Why Uber-isation Makes Us All Poorer

I wrote a couple of years back about the way that the UK tax system disadvantages working people at the expense of the wealthy. A systemic tilting of the playing field that occurs in most developed economies, not just the UK.

One of the things that I noted was that, because employees and employers both have to pay National Insurance as well as income tax, workers are double taxed compared to assets. No one has yet tried to levy National Insurance on the profits of a property deal.

This distortion of the tax system has an important consequence, which I think explains in part the trend towards self employment in large parts of the economy. An employee will pay more tax, and hence have less take home pay, than a self employed person who takes individual “contracts” from an agency for the same work.

All other things being equal, that means that over time, people will realise that they can earn more take home pay if they work for themselves, and will do just that. A process called Uberisation in the press at the moment, though in truth it is a trend that has been going on for the better part of two decades.

But there is a prisoner’s dilemma here - the worker who chooses self employment will only be better off IF all other workers remain in full time employment. If everyone in a particular profession chooses to become self employed, then supply will increase and, as sure as eggs are eggs, the prices that companies will pay for the “contracts” will decline. It is an example of the prisoner’s dilemma in action. Let me explain.

The Old Economy Model - Employment Contracts

The standard labour relation for much of the twentieth century was based on employment contracts, which provided for a mix of pay, benefits and rights for the employee in exchange for work. Take Driver A and Driver B, both employed as taxi drivers and earning ￡200/week. They pay income tax and national insurance on their earnings, resulting in a net wage of ￡160/week. It looks something like this:

National insurance contributions were originally conceived as a way of funding state benefits for the worker. You pay ￡xxx in national insurance, and in exchange the state provides ￡yyy of unemployment benefit, sickness benefit, a state pension and various other safety nets.

However, over time National Insurance contributions have become disconnected from the state benefits that they fund. These days, National Insurance acts simply as a complicated form of income tax, applied to both employers and employees.

The Gig Economy - Everyone’s an Entrepreneur

In the twentieth century a new model of business has emerged - the Gig economy. Individuals working for themselves taking on contracts to provide services, usually in the form of their own labour.

Its this type of business that Uber has established. Uber realised that it doesn’t really need to employ taxi drivers, it can act as an “agent” to connect drivers with people needing a ride. It earns its money by taking a commission from the fare paid.

Driver A signs up for Uber, and discovers that since he is now self employed, then whilst he still earns ￡200/week, he now pays lower national insurance and takes home a bit more - ￡170/week. Now the world looks like this: 

Driver A feels pretty happy with his new lot. He's taking home more than he was before, and at the low-middle income levels that most taxi drivers earn it makes a big difference to his life. Of course, you could argue that Driver A is effectively trading in his employment rights for a bit more take home pay, so everything’s fair enough isn’t it?  

Well, it would be, except for the fact that Driver B is no fool. Once he hears that Driver B is taking more money home (there’s lots of chat between taxi drivers), he decides that he wants in on the action too. 

Pretty soon both Driver A and Driver B are self employed, and feeling pretty happy with themselves as a result. There are press reports about the fantastic increase in self employment and people congratulate themselves about how dynamic the economy is. 

Its a Jungle Out There

But then Uber realises that it doesn’t really need to pay so much to its taxi drivers any more, since there are so many self employed drivers out there. So, it starts driving the price for each job down. After all, each of these self employed drivers are now in competition with each other, where they used to be colleagues. (this is exactly what Uber did in 2015, by the way, increasing its commission on rides from 20% to 25% of the taxi fare)

Driver A and B discover that, over time, their rates start to get cut back further and further until, lo and behold, they are no longer earning ￡170/week, they are back to ￡160/week. Only now they don't have any employment rights, since they are working for themselves now.

This is an example of the prisoners dilemma in action. Both Driver A and B would be better off in the long term if they rejected models like Uber and stuck together. You and I would pay higher taxi fares, of course, but the drivers would be better off. In practice, individual self interest will push them both to become self employed, and for a while those that do so will feel better off. However, at the end of this process, both drivers are taking home the same amount of money that they were in the first place.

Only now, neither of them have any employment rights to speak of, and in fact their take home pay may get squeezed even more as they are in competition with each other, not bargaining collectively.

But What Do I Care?

You might think that this is just the way things are in a competitive market. What does it matter to me as long as my ride is a bit cheaper? Market forces will simply adjust supply and demand for drivers to the point where a balance exists. Except….

The combined enterprise (Uber plus its cadre of drivers) is now paying less tax, a lot less tax, than they would have done under the old model. The amount will vary depending on the profile of the workforce, but it will be at least 16.6% of total payroll/worker costs (That's 12.8% Class 1B NICs from Uber plus the difference between class 1A and class 2/4 NI rates for the driver). That's a massive difference in service businesses, where labour is often the largest element of cost.

Who pays that extra 16.6%?

You do.

Whether self employed or employed, drivers still accrue the most valuable benefit of all - a right to a state pension and a range of other benefits, even though their contributions through self employment don’t remotely cover the costs. The difference has to come from an increased tax burden on other parts of the economy.

This odd tax loophole - that National Insurance utterly distorts the employment and services market in favour of self employment - overwhelms everything else in the system. It creates incentives for companies like Uber to create elaborate systems to avoid employing drivers; and creates incentives for drivers to go along with those systems. It operates at low, middle and high income brackets and across industries. It is one of the driving reasons for this graph (source: ONS Self Employment 2001-15).

Now I’m not suggesting that government should adopt a harder line on National Insurance, or act to try to close this loophole. They’ve been trying, and failing, to do that for the whole of the 21st century. Its like watching Canute trying to hold back the tide.

Instead, I’m advocating that it be eliminated entirely.

If income tax and NI were merged, then the labour market would function far more effectively.

• People wanting the security of employment would weigh up the benefits of an employment contract (security of tenure, collective bargaining rights, notice periods, sick pay etc) against the benefits of self employment (flexibility, ability to set your own rates, variety of opportunity) without the distorting effect of national insurance.
• Employers would make decisions about whether to create full time jobs or use freelance resources on the basis of their relative costs and merits, not on the basis of tax planning.
• It also has the beneficial effect of removing the tax incentive on investors to favour buying assets to hiring people; since income would be taxed on the same basis regardless of source. Something that I modelled in a bit of detail here.

The current system also has the effect of reducing overall labour productivity. Hiring decisions are informed by the total cost of different options: how much does it cost to create a full time job vs. hiring a freelance or self employed worker for a short period to do the same work? The tax system distorts these decisions, meaning that even if a company would be more productive if it created a full time job, it is more likely to use temporary or contract resource instead.

Something to think about next time you catch a cab to your meeting? I hope so...!

Thanks for reading. I use LinkedIn to write about management issues, particularly on topics related to public sector business. Please click “follow” if you would like to hear more from me. Feel free to connect via Twitter or LinkedIn or to see more insights at www.newburyconsulting.com/insights/.

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