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Reforming national insurance might not be popular in Westminster - but it is the right thing to do

Reforming tax for the self-employed should be welcomed by progressives and fiscal hawks alike.

Raising taxes is hard for Chancellors to do. That shouldn’t be a surprise; saints aside, most human beings would rather not have less cash in their pocket. But that can’t be the end of any discussion on tax, unless you’d rather not have any schools, roads or the NHS. 

That’s why it’s time to put some perspective back into the political hot air that has followed the Chancellor’s decision to raise National Insurance for the self-employed, because this change is fundamentally the right thing to do. 

The first part of that perspective is to recognise that this is a tiny tax rise. £200 million a year is a lot to you and me, but is lost in the roundings at the Treasury. For example it pales into insignificance compared to the more than £12 billion worth of benefit cuts being rolled out over the next few years. These mean the incomes of the bottom third of working-age households are expected to fall – a fact which is not exactly filling the front pages of newspapers.

Second, this tax rise is progressive. Those earning less than £16,250 are unaffected or gaining. Because the self-employed have typical earnings of just under £14,000 this means over half will be better off or unaffected by these coming changes - including two-thirds of all self-employed women. And because rate increases fall heaviest on the higher earners, over half of the overall tax increase will come from the richest 10 per cent of households - meaning a (very small) reduction in inequality.

Third, there are some differences in the benefits that the self-employed are entitled to compared to employees, but that gap has narrowed hugely in recent years. This tax increase needs to be seen in the context of the new single-tier state pension – which came in last April. This closes by far the biggest remaining benefit differences between the self-employed and employees.

Fourth, because this tax rise is so tiny, it’s worth reflecting on why the Chancellor has brought it in. It can’t be just to raise revenue, because there are hundreds of easier ways to do that, like scrapping expensive and unwise corporation tax cuts between now and 2020 that would raise £5bn. 

So the Chancellor's action is not about the revenue raised but the incentives changed. He and many others rightly recognise that fast growing self-employment - combined with a much lower tax take for each person who is self-employed - is posing an ever growing risk to our public finances. Or to put it another way, to everyone else’s tax bill and public services. 

Fifth: crucially, even after this change, self-employment will still be heavily incentivised by much lower national insurance bills. That’s partly because the self-employed will still pay only 11 per cent compared to the 12 per cent paid by employees. But much more importantly it reflects the fact that there is no equivalent of employer national insurance (a 13.8 per cent tax on wages) when it comes to self-employment. Overall, the Treasury is still forecast to lose around £6 billion each year from this favourable tax treatment.

Now of course the Treasury could have done a better job. They should have been open that this was a breach of the 2015 manifesto – but honest too, that the reason for this change is that is the world has changed. If you favour total transparency, you could also argue – as some of its authors have – that the manifesto commitment was very silly in the first place. You'd be right.

It would also have been better if the changes were part of a wider set of reforms, looking at the full picture of self-employed taxation and giving the self-employed more support with the likes of maternity pay and private pension saving. Increasing such support for the self-employed is an important part of how we update our tax, benefit and employment laws for the 21st Century world of work. A new consultation on parental benefits for the self-employed may lead to welcome improvements in this area.

But those reasonable criticisms of how the Chancellor’s self-employment National Insurance rise has been handled are totally different to most of the opposition to this change – which is that it is wrong to try and narrow the large tax gap between the self-employed and employees. Far from it, on both fairness grounds and to protect the public finances, narrowing that gap is the right thing to do.

Torsten Bell is director of the Resolution Foundation.

Torsten Bell is director at the Resolution Foundation. Prior to that, he was director of policy for the Labour Party and worked in the Treasury, both as a special adviser and a civil servant.

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We're racing towards another private debt crisis - so why did no one see it coming?

The Office for Budget Responsibility failed to foresee the rise in household debt. 

This is a call for a public inquiry on the current situation regarding private debt.

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous. 

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

If the public sector reduces its debt, overall private sector debt goes up. That's what happened in the years leading up to 2008. Now austerity is making it happening again. And if we don't do something about it, the results will, inevitably, be another catastrophe.

The winners and losers of debt

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017. 

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

As in any ledger sheet, credits and debits have to match. The easiest way to understand this is to imagine there are just two actors, government, and the private sector. If the government borrows £100, and spends it, then the government has a debt of £100. But by spending, it has injected £100 more pounds into the private economy. In other words, -£100 for the government, +£100 for everyone else in the diagram. 

Similarly, if the government taxes someone for £100 , then the government is £100 richer but there’s £100 subtracted from the private economy (+£100 for government, -£100 for everybody else on the diagram).

So what implications does this kind of bookkeeping have for the overall economy? It means that if the government goes into surplus, then everyone else has to go into debt.

