IPSE response to IFS report on sole traders

Last month’s (Wednesday 10 July) report by the IFS on the self-employed painted a gloomy picture of a sector otherwise known for its innovation and £275bn contribution to the economy. While the research sheds some interesting light on sole traders, IPSE take issue with a few of these conclusions and the policy recommendations drawn from them.

Using tax records provided by HMRC, the report tracked the life-cycle and incomes of business owners between 2007-8 and 2015-16. The findings appear stark. One in five businesses set up by sole traders close within a year, six in ten fail by their fifth year; average incomes are low and have been falling; and hiring and capital investment is low. These factors, in the words of the report’s author, “should lead us to question why we are incentivising people to quit employment and start their own business”.

First, the causes of people exiting self-employment are varied and not only down to business ‘failure’. The report itself shows that only 7% of sole traders recorded a loss in 2015-16 – not only is this lower than the 2007-8 figure but a loss can also simply reflect the initial start-up investment costs for new businesses. A sole trader’s business can close for several reasons, including retirement or the natural, successful conclusion of a project. Freelance work, as new research from the CRSE has shown, is typically project-based, with people working on multiple projects outside traditional employment and using different forms of self-employment. This may explain some of the ‘churn’ in the entry and exit figures, particularly the growth in sole traders with profits lower than £2000. It is also simply the nature of a competitive economy that some start-ups will not survive. But we should be supporting those willing to take a risk and not be so alarmist to suggest they should be in traditional employment instead.

On sole traders’ incomes, there are also grounds to be sceptical. The report states that turnover is lagging behind a pre-crisis peak. However, the data used only runs until 2016, at which time aggregate profit rates were on a steady rise, reflecting how the economy has improved following the recession. This trend is similar to what has happened with average wages, which as the IFS have shown elsewhere also hadn’t returned to pre-crisis levels even by 2018. Singling out self-employed income without reference to the wider labour market can make it seem as if this is a uniquely underperforming sector. Tracking self-employed income in an accurate way is notoriously tricky. As the ONS has discussed, there are multiple challenges around timing and irregular income when it comes to understanding the flexible world of freelancers.

Lastly, the report notes that most sole traders are not employing anyone else or investing in their businesses, with less than a quarter making any use of deductions for capital investment. This does not consider, firstly, that there are multiple barriers to expanding a small business and there is little incentive for many to do so at present. These range from the cost and compliance implications of crossing the £85,000 ‘VAT threshold’ to the myriad tax and employment obligations of taking on additional staff.

But the bigger problem with the IFS’ view is that it fundamentally misunderstands why people are entering self-employment, which is not to expand and take on more staff or spend money on the infrastructure required to build the next Amazon or Google. Instead, most simply want to control their own work, with flexibility, freedom, and a better work-life balance. Using hiring and investment measures as a barometer of the health of self-employment is unhelpful.

Beyond the methodology and findings of the report, our biggest concerns are the policy conclusions. Having highlighted the financial fragility of many sole traders, it is frustrating that the report raises again the issue of differential tax treatment between freelancers and traditional employees. People are not moving into self-employment because they are incentivised by a tax cut or expect to vastly increase their incomes. As IPSE’s Freelancer Confidence Index shows, the rise in self-employment is happening in spite of, not because of, the current policy environment.

The IFS report, looking at the self-employed purely through a financial lens, suggests that we should not be encouraging people to have a go at working for themselves, but remain in traditional employment instead. We disagree. As CIPD research has found, job satisfaction among the self-employed is 81%, much higher than the 61% among full time employees. Singling out the self-employed for more tax is far too narrow an approach to the many challenges facing sole traders and the economy in general - and massively overlooks their wider economic and social contribution to the UK.

Meet the author

Alasdair Hutchison

Policy Development Manager