Memorandum submitted by the Low Pay Unit (CP 19)
1. THE PRESENT SYSTEM
The current structure of the National Insurance system and its role in giving access to welfare benefits, as the Low Pay Unit has long argued, is regressive and distortionary. It disadvantages the low paid, especially women. This paper outlines the problems with the current system and offers options for reform, aimed at creating a more inclusive system which can deliver income security for today's flexible labour market.
Under the current system national contributions are only paid on earnings of between £66 (Lower Earnings Limit) and £500 (Upper Earnings Limit) a week paid at a rate of 10 per cent.
If earnings are too low and no contributions are made, or the contribution record is interrupted, the employee will not qualify for a range of benefits related to sickness, maternity, unemployment and old age.
The threshold system also has an effect on working hours, causing substantial incentive problems in terms of hours of work and rate of pay, especially for those at the lower end of the income distribution.[21]
Until April this year, when the "entry fee" was abolished, if someone earning just under the limit was offered an extra hour's work, they could have been worse off financially as they had to pay 2 per cent on all earnings under the limit. For the employer, the disincentives had been even greater, as their contributions were made at 3 per cent, 5 per cent, 7 per cent and 10 per cent with no upper limit.
The effect on the labour market is demonstrated by the concentration of employees on pay below the LEL, suggesting an incentive for the lower paid to work fewer hours than they might in other circumstances.[22] The incentive for an employer to keep wages below the contribution level has led to practices such as paying the portion of the employee's wages above the LEL in alternative forms such as vouchers.
Recent budgets have made significant changes to the NI system which have gone some way towards alleviating this problem. The Chancellor simplified the employer contribution removing some of the complexity and distortionary elements. However the failure to deal with the UEL means the system remains inequitable and regressive.
From April this year the LEL threshold for employers and employees has been abolished and converted into an allowance, so no contributions are now paid on earnings below £66. On top of this employers no longer have to pay contributions for employees earning less than present tax allowance (£83 per week), and earnings above that are taxed at a single rate of 12.2 per cent.
Despite these changes, the National Insurance system has failed to adapt to the dynamics of the modern labour market and especially the entry of women into the labour force.
There are currently 2.45 million workers earning below the Lower Earnings Limit and therefore not accruing entitlement to benefits. Developments in the labour market mean this figure is likely to remain, if no increase. The number holding more than one job has grown steadily in the UK since 1985. It was around 50 per cent higher by 1996–97. This is related to the increase in part-time working. In 1985, 636,000 employees had a second job, by 1996–97 this had risen to 1.05 million, accounting for 4 per cent of all male employees and 6 per cent of all female employees. While the combined income may be over the LEL, no contributions will be made if earnings from any individual job do not exceed that level.
There are also increasing numbers of short hours jobs in the economy. Between 1993 and 1996, two-thirds of the 707,000 net increase in jobs were part-time, while only 13 per cent were full-time, permanent jobs. There are currently 2.5 million employees who usually work less than 16 hours a week in their main job—accounting for around 43 per cent of all part-timers (11 per cent of the total workforce). A large proportion of them will be low paid and will not earn enough to pay NI contribution. The introduction of a minimum wage at £3.60 will not bring many of them over the LEL.
Four out of five of those earning under the LEL are women, 95 per cent of whom are part-time workers, the majority over 25 and with young children.[23]
The effect of the system means:
— around 37,000 workers do not receive Statutory Sick Pay.[24]
— 50,000 fail the test for maternity pay.[25]
— low paid workers also fail to qualify for short term social security benefits such as JSA, Incapacity Benefit and Maternity Allowance, due to a combination of low annual weekly earnings.
Access to pensions is a particularly serious problem for low paid women, with major consequences for social exclusion and poverty in old age.
— Only 33 per cent of part-time workers have access to occupational pension schemes, which means they are likely to rely entirely on state provision in retirement.
But access to even the basic state pension is restricted by the LEL.
— Over one million pensioners are currently claiming income support as they do not qualify for a full basic pension in their own right[26], and a further million are not claiming the top up benefit they are eligible for. Over 40 per cent of women earning below the LEL are not receiving Home Responsibilities Protection.[27]
The rate of poverty in retirement is increasing for certain groups. Since 1988 the proportion of males aged 65–69 on Income Support has risen from 3.1 per cent to 4.2 per cent and the proportion of single females aged 60–69 from 6.9 per cent to 7.5 per cent.
The need to maintain a National Insurance benefit system
Despite the problems outlined above, it is important that a non-means tested, work-related, social security system is maintained.
People who fall out of the system have to rely on means-tested benefits such as Income Support in times of sickness or maternity. However, as most of those excluded are women with children, they may not get any earnings replacement at all due to the household basis of assessment. In effect, their independent work history is valueless.
