Chris Riley: Is the National Insurance increase Philip Hammonds’ Pasty Tax?

Chris Riley, PKF Littlejohn’s head of tax, gives his personal opinion on the most controversial announcement in the recent Spring Budget.

Yesterday, we reported on what, in my view, was the dullest budget in my career as a tax advisor.  That isn’t to say that every previous budget has been full of excitement, but never before have we had to work so hard to say something useful in our Budget guidance to clients.

Then I got the train home, and started thinking about the National Insurance changes that led the news headlines.  The mainstream press has focussed on the potential breaking of the 2015 Manifesto commitments, but I’m far more vexed by the reasons given for the changes, and whether they stack up.

The build up to the announcement was big on words but little on detail.  As the Chancellor prepared his ‘reveal’, those of us watching on TV were starting to shift uncomfortably in our seats.  This was going to be big, given the detailed introduction.  This was going to hurt.  And then it came, a 2% increase in Class 4 NICs.

Oh.  Just that?

The change will raise a fair amount of additional revenue for the Government, up to £645m in 2019/20 before the savings start to reduce (a result, I assume, of the presumption that fewer people will ‘volunteer’ for self-employment status if the tax benefits are eroded).  But in a typical Budget, that isn’t a significant change.  The 2% increase to Insurance Premium Tax announced in the Autumn Statement last November will raise £840m per year.  The apprenticeship levy that takes effect in April will raise £2.6bn in its first year.  In tax policy terms, the Class 4 increase is small potatoes.

However, do the reasons and justifications for the change stand up to scrutiny?  Here I must declare a vested interest.  I am self-employed, and therefore pay Class 4 National Insurance and so my tax cost will be higher from 2018 due to the increase.   With that admission out of the way, let’s look at some of the issues with the Class 4 increase in turn.

Do people really choose to be self-employed?

We’ll begin by taking a look at an important passage from the Chancellor’s speech:

People should have choices about how they work, but those choices should not be driven primarily by differences in tax treatment.

I completely agree.  However, we should also consider whether, for example, a minicab driver has the flexibility to choose if they are self-employed rather than employed.  If they do, then it seems reasonable that the incidence of the tax increase should fall on them. 

But what if the worker hasn’t had the opportunity to decide their employment status?  The Chancellor told us that:

The lower National Insurance paid by the self-employed is forecast to cost our public finances over £5 billion this year alone

So the 2% increase in Class 4 NIC raises £645m as noted above.  The remaining £4.4bn must therefore be the employer’s saving – i.e. the amount that employers are not paying because their workforce is self-employed rather than employed.  This suggests that there is an incentive for employers to restrict an individual’s ability to decide on their employment status, with the increased cost now being borne by the self-employed individual.

Using a sledgehammer to crack a nut

It is suggested that changes are aimed at tackling the ‘gig economy’:

As our economy responds to the challenges of globalization, shifts in demographics, and the emergence of new technologies we have seen a dramatic increase in the number of people working as self-employed.

But why is the mechanism to address ‘new challenges’ not targeted at those specific and readily identifiable challenges, and instead applied to the whole self-employed base? 

New legislation takes effect from April 2018 to deal with off payroll working in the public sector, bringing people doing ‘employment type’ jobs onto the payroll.  In fact, we were awaiting the announcement that it would roll out to the wider employer base in the near future.  After all, applying that measure to the wider commercial sector alone would fundamentally deal with the main issue presented in the speech:

But a fair system will also ensure fairness between individuals, so that people doing similar work for similar wages and enjoying similar state benefits pay similar levels of tax.

 The difference in National Insurance Contributions is no longer justified by the difference in benefits entitlement.

It is noted that the gap in state benefits between employees and the self-employed has closed in recent years, and a further review in the summer promises to close this further still.  However, this does not mean that the two classes of worker are equal – many a self-employed worker looks at redundancy pay, holiday pay and general employment protections afforded to employees with a degree of envy, which is not compensated in the relatively small NIC saving arising. 

Lower earners to be hit hardest

The Chancellor tells us that the measure is definitely fair, as he also identifies that the fat cats will be equally affected:

Indeed, many of our most highly-paid professionals work through Limited Liability Partnerships and are treated as self-employed.

Hi!  That’s me.  Well, apart from the highly paid part obviously.  But it isn’t fair, primarily because of the way that the National Insurance system works – in that the increase in Class 4 National Insurance only applies up to the ‘Upper limit’ (£45,000 of profits next year).  Above that level of income, the rate of Class 4 NICs is 2%, and will remain at 2% even after the Chancellor’s announcement.  So at £45,000 of earnings, you’ll pay in the region of an extra £740 when these changes take effect.  At £450,000 of earnings, you’ll still only pay the same £740 extra per year. 

Over the same time frame, the personal allowance and higher rate income tax threshold will increase, which will largely negate this increase.  The relief is lower for those not in the higher tax bands.

So the changes won’t have much impact on higher earning self-employed individuals (and will be largely adjusted out anyway by the increase in the Higher Rate income tax threshold that arrives at the same time), but will be a more significant issue for the self-employed plumber outside London.

Which makes the following statement all the more difficult to comprehend in context:

I have considered the possibility of simply reversing the decision to abolish Class 2 contributions, but the Class 2 NIC is regressive and outdated.

Which I now read as “I discounted the very regressive option and decided to instead choose the option that is still very regressive only slightly less so”.

Where do we go from here?

Before I close this thesis, give my compliance partner a mild heart attack and have my other fellow partners wondering whether I’ve completely lost it by getting so irate at such a small issue, I’ll summarise my issues with the Class 4 increase:

  1. It isn’t fair.  It takes an issue of tax benefit that heavily accrues to one party (the potential employer) and moves the incidence of correction to another party (the potential employee).
  2. It isn’t fair.  The incidence applies to all self-employed taxpayers, whereas the option exists for the Government to challenge the problem at source.
  3. It isn’t fair.  The charge is regressive, with lower earners suffering far, far more in percentage terms than high earners.
  4. A difference in the tax basis between two taxpayers is not an automatic unfairness.  There are also many other aspects of the tax system that can be considered ‘unfair’ that have not been addressed for many years.

There may be many good reasons for changing the basis of charging National Insurance for the self-employed, but fairness can only be applied as the reason if the change itself is applied fairly.

The Pasty tax in the Omnishambles Budget of 2012 never made it to the statute books.   A further review of employer taxation is proposed for the summer, which may mean that the issues above are addressed through that mechanism and these changes never see the light of day.  Maybe this is a clever softening up ploy for the future.

For more information on the Chancellor’s announcements, download PKF Littlejohn’s Spring Budget 2017 guide.