Select Committee on Social Security Minutes of Evidence



RATES AND BANDS OF EMPLOYERS' NATIONAL INSURANCE CONTRIBUTIONS 1997–78

Weekly Earnings Employers contribution rates

Less than £62 No NICs due
£62  £109.99 3 per cent of total earnings
£110  £154.99 5 per cent of total earnings
£155  £209.99 7 per cent of total earnings
Over £210 10 per cent of total earnings

  100.  This system provided an incentive for employers to hold wages below each of the payment thresholds. This sort of structure was described by the Institute of Fiscal Studies as having "a substantial distorting impact on the labour market . . . (I)n addition to work disincentive problems, such a system encourages employees and employers to collude in avoiding NICs." (Dilnot and Webb, 1988, 8–9.)

  101.  Reforms, such as the introduction of the 2 per cent contribution for employees (where previously the full standard rate for employees became due on all earnings once the threshold was breached), helped to lessen this distorting effect. But, as a Department of Employment Research Report concluded in 1995, "Owing to the existence of a contributions floor . . . there is an incentive for employers to recruit low-paid part-time staff for less than 16 or 8 hours a week." (Marullo, 1995, 31.)

  102.  For these reasons Martin Taylor, Chief Executive of Barclays Bank who headed the Government's tax and benefits review, identified the structure of NICs as a barrier to employment—creating an incentive to hold wages down. The stepped structure of employers' NICs encourages firms to take on part-timers earning less than the LEL. As described by Mr Taylor, "This is a powerful incentive not to create jobs at or above this earnings level."

  103.  Martin Taylor's proposals for the reform of employer NICs to reduce the "NI trap" have been implemented from this year: raising the threshold for employer NICs to £83, and exempting all earnings below that threshold. To pay for this, a uniform employer NIC of 12.2 per cent was introduced on earnings above the threshold (for non-contracted-out employment). This, he argued, would reduce the incentive to hold wages just below the LEL or below each step in employer NICs. The TUC has welcomed this reform, but we are aware that it will not abolish the trap: because earnings below the threshold are exempt from NICs, there will continue to be some incentive to hold wages below that level in order to keep workers "off the books." Retaining a threshold may continue to encourage employment below the LEL.

  104.  Another way of eliminating the employers' NI trap would be to extend employer NICs to all employees—including those earning below the LEL. This would help to reduce avoidance and encourage proper record-keeping. It would also be desirable to have a uniform employer NIC—set at between 8–9 per cent—as part of this, making employer NICs a simple, payroll tax.

The zero rate

  105.  In this year's budget the Chancellor announced "a better deal for work" and he continued to develop his strategy of helping the poorest people move from welfare to work, by cutting the amount deducted from low-paid workers' salaries in tax and National Insurance Contributions. Workers with earnings above the current National Insurance threshold but below the threshold for income tax will continue to build up eligibility for National Insurance benefits, but they won't have any National Insurance Contributions deducted from their pay. Instead, they will be covered by a "zero rate band" of Contributions. This will be done in two stages:

    —  In April 2000 the threshold will rise from £66 per week to £76.

    —  In April 2001 it will rise again, to £87, in line with employers' NICs and income tax.

  106.  More than 400,000 low-paid workers with earnings above the LEL and below the new threshold will gain from this measure in 2000–01, rising to nearly a million in 2001–02: 8


Year All employees (thousands)

2000–01 430
2001–02 960

  (Hansard, 1999).

  107.  These workers will no longer have to pay NI Contributions at all, but will still be entitled to National Insurance benefits. On top of this, the zero rate band will mean that every employee paying Contributions at the non-contracted out rate (most low-paid workers are not contracted out) will gain up to £1.00 per week from April 2000, and another £1.10 per week from April 2001. For low-paid workers, this is the equivalent of an annual pay increase of up to 2 per cent.

  108.  The TUC is obviously pleased that low-paid workers' incomes will be increased. If this was all the Government was doing, however, we would have been very worried about the exclusion from NI entitlement of 960,000 more workers. It is therefore a great relief that the Government has taken this concern into account with the introduction of the "zero rate band".

