We need a brave chancellor to iron out the unfairness in our tax
This week, the spotlight has been on employment and the labour market. The UK has hit a new record employment level – with the number of people employed above 32million for the first time. But there is growing concern about the quality of jobs being created. Average pay levels are up just 1.8pc on a year ago, well below the rate of inflation.
Earlier this week, Matthew Taylor published his government-sponsored review into modern working practices, considering the impact of new flexible patterns of employment – sometimes described as “the gig economy”. His main conclusion was that we need more “good work”. He argues that the benefits, rights and tax treatment of some types of self-employed and part-time work need to be more closely aligned to full-time regular employment. We can all agree with that in principle – the question is how it can be achieved in practice.
Since the mid-eighties, the UK economy has created more than eight million extra jobs – an impressive achievement. But less than half of these additional jobs have been in full-time regular employment. Some 57pc of the job growth has been in part-time employment or self-employment.
This is not necessarily a bad thing. Many people want to work flexibly – to balance work and family responsibilities, or to take advantage of the opportunities being opened up by the internet or from other new technologies. Flexible employment patterns can allow people to be more independent and remain in control of their own lives. More opportunities for part-time or self-employed work also helps older workers to remain in work.
But we have to be able to adjust to this new situation. Now just 63pc of workers are working full-time for an employer, down from 70pc in the mid-eighties. We are heading for a 50:50 economy in the world of work – with 50pc of jobs in full-time regular employment and the other half in part-time work and self-employment.
This is the challenge highlighted by Mr Taylor’s report. But finding the answer must be a two-way movement. We should find ways of ensuring that the flexible employment model can provide rights and benefits similar to those enjoyed by full-time regular workers. At the same time, though, we must adapt our systems of taxation and regulation to accommodate more flexible employment patterns. Otherwise, we will stifle the new sources of jobs growth.
The experience of many other European economies shows the dangers of maintaining inflexible approaches to employment regulation and taxation. France, Italy and many other southern European economies have not adapted their systems to the modern economy in the same way that we have – and have suffered high unemployment as a result.
Some of these countries are now starting to adapt and are embracing economic reform. Spain has embarked on a programme of introducing more labour-market flexibility and its unemployment rate has fallen from over 26pc to below 18pc. Employment in Spain has increased by 2.4pc in the past year alone. France may well be about to start on a similar programme of reform under president Macron.
So what should we be doing here in the UK to ensure our approach to employment is properly adapted to the modern economy of the 21st century?
One of the issues I have touched on many times in this column is the importance of reforming our tax system to the changing structure of the UK economy. Mr Taylor’s report puts a clear spotlight on one area of taxation that creates unfairness and distortion in our current employment patterns – National Insurance. The
‘We need to take the lower paid out of the National Insurance net – and consider raising taxes elsewhere’
National Insurance system in the UK is the second biggest revenue generator for the Treasury.
It is expected to produce more than £130bn of revenue this year, compared with £175bn from income tax and just ahead of £125bn from VAT. No other source of revenue comes close to these big three taxes, which generate nearly two thirds of all UK government tax receipts.
But there are problems with the current structure of National Insurance, some of which are highlighted in Mr Taylor’s report. First, it bears down particularly heavily on the low-paid. The personal income tax allowance has been raised to £11,500, but National Insurance is paid by those in regular employment earning just over £8,000 a year. The combined rate paid by employers and their employees is 25.8pc – a 12pc employee rate and a 13.8pc employer rate. This is a higher combined tax rate than the basic rate of income tax (20pc) and kicks in at a much lower level of income.
Second, National Insurance is a jobs tax. While the Government has sought to ameliorate this impact by exempting younger workers and apprentices, taxing employment in this way risks holding back job creation and economic growth.
Third, National Insurance is a regressive tax. It is levied on employees at 12pc who are earning up to £45,000 a year, and then drops to 2pc a year. This is offset by the fact that higher rate income tax cuts in at 40pc at around the same income level. But compensating for the deficiencies of one tax by adapting the structure of another tax makes the resulting system of income and employment taxation more complex and less transparent.
Fourth, as Mr Taylor’s report highlights, National Insurance can be distortionary – as it differentiates between alternative ways of paying people for work. The full burden of National Insurance falls on individuals who work for an employer. Self-employed people pay a lower rate (9pc). And income that falls outside the National Insurance system is not liable for any payments at all.
A full-blooded reform is needed to address these issues. We need to take the lower paid out of the National Insurance net, and reduce the differentials between taxing different sources of income. To achieve that we may need to consider raising taxes elsewhere – for example by increasing property taxes or introducing new environmental levies.
Tax reform is difficult – particularly in the current political environment shaped by Brexit. But if we are to address the issues raised by the Taylor Review, a radical reshaping of our National Insurance system will be needed. We need a brave chancellor who is willing to take on this challenge and set out a long-term programme for reform.
Andrew Sentance is senior economic adviser at PWC and a former MPC member