The UK’s financial plumbing no longer delivers the required flow of National Insurance Contributions (NICs) because the world of work is changing. But rather than add more legislative patches, such as the controlling persons legislation – that will choke off the flow of cash through the economy so badly needed for growth – fresh thinking is required.
Think of the cash flowing through the UK economy as a gigantic pipe network supplying the economic turbines of growth. The government uses various ‘tax’ taps to siphon off cash in the form of VAT, income tax, corporation tax and so on. Then there are NICs, which are technically not a tax but we all know what the contributions really are. This cash is redistributed by government, generally quite inefficiently and with lots of leakage, to other parts of the system.
Because the world of work is changing, moving away from the industrial age model of full employment towards the flexible workforce of the knowledge economy with increased numbers of contractors and freelancers, flows from the NIC tap are decreasing. That’s because flexible workers are paying fewer NICs because of the way they trade, and their clients no longer have to pay employer’s NICs when hiring contractors.
But the government needs more, not less, tax. So, it adjusts the flow of the other taps, which has already happened with VAT and NICs. It also plumbs in new taps by creating legislative patches to try and maintain the flow of tax. However, the trick is to tinker with the taps so as not to affect the pressure in the system, which is not what is happening.
New taps have been introduced, such as IR35, and more are forthcoming, such as the controlling persons legislation. These are expensive taps to run and represent a drain on the productiveness of the economy. The cost, in reduced productivity and growth, of running these taps may ultimately outweigh the flow of cash that comes out of them.
Fresh thinking is required to replace the flow of NICs that has reduced because more people are choosing contracting and self-employment. We certainly don’t need more taps. So what does that mean in practice? Well, the solutions currently being discussed in tax circles are:
- Merging NICs and income tax
- Increasing compliance to catch abusers of the system
- Taxing flexible workers as if they are employees.
The Office of Tax Simplification (OTS) mooted the possibility of merging NICs and income tax in its interim report on the Small Business Tax Review in 2011. And the Treasury is currently considering proposals to merge the collection of income tax and NICs via Pay As You Earn (PAYE). But it lacks the courage to merge the two taxes for fear that workers would baulk at what would be perceived as a massive increase in tax.
Introducing legislation to catch abusers was tried in 2000 when IR35 was introduced, and the off-payroll and controlling persons legislation are further examples of poorly applied patches to fix the leaky NIC pipe. Not only does IR35 not work, but most flexible workers pay less NICs as a result of using perfectly legitimate trading models such as limited companies. No amount of ‘disguised employee’ legislation can address what is in fact a major workforce trend.
A striking feature of the appallingly researched media coverage of the Ed Lester affair, earlier this year, and subsequent limited company contractor witchhunt by politicians and the media, was the direct comparison between the circumstances of employees and flexible workers. They are not comparable; employees receive paid holidays, sick pay and a raft of other benefits, contractors do not.
Contractors and freelancers not only receive none of these benefits; they have to make provision for holiday, sickness and pensions, and all the costs of running a business, out of their fees. Furthermore, contractors don’t enjoy employment rights and run the constant risk of not getting paid. And in addition to all of that, contractors do not have the relative security of employees. Indeed, their current contract may be their last, if they don’t invest in their own skills and marketing.
Removing the opportunity to profit and reduce tax liabilities by taxing flexible workers and the employed the same would be a massive disincentive. We need to encourage flexible knowledge workers to become part of the UK’s economic growth solution, not put them off.
The controlling persons legislation, and measures like it to force contractors to pay more NICs and income tax, won’t replace the lost flow of NICs to bolster flagging government finances. In fact, it will have the opposite impact, as poorly thought through punitive measures often do, by driving the UK’s most effective managers out of the contracting sector, and possibly out of the UK altogether.
Fresh thinking on taxation and the economy’s pipework, and incentivising enterprise is what’s needed to unleash productivity and grow the UK out of its crippling public sector debt burden. But we won’t find such thinking in the pages of the controlling persons legislation consultation, nor measures like it. We can only hope that the government heeds the warnings and leaves the proposed legislation out of next year’s Finance Act.