  109.  The zero rate band has the potential for being extended downwards, thus reducing the number of low-paid workers excluded from the National Insurance system. Continued `fiscal drag' resulting from simply maintaining the current up-rating policy 9 will have this effect in any case. It would be even better to freeze the lower edge of the zero rate band in cash terms and thus allow inflation gradually to raise the number and proportion of workers entitled to National Insurance benefits, Statutory Sick Pay and Statutory Maternity Pay.

VII.  THE UPPER EARNINGS LIMIT

  110.  One of the weaknesses of the Beveridge report was the fundamental insistence on flat rate Contributions matched by flat rate benefits. In principle, the concern with promoting cohesion (everyone paid the same amount when in work, and would receive them same out of work) was admirable, but this feature of the report had an inherent flaw.

  111.  When the Government drafted the legislation implementing the report (the 1948 Act) it was found that a level of benefit which met subsistence needs would require a flat-rate Contribution far too high for low-paid workers to afford. As the provision of subsistence-level benefits had also come up against what Beveridge called "the problem of rent" 10 it was easier to abandon Beveridge's assumption that NI benefits would be set at a level to stop most recipients having to supplement them with National Assistance than to abandon the flat rate principle. Most people, the Government hoped, would be able to fill the gap with savings and/or private insurance.

  112.  This turned out to be unrealistic. By 1952, 856,000 pensioners were already having to claim assistance as well as the contributory pension, (DSS, 1998f, para 26) and the situation steadily deteriorated thereafter, despite the value of pensions being raised by a quarter in 1958. The first step away from the flat-rate principle came in 1961, with the introduction of graduated Contributions and graduated pensions, and earnings-related supplements to other benefits in 1966. In 1975, the Social Security Act introduced Contributions which, between a Lower and Upper Limit were levied as a proportion of earnings. In 1985 the upper limit was abolished for employers' Contributions. Finally, from April 2000, the zero rate band of Contributions will come into effect.

  113.  This leaves the Upper Earnings Limit on employees' NICs as the only remaining element of Beveridge's flat-rate scheme. This anomaly makes NICs far more regressive than income tax. Not only are NIC rates not progressively raised as income rises, for workers with earnings above the UEL, the proportion of their income paid as Contributions falls if their earnings rise.

  114.  In the coming decades, the UEL will be redrawn by fiscal drag unless major changes are made. As with benefits, the level of the Upper and Lower Limits has been linked to prices since 1980. This has meant that the proportion of average earnings represented by these Limits has fallen. As a result, some 2.1 million more high earners avoid NICs on the top slice of their earnings, compared with 1980. (Hansard, 1997e) The net result, including the effect on contribution rebates, has been a loss of £100 million in NI revenues. (Hansard, 1997f) While the UEL is currently 125.5 per cent of average earnings, by 2035 it will have fallen to just 59.1 per cent of the average. (Hansard, 1997g) 11

  115.  This would be a ludicrous situation. While there may be political obstacles to changes, equity and the health of the NI Fund demand fundamental reform. The levying of Contributions on all earnings over the threshold is long overdue.

VIII.  THE FUTURE OF THE CONTRIBUTORY PRINCIPLE

  116.  Social Insurance and the contributory principle have important advantages when contrasted with the alternatives, so it is no surprise that social insurance systems have been established throughout the world, even in countries with otherwise undeveloped welfare states. A recent guide to benefit systems reported on contributory social insurance systems in Argentina, Austria, Belgium, Bermuda, Brazil, Canada, Costa Rica, Cyprus, Czech Republic, Ecuador, Egypt, Finland, France, Germany, Greece, Guatemala, Guernsey, Hungary, Ireland, Israel, Italy, Japan, Jersey, Luxembourg, Mexico, Netherlands, Norway, Pakistan, Panama, Peru, Philippines, Poland, Portugal, Russia, Slovakia, South Korea, Spain, Sweden, Switzerland, Taiwan, Turkey, USA, Venezuela and Zimbabwe. (Mercer, 1998)

  117.  A strengthened National Insurance system would bolster the Government's emphasis on work, and reduce the scope and impact of the poverty trap.

