The U-Turn and its Consequences

The U-turn will result in a meaningful hole in government finances.

This year’s Budget saw a couple of key themes emerging of relevance to the financial planning process. Both were substantially driven by the government’s disquiet with the (in its view) unfair differences in the tax and National Insurance liabilities on the earnings of the self-employed, employees and owner managers of private limited companies. And, of course, as well as the unfairness there’s the cost – to the Exchequer- of said unfairness.

The first proposal was to reduce the difference in the National Insurance liabilities of employees and the self-employed. In his Budget Speech the Chancellor made the point that on earnings of £32,000 in a year £6,170 of NICs would be paid in relation to an employee (by employee and employer) whereas just £2,300 would be payable by a self- employed individual.

The government had already committed to the abolition of the essentially regressive flat rate Class 2 National Insurance liability for the self-employed from tax year 2018/19. The Chancellor affirmed his continued commitment to this change. But as well as this, and related directly to reducing inequality, he also announced that there would be an increase to the Class 4 rate payable on profits within the band (£8,164 – £45,000 for 2017/18) from 9% to 10% in 2018/19 and to 11% in 2019/20.

Harsh, but still below the 12% employee rate, and, of course, there is no employer contribution which, in most cases, reduces the amount paid to employees.

Leaving aside the philosophical arguments, as a fact this proposal represented clear evidence of the government’s commitment to remove inequality. And then came the furore. At the heart of the protestations was the pre-election Conservative pledge not to increase income tax, VAT or National Insurance in the life of the post-election Parliament should the Conservatives be elected – which, of course, they were.

On the proposed Class 4 NIC increases, the then party leader, David Cameron, said “…we can commit to no increases in VAT, income tax or National Insurance.” And, so stated the triple tax lock pledge on page 9 of the Conservative’s 2015 manifesto. At the time it was something of a surprise commitment, probably prompted by David Cameron responding in PMQs to a question from Ed Miliband about whether a future Conservative government would raise VAT after the election (as had happened in 2010).

The announcement in the 2017 Budget that the main Class 4 rates would rise by 1% to 10% in 2018/19 and another 1% to 11% in 2019/20, perhaps unsurprisingly resulted in those manifesto words being exhumed as proof of government duplicity. It is arguable though that those protesting should have done so long ago, when the true meaning of the triple lock electoral pledge emerged shortly after the June 2015 general election.

The ‘Income tax lock’ and ‘VAT lock’ were the first two clauses in the Finance Act (No 2) 2015. However, the ‘National Insurance Contribution lock’ was in separate primary legislation, the National Insurance Contributions (Rate Ceilings) Act 2015, which received Royal Assent in December 2015.

That Act showed that the NIC lock was not all it seemed. It always seemed odd that there should be a pledge not to increase NIC rates when, before the 2015 election, the government had committed to killing off Class 2 and bringing Class 4 on to a contributory benefits-related basis. And that was before anyone had raised the question of what Class 4 contributions should be when the single tier pension started in 2016/17, boosting state pension benefits for the self-employed.

Probing of the Treasury after the election eventually teased out that the NIC lock only applied to Class 1. It was thus no great shock that when the National Insurance Contributions (Rate Ceilings) Bill emerged in July 2015 it only dealt with Class 1 NICs. In addition to a Class 1 NICs rate lock, the Bill provided a guarantee that the upper earnings limit (UEL) would not exceed the higher rate tax threshold. There were no protests about the Bill’s (lack of) contents from the multitude now up in arms. Perhaps not surprising, as detailed reading of legislation is not something that many make a practice of in this headline driven society.

Of course, the government announced its “crusade” against unequal treatment of earnings in the shape of the wide-ranging Taylor review of working practices announced last November. The review will be countrywide and stretch over six months. Lots of hard evidence will be gathered. The so-called “gig” economy will definitely come under review. We have already seen the widely publicised Uber case on whether Uber drivers are employees or contractors.

So the U-turn has happened and it seems that will cause a meaningful hole in the Government’s financial plan. In response, some commentators believe that this will prompt the Chancellor to turn his attention to reviewing pension tax relief as a source of “recovering” the lost revenue that the NIC increase would have delivered. While this can’t be ruled out, there is no obvious direct connection between a non-implemented NIC increase for the self -employed and pension tax relief for all. And the amount at stake in relation to pension tax relief is such (over £30bn) that this is always going to be under the microscope.

It’s also worth remembering that saving on the cost of pension tax relief is not the only factor that may drive change. Fundamentally changing savings behaviour will also be a key objective. Arguably, the LISA is a “market research project” that will test the attraction of incentivising saving in a different way with a different project. In short, all we are saying is that pension tax relief reform is a big enough issue on its own not to be substantially affected by a U-turn on National Insurance for the self-employed. Separately, on the point of encouraging greater pension saving by the self-employed and removing another disparity between self- employment and employment, some have been suggesting that some form of NIC rebate should be introduced for the self-employed in relation to pensions savings made by them.

There are clearly many moving parts in this multi-faceted debate and, especially given the Taylor review, it seems unlikely that we will see no further changes to taxation or National Insurance – though maybe not to the rates – at least in this Parliament.