The Uber ruling reminds us that sometimes tax does have to be taxing

Last Friday’s Uber ruling whipped up a storm of commentary about the tech giant’s behaviour. Yet little attention was paid to the elephant in the room: the disparity in tax paid by employees and independent contractors, and the incentives this creates for dubious employment relationships.

So there we have it. Uber’s controversial practice of designating its drivers as independent contractors has been judged improper and may eventually come to an end.

The judges in the employment tribunal case pointed to a number of behaviours that indicate Uber acted more like an employer than the mere marketplace it professed to be.

Included in the list – now doing the rounds on social media – were that the drivers in question were unable to set their own prices, had key information withheld from them about passenger journeys, and were obliged to accept ride requests or face the prospect of being removed from the app.

Far from being the final word on the matter, however, the wrangling surrounding the status of Uber drivers is likely to continue for many months to come. As my colleague Nich Bull explains, Uber are almost certain to appeal and take the litigation all the way to the Supreme Court should they need to.

This begs the question of why Uber are so keen that drivers remain firmly seated in the self-employed camp.

Part of the answer is that the tech giant wants to avoid having to pay for pension contributions, holiday leave and a minimum wage. But perhaps a bigger factor - albeit one not addressed directly in this tribunal case - is their reluctance to pay Employer National Insurance Contributions (NICs), something that can be sidestepped when engaging with independent contractors.

It is worth reminding ourselves of how National Insurance Contributions (NICs) work. For the self-employed, there are two types: Class 2, currently levied at £2.80 per week for most workers, and Class 4, levied at 9% of earnings above £8,060 and 2% of earnings above £43,000.

For employees, the arrangement is notably different. They pay 12% in personal NICs above a threshold of £8,060, which is already more than the self-employed. And on top of this their employer pays NICs at a rate of 13.8% above £8,112 per year.

The Employer NICs is no insignificant tax. A business employing someone on a salary of £25,000 is looking at a gross annual bill of £2,330. Multiply that by thousands of staff and you can see why a company like Uber is wary of how its drivers are classified.

Yet the effects of this tax disparity ripple far beyond the case of one gig economy platform. Occupations as diverse as social care work, teaching, journalism, delivery driving and even news reporting all appear to be afflicted by false self-employment.

The other big issue with the self-employed paying lower tax rates is that it becomes almost impossible to secure for them any extra social security protections. Writing in the Evening Standard, Rohan Silva rightfully argues that the self-employed merit greater benefits such as paid parental leave. But the reality is that this will only happen once they pay close or equivalent NICs rates to everyone else.

So what to do about the NICs quandary?

Here are five future scenarios that are being toyed with (including by the Office for Tax Simplification):

Option 1: Business as usual – The self-employed continue to pay lower rates of National Insurance Contributions than their employed counterparts, partly justified as a tax break to reward risk-taking behaviour (although some argue this would be better incentivised through targeted interventions like EIS, which gives tax relief to investors in higher-risk trading companies). The motivation for false self-employment remains, the Exchequer continues to lose out on a significant chunk of tax receipts, and it remains difficult to grant the self-employed extra benefits.

Option 2: Soft levelling – The self-employed begin paying the same personal NICs rate as employees (ie 12% instead of 9%), but employers continue to pay their NICs as usual. This ‘soft levelling’ may help to partially dampen false self-employment, given workers no longer have anything to gain financially from being complicit in a misclassification. But it would leave the already self-employed materially worse off, unless there was a rise in the threshold at which NICs kicks in.

Option 3: Hard levelling – The self-employed begin paying the same personal NICs rate as employees. And in addition, employer NICs is replaced with a new ‘transaction tax’ to be paid by anyone contracting the services of any worker, be it employees or the self-employed. Think of the way VAT is currently administered, just wider. This could eliminate the incentives for companies to misclassify their workers, but we may find that self-employed workers swallow the new tax themselves rather than pass it on to customers.

Option 4: Payroll tax plus – The same as the hard levelling option above, but rather than transform employer NICs into a transaction tax, it is recalibrated as a ‘payroll tax plus’ with employers paying a levy for all the workers they employ plus their use of independent contractors. This would resolve some of the false self-employment problems, and bring in extra revenue to pay for extra benefits, but would do little for self-employed workers who operate in B2C markets and sell directly to everyday customers (think of plumbers, builders and other tradesmen and women).

Option 5: Wealth tax filler – A fifth option would be to remove employer NICs altogether and plug the gap in the government’s finance using an entirely different tax, such as a hike in wealth taxes. This could be more politically palatable to the electorate if framed as a tax cut on earned income (i.e. from work) paid for by a tax rise on unearned income (e.g. derived from property price rises).

If you’re still awake, then well done. The reformation of National Insurance Contributions is nothing short of a mammoth technocratic exercise with multiple moving parts and unintended butterfly effects. And we haven’t even talked about the tax paid by self-employed workers who register their business as a company.

But if we’re determined to create a fully functioning 21^st century labour market that balances flexibility for businesses with security for workers, then we need to begin grappling with the NICs dilemma and putting new ideas on the table.

The RSA is working with Crunch, the online accountants for micro businesses, on a project that seeks to deepen our understanding of what works in supporting the self-employed and micro-businesses.