  118.  On the other hand, the contributory principle faces important challenges. The exclusion of large groups of workers—including some who are most likely to need the support of the benefit system—undermines its validity. The complexity of the contributory principle makes it remote from the day-to-day concerns of anyone without a specialist knowledge of the system, reducing the level of public support.

  119.  The zero rate band of NICs could be a first step towards extending coverage to millions of excluded workers. Lowering or freezing it, or (at the very least) raising its lower boundary in line with prices, not earnings, will gradually extend coverage in a controllable way.

  120.  The re-introduction of partial benefit rights in return for partial Contribution records would also extend coverage to temporary and seasonal workers. Until comparatively recently, these workers could claim benefits worth a quarter, half or three quarters of the full rate, depending on their level of Contributions. A return to this provision would be comparatively inexpensive.

  121.  These measures would extend membership of National Insurance, making more people aware of it. It is also possible to simplify the complicated system of "contribution years", "earnings factors" and different types of Contribution credit. A simpler system would make it possible for the Inland Revenue, in taking over the Contributions Agency, to produce an annual statement for each worker of their current and prospective rights to the different benefits. Private insurers are required to provide this information and it is unfair that the state has exempted itself from this obligation.

  122.  More radical reforms are also possible—indeed, necessary. In the past National Insurance could be static: there was a clear distinction between workers paying Contributions and those without work, receiving benefits. Social security provided insurance against the loss of wages, and aimed to cover contingencies such as unemployment, sickness and retirement.

  123.  The characteristic of the next century will be change. Time away from work for training or family responsibilities will be more common, and the growth of atypical work will not be reversed. Periods without a wage will not be infrequent contingencies, and most people's working lives will include several transitions between traditional employment, atypical employment, training and education, family responsibilities, incapacity, sickness and unemployment. National Insurance should therefore focus on transitions, not contingencies. In particular, the system should seek to smooth transitions out of unemployment, into training and education and between typical employment, atypical employment and family responsibilities.

  124.  This suggests an agenda which is wider than the reform of the contributory principle, and the Government is right to adopt a holistic approach to welfare reform: active labour market policies, housing support, income tax and employment rights all need to be reformed at the same time as National Insurance.

OTHER ISSUES

NICs and performers

  125.  The Department of Social Security and Inland Revenue have for some time sought to implement the "common approach"—an alignment of the tax and NI systems, using a single definition of employment and self-employment, and applying the same criteria to both NI and income tax. Anyone classed as employed for NI purposes would be employed for income tax, and anyone classed as self-employed for tax would be classed as self-employed for NI.

  126.  The objectives of the common approach are admirable—to avoid inconsistency and reduce burdens on business. The common approach's advantages, are however, outweighed by the problems it creates when applied to the performing arts. Performers have traditionally been treated as self-employed for income tax purposes, but as employees for NI, and there are good reasons for this. The arts are unusual in being typified by short determinate contracts, low levels of pay, high levels of unemployment and a high level of professional expenses.

  127.  Treating performers as self-employed for tax purposes enables them to offset professional expenses (such as agents' fees, photographs and publicity, musical instruments) against tax. This can be justified by the prevalence of low pay in these professions, and the fact that these are expenses which employees would normally expect to see paid by their employers.

  128.  Treating performers as employees for NI purposes allows them to build up entitlement to NI benefits, especially Jobseeker's Allowance: vitally important, given the high levels of unemployment.

NICs and non-cash vouchers

  129.  In 1998 the Government introduced regulations making non-cash vouchers (such as luncheon vouchers) liable for National Insurance Contributions. The TUC opposed this decision. Our first concern was that this reform would increase the dispersion of net earnings. Whilst the net income of lower paid workers when they have to pay NICs on any vouchers they receive, employees with earnings above the Upper Earnings Limit remain unaffected, as they already pay the maximum.

  130.  We were also concerned that luncheon vouchers are often provided following negotiations between unions and employers. These negotiations took place on the basis of there being no NIC liability, and these regulations could therefore have an impact on future negotiations. Workers whose employers provide canteens face no increased liability, but those who receive luncheon vouchers will. Sometimes these will be employees of the same company: where, for instance, an organisation has a canteen at its main site(s), but provides vouchers for those working elsewhere. This different treatment will not promote good morale or industrial relations.

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