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The Conservative government has reversed a controversial proposal to raise tax contributions on self-employed workers just a week after it was announced in the annual Budget.

In a letter to MPs, chancellor Philip Hammond said there would be no hike to national insurance contributions for the self employed in the Class 4 band “in this parliament”. It was announced only last week at Mr Hammond’s first spring Budget, with the U-turn estimated to cost the government £500m a year.

“We will continue with the abolition of Class 2 NICs from April 2018. The cost of the changes I am announcing today will be funded by measures to be announced in the Autumn Budget”, said the Chancellor.

The measure was announced after the government said an increase in self-employment since the financial crisis was hurting the government’s coffers through reduced tax revenues. In their 2015 manifesto however, the Conservative party had vowed never to raise the tax burden on the self-employed, with the shift provoking a fierce backlash over the last seven days.

The plans would have involved raising national insurance contributions on some classes of the self-employed from 9 per cent to 11 per cent by 2019 with the hikes kicking in next April.

An estimated 15 per cent of the UK workforce – just under 5m people – are self-employed. The Treasury calculates the differential tax treatment will cost the government £5.1bn in the year to April 2017.

In the wake of the swift U-turn, Mr Hammond said the government would now explore other ways to address the gap in entitlements for employed and self-employed workers through looking at discrepancies in parental benefits.

The Chancellor added the government still fully backed the idea of equalising tax treatments between the two classes of workers. In the Budget, Mr Hammond described the tax system as “unfair”.

The letter added:

Ahead of the Autumn Statement last year, the Prime Minister and I decided that, however difficult the fiscal challenges we face, the tax-lock and spending ring-fence commitments we have made in this Parliament should be honoured in full.

It is very important both to me and to the Prime Minister that we are compliant not just with the letter, but also the spirit of the commitments that were made.

Prime Minister Theresa May said the government would now await a review on workers’ rights from Matthew Taylor at the RSA before “bringing forward further proposals” on tax reform.

“But we will not bring forward increases to NICs”, said Mrs May during Prime Minister’s Questions.

Latest figures from the Office for National Statistics show the UK’s unemployment rate has dropped to the joint lowest level in 42 years at just 4.7 per cent at the start of the year – driven largely by rises in self-employment.

Responding to the government’s embarrassment, Labour leader Jeremy Corbyn said the the Budget had “unraveled” in seven days, accusing the government of being in “chaos”.

Angus Robertson, a Scottish National Party MP said: The PM has admitted she is for turning with her screeching, embarrassing U-turn on national insurance”.

Mr Hammond will explain his decision to MPs later this afternoon.

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