The Institute for Fiscal Studies (IFS) says the way the tax system treats the self-employed, owner-managers and employees are ‘costly, inefficient and unfair’ and says a new approach is required following its research into changes in the labour market
While employees still make up 85% of the workforce, most of the growth (39%) over the last eight in the workforce has come from the self employed and company owner-managers. However, the IFS argues that the current tax system is much less favourable to those in employment than it is the 15% who work for themselves.
The tax differences are small at lower earnings levels but substantial for higher earners. For example, at £15,000 (employer cost), tax on employees is £631 a year higher than if the income was earned by a self employed person and £818 higher than if earned by a company owner manager. At £40,000 the differences are £3,442 and £4,502 respectively, while at £100,000 the differences are £7,365 and £8,035 respectively.
The IFS points to estimates from the Office for Budget Responsibility that rapid growth in the number of small companies will cost the Exchequer an additional £3.5bn in 2021–22. In addition, the current tax system is inefficient as it drives people to change their behaviour – to register themselves as a company rather than work as an employee, for example. It is also unfair because two people earning the same amount for doing similar work can pay different amounts of tax.
The IFS says its research suggests that levelling the playing field requires a two-part solution. It calls for the money invested in a business to be deductible from taxable income. Secondly, each additional pound of income should then be taxed at overall rates that are the same for an employee, self-employed person or company owner-manager and regardless of whether it comes in the form of wages, dividends or capital gains.
Stuart Adam, a senior research economist at the IFS and a co-author of the report, said: ‘The taxation of the self-employed and company owner-managers sits at the point where many different parts of the tax system meet. This makes it a tricky business because incentives are shaped by the interactions of taxes on wages, dividends, capital gains and corporate profits.
‘Making changes to any one can be the policy equivalent of “whack-a-mole”; well-intentioned policies can lead to problems popping up elsewhere. To create a truly level playing field we must be bold and work towards a solution that sees the tax system for what it is: a system.’