The impact of increased self-employment and insecure work on the public finances

In recent years the idea that work is growing more insecure has risen up the policy agenda. The TUC has documented the growth in insecure work in recent years in its recent report Living on the Edge: the Rise of Job Insecurity in Modern Britain.

The current report addresses an important dimension of work insecurity not addressed in previous TUC work, which is the fiscal impact of insecure work on the public finances. This impact has two components:

1. There is an earnings penalty for insecure work. Self-employed workers and employees on temporary contracts (such as zero-hours contracts) earn considerably less than employees. This earnings penalty adversely affects the public finances because lower gross earnings mean lower revenue from income tax and National Insurance Contributions (NICs), and secondly because many workers on lower earnings have a higher entitlement to tax credits and Housing Benefit.
2. The treatment of self-employed workers for income tax and National Insurance purposes means that a self-employed worker pays less tax above the lower limits for NICs than an employee on comparable annual earnings.

The aim of this report is to estimate the size of the 'fiscal gap' which occurs due to increased levels of insecure work. We model the impact of two changes in the UK labour market which occurred between 2006 and 2016:

• an increase in the number of self-employed people in the UK, from 13.1% to 15.1% of the workforce (around 1 million extra self-employed workers);
• a net increase in the number of employees on zero hours contracts (ZHCs) from 0.2% to 2.0% of the workforce (around 700,000 extra employees on zero-hours contracts).

The earnings penalty for self-employment and zero-hours contracts

Analysis of data from the UK Family Resources Survey shows that self-employed people have lower earnings than employees across almost the whole of the distribution of weekly incomes from work (with the exception of the very top of the distribution). At the median – in the middle of the earnings distribution – self-employment earnings are 36 per cent lower than employee earnings, not controlling for other factors which affect earnings (such as age, gender, qualifications, occupation and industry). When these other factors are controlled for, the median pay penalty is slightly higher, at 44 percent. The gap between self-employed incomes and employee earnings is larger (in percentage terms) lower down the distribution of weekly earnings.

Analysis of data from the UK Labour Force Survey shows that employees on ZHCs earn between 55 and 70 per cent per week less than employees on other types of contract across the whole distribution of earnings, not controlling for other worker and job characteristics. When other characteristics are controlled for, the median weekly pay penalty for ZHC workers compared to other employees is 37 percent. The penalty is smaller in percentage terms at higher points in the distribution, and bigger below the median.

Differences in the treatment of self-employment income and employee earnings in the tax and National Insurance systems

The income tax system in the UK treats employees and self-employed workers the same in terms of headline rates on earnings. However, the National Insurance Contributions (NICs) system is more generous for self-employed people than employees. Whereas employee earnings are subject to Class 1 Employee and Employer NICs, self-employed workers who are registered as 'sole traders' pay Class 4 NICs at a much lower combined marginal rate than Class 1 NICs. Meanwhile, self-employed people who have incorporated their own business ("owner-directors") do not pay any NICs on dividends paid out of company profits. These differences in tax mean that self-employed people pay a lower combined income tax and NICs sum on earnings above the lower limits for NICs. For example, given annual gross earnings of £30,000, a sole traders' income tax and NICs liability is around 37% lower than an employee's, while an owner-director's income tax and NICs liability is almost 60% lower than an employee's.

Estimating the size of the 'fiscal gap'

The size of the fiscal penalty to insecure work is estimated using data from the UK Family Resources Survey and the Landman Economics tax-benefit model.

The tax-benefit model is used estimate the impact on the public finances of the increase in self-employment and zero-hours contracts as a proportion of the UK labour force between 2006 and 2016. This analysis compares the growth in the proportion of self-employed and ZHC workers against a counterfactual scenario where the total number of people in employment increased by the same amount, but the proportion of self-employed and ZHC workers was unchanged from 2006. This would have meant that 1.25 million workers entered more secure employee jobs rather than self-employment or ZHC jobs. 

Rather than just modelling the impact of an increase in self-employment at the average (mean or median) self-employed incomes and ZHC earnings, the methodology used here takes account of the distribution of earnings of the extra self-employed and ZHC workers. Analysis of recent income data for self-employed people and earnings data for ZHC workers shows that most of the increase in the proportion of insecure workers in the workforce has come in the lowest 60% of the weekly earnings distribution, with the fastest growth in insecure work for the lowest- paid workers. Accordingly, the analysis here assumes that the extra self-employed and ZHC workers are mainly low-paid.

The model used here estimates the fiscal impact of increased self-employment and ZHC 'in reverse' – by estimating the extra tax receipts which would accrue to the Exchequer if the increases in self-employment and ZHCs as a proportion of the workforce between 2006 and 2016 had not happened, and instead, self-employment and ZHCs had remained constant as a proportion of the workforce since 2006 and more people had moved into secure employee jobs.

Results

• The overall impact of additional insecure working over the last decade on the public finances is estimated to be a net loss of revenue of £5.3bn (assuming that all the additional self-employed people in the UK workforce are sole traders), or £5.6bn (assuming that all the additional self-employed people are owner-directors). In tax terms, this is roughly equivalent to the revenue yield from raising the basic and higher rate of income tax by 1p.  In public expenditure terms, it it is equivalent to just over a third of the social care budget for England.
• The negative impact of increased self-employment on the public finances is around £3.4bn, compared to £1.9bn for the impact of increased zero-hours contracts.
• Around 45% of the total fiscal impact is due to reductions in NICs receipts, 32% due to reduced income tax receipts and 23% due to increased tax credit and benefit payments.
• Most of the impact of increased self-employment on the public finances (between 85 and 92 per cent, depending on the assumptions about whether the extra self-employed are sole traders or owner-directors) is due to self-employed people having much lower wages than employees (conditional on worker and job characteristics). Only between 8 and 15 percent of the impact is due to the more generous treatment of self-employees in the National Insurance Contribution system. This implies that equalisation of the tax and NICs treatment of self-employed people with employees, while welcome for other reasons, would only close a small part of the fiscal gap arising from increased self-employment.
• The lowest-paid self-employed people and ZHC employees – those in the bottom quintile of the weekly earnings distribution – account for around one-third of the total fiscal impact, while workers in the bottom two quintiles (the bottom 40% of weekly earnings) account for over two-thirds of the total impact.
• For the lowest paid 40% of workers, the fiscal impact of additional insecure work over the last decade is estimated to be a net revenue loss of £4.0bn (assuming that all the additional self-employed people in the workforce are sole traders. This breaks down into an impact of increased self-employment of £2.1bn, and an impact of increased ZHC working of £1.9bn.
• In the top quintile, the fact that the proportion of self-employed people actually fell between 2006 and 2016 – coupled with the fact that there are almost no ZHC workers in the top quintile – means that the fiscal impact in the top quintile is actually positive – strengthening the public finances by between £470m and £610m depending on which definition of self-employment is used. However, this only makes a small impact on the overall negative fiscal impact of the increase in insecure work.