We tend to think of money as if it is a bunch of poker chips already lying around, but that’s not how it really works. Money has to be created. And money is created when banks make loans. Either the government borrows money and injects it into the economy, or private citizens borrow money from banks. Those banks don’t take the money from people’s savings or anywhere else, they just make it up. Anyone can write an IOU. But only banks are allowed to issue IOUs that the government will accept in payment for taxes. (In other words, there actually is a magic money tree. But only banks are allowed to use it.)

There are other factors. The UK has a huge trade deficit (blue), and that means the government (yellow) also has to run a deficit (print money, or more accurately, get banks to do it) to inject into the economy to pay for all those Chinese trainers, American iPads, and German cars. The total amount of money can also fluctuate. But the real point here is, the less the government is in debt, the more everyone else must be. Austerity measures will necessarily lead to rising levels of private debt. And this is exactly what has happened.

Now, if this seems to have very little to do with the way politicians talk about such matters, there's a simple reason: most politicians don’t actually know any of this. A recent survey showed 90 per cent of MPs don't even understand where money comes from (they think it's issued by the Royal Mint). In reality, debt is money. If no one owed anyone anything at all there would be no money and the economy would grind to a halt.

But of course debt has to be owed to someone. These charts show who owes what to whom.

The crisis in private debt

Bearing all this in mind, let's look at those diagrams again - keeping our eye particularly on the dark blue that represents household debt. In the first, 2015 version, the OBR duly noted that there was a substantial build-up of household debt in the years leading up to the crash of 2008. This is significant because it was the first time in British history that total household debts were higher than total household savings, and therefore the household sector itself was in deficit territory. (Corporations, at the same time, were raking in enormous profits.) But it also predicted this wouldn't happen again.

True, the OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

In the second diagram, two years later, the OBR is forced to acknowledge this. Corporations are just raking in the profits and sitting on them. The household sector, on the other hand, is a rolling catastrophe. Austerity has meant falling wages, less government spending on social services (or anything else), and higher de facto taxes. This puts the squeeze on household budgets and people are forced to borrow. As a result, not only are households in overall deficit for the second time in British history, the situation is actually worse than it was in the years leading up to 2008.

And remember: it was a mortgage crisis that set off the 2008 crash, which almost destroyed the world economy and plunged millions into penury. Not a crisis in public debt. A crisis in private debt.

An inquiry

In 2015, around the time the original OBR predictions came out, I wrote an essay in the Guardian predicting that austerity and budget-balancing would create a disastrous crisis in private debt. Now it's so clearly, unmistakably, happening that even the OBR cannot deny it.

I believe the time has come for there be a public investigation - a formal public inquiry, in fact - into how this could be allowed to happen. After the 2008 crash, at least the economists in Treasury and the Bank of England could plausibly claim they hadn't completely understood the relation between private debt and financial instability. Now they simply have no excuse.

What on earth is an institution called the “Office for Budget Responsibility” credulously imagining corporate borrowing binges in order to suggest the government will balance the budget to no ill effects? How responsible is that? Even the second chart is extremely odd. Up to 2017, the top and bottom of the diagram are exact mirrors of one another, as they ought to be. However, in the projected future after 2017, the section below the line is much smaller than the section above, apparently seriously understating the amount both of future government, and future private, debt. In other words, the numbers don't add up.

The OBR told the New Statesman ​that it was not aware of any errors in its 2015 forecast for corporate sector net lending, and that the forecast was based on the available data. It said the forecast for business investment has been revised down because of the uncertainty created by Brexit. 

Still, if the “Office of Budget Responsibility” was true to its name, it should be sounding off the alarm bells right about now. So far all we've got is one mention of private debt and a mild warning about the rise of personal debt from the Bank of England, which did not however connect the problem to austerity, and one fairly strong statement from a maverick columnist in the Daily Mail. Otherwise, silence. 

The only plausible explanation is that institutions like the Treasury, OBR, and to a degree as well the Bank of England can't, by definition, warn against the dangers of austerity, however alarming the situation, because they have been set up the way they have in order to justify austerity. It's important to emphasise that most professional economists have never supported Conservative policies in this regard. The policy was adopted because it was convenient to politicians; institutions were set up in order to support it; economists were hired in order to come up with arguments for austerity, rather than to judge whether it would be a good idea. At present, this situation has led us to the brink of disaster.

The last time there was a financial crash, the Queen famously asked: why was no one able to foresee this? We now have the tools. Perhaps the most important task for a public inquiry will be to finally ask: what is the real purpose of the institutions that are supposed to foresee such matters, to what degree have they been politicised, and what would it take to turn them back into institutions that can at least inform us if we're staring into the lights of an oncoming train?