02. Following the removal of the 0% rate for distributed profits in 2004-05, the number of new companies created per financial year fell by around 54,000 from 387,000 in 2003-04 to 333,000 in 2004-05.
As Roy-Chowdhury says, where there are differences between corporation tax rates, which – depending on the result of the general election – are set to move down to 17% by 2020, and income tax rates, a move towards incorporation could still prove attractive. ‘Where there is a divergence, there will always be decisions required of individuals about whether to incorporate,’ he says.
‘People who have this flexibility will form companies,’ agrees George Bull, senior tax partner at RSM. Bull argues that it is easy to criticise people who follow that route, but the onus is on the government to get the legislation right, and if it isn’t right, to correct it.
‘If there are taxes and allowances that push people in one direction, and another set that push them in another direction, the government cannot complain if people legitimately follow the route that suits their circumstances best,’ Bull says. ‘Unless there is an overall plan, I don’t think that tax incentives used to change public behaviour will always achieve a good outcome.’
Looking more widely, Bull observes that the current debate over diesel car engines encapsulates this. Government incentives had driven people towards diesel engines, but this policy was based on what now appears to be incomplete data. Now drivers face the possibility of pollution charges in major cities, though some may hold out replacing their vehicles until the government introduces incentives such as a scrappage scheme. ‘You could see how people reacted stupendously well originally, only to realise that we were being encouraged to do the wrong thing,’ Bull comments.
The plastic bag levy seems to be equally successful in changing behaviour, though the jury is still out on the sugar levy: producers have reacted by making their products smaller rather than increasing prices, but how many consumers will now be tempted to buy multipacks of their favourite sweets?
And returning to business structure, the jury is also out on the chancellor’s next move, though this has been the subject of some debate in the run-up to the general election and beyond among all political parties. He knows tax can influence behaviour, but previous manifesto commitments and backbench pressures in this case could have an even greater influence on his own behaviour.
Philip Smith, journalist
CPD technical article
"The government doesn't want tax to have a neutral effect on behaviour - they are continually tinkering"