There is often no alternative to the state social insurance system for these low paid employees as many have no access to occupational schemes. Around three-quarters of full-time employees have access to company pension schemes compared to less than half of part-timers. Almost all full timers (97 per cent) get occupational sick pay compared to two-thirds of part-timers. Access is worse for those working under 20 hours per week.[28]
When the system was first established, women`s low earnings were seen as "pin money" supplementing the main, male, wage. Today these earnings, below the LEL, are vital to maintain family income. Women with earnings below the LEL live in households where total income is well below average. Nearly a quarter live in households with an annual income of less than £12,000. They also have to rely on this low income for a long period, as research shows only a minority move into better paid work.[29]
2. REFORMING THE SYSTEM
The key aim of any reform of the system must be to remove disadvantage and discrimination and give access to those with low pay or interrupted contributions records to non-means tested income replacement benefits, whether provided by the state or the employer. It would be regressive and inequitable to require the low paid to pay tax on this income and it would contradict moves in the last budget to integrate tax and National Insurance. The answer must be to credit the low paid into the NI system.
Extending Voluntary Contributions
A mechanism exists for voluntary contributions to safeguard entitlement to retirement pensions. But these contributions (Class 3 NICs) currently cost £6.25 per week; this is not a realistic option for people on low pay and it would not be appropriate to extend the system to other NI benefits.
Inclusion of the low paid
The concept of including those on low or no income in the National Insurance system is not a new one. There is already a system of credits for the basic retirement pension when people are not earning ie during periods of unemployment, when bringing up children or caring for a disabled person, or when they are working but receiving Family Credit. The concept has been partially extended to the low paid in recent Budgets via "zero-rating".
— From April 1999, employers make no contributions on employees' earnings below £83, but employees do not loose entitlement to benefit.
— From April 2000 the LEL for employees will rise to £76 a week, but those earning between the present LEL and the income tax threshold (£85 a week) will have these earnings "0-rated" for NI purposes ie, they will be credited with a payment.
— Women with babies due on or after August 2000 who earn over £30 per week but less than the LEL will have access to Maternity Allowance.
— From April 2001 the LEL will increase to £87, aligning with the tax threshold.
The main issues to be addressed, when one considers a zero-rating system:
— the role of contributions in determining the level of benefits;
— their role in demonstrating attachment to the labour market; and
— whether any pay threshold should be maintained.
1. Level of benefits
Given the flat rate payments that now characterise the social security system, apart from SERPs, there is presently no relationship between earnings and benefit levels. Thus a contribution each week is not necessary to determine the level of benefit entitlement.
If the low paid are credited into the NI system and entitled to the same level of benefit as other workers, it could produce a situation where they get more on benefits than they earned (ie, they are over-compensated for income loss). SSP, for example, is currently £57.50 per week but many on low pay earn less than this.
We therefore propose that the low paid receive benefits equal to their lost income, up to the amount of the flat rate. (The current flat rate needs to be reviewed).
2. Attachment to work
Contributions do have an important function as an indicator of attachment to work. This is necessary as it shows reliance in the earned income and avoids payment to occasional workers in the same way.
We suggest that a combination of NI credits and length of recent service requirement as already exists could overcome this problem. Any length of service requirement, however, must be set carefully to avoid discriminating against women. Length of service requirements for short-term benefits crrently range from three to six months continuous employment.
It is worth noting that in some countries attachment to work is measured by an hours threshold (Germany is five hours per month). The EC directive on equal treatment for part-time workers' allows member states to set such hours thresholds for entitlement. We would warn that this could lead to discrimination.
Debate has already begun about the nature of the attachment to work test with respect to new entitlement to Maternity Allowance and the "zero-rated" band of pay between the existing and future LEL for employees, as the DSS will have no earnings records for those paid below the LEL. Whatever method is chosen, it must complement the existing system. The onus must be on the employer to provide earnings information and for the DSS to monitor entitlement. A system which placed the burden of proof of earnings and employemnt exclusively on the shoulders of the low paid would be inequitable and would present a major barrier to access to benefits.
Currently the only proof an employee may have of pay and employment is their pay statement. Most employees have a statutory right to an itemised pay statement. But our experience is that for many low paid this obligation is widely ignored by employers, especially when no deductions have to be made. In a recent survey of low paid workers contacting the Unit's Employment Rights Advice Line, 20 per cent did not receive pay statements, all of whom earned under the current LEL.
We have also found that when pay slips are given, they may consist of only a few hand written figures on the envelope. Will such documents be considered enough proof of employment and earnings?
The employment/earnings test must therefore fit in with the information on employees earnings that employers have to provide. This will minimise administration and will be compatible with current DSS monitoring systems helping to prevent disruption.
SMP and SSP
We agree with Equal Opportunities Commission in its assessment of SMP and SSP.[30] These "benefits" are paid by employers and are based on the employment relationship. They are counted as pay for contractual reasons and should be treated separately to social security benefits. We suggest there is no reason for maintaining the link with the NI earnings test, and that continuity of service with the same employer is all that should be required for both the higher and lower rates.
3. BUILDING AN INCLUSIVE AND FLEXIBLE SYSTEM
Changes to the labour market and increasing numbers of people on low pay have produced damaging discrimination in the NI system and disadvantage in the labour market. A modernised NI system with extended "zero-rating" would overcome some of these problems through accommodating flexible work.
Counting multiple jobs
To replace earnings adequately, income from all jobs must be counted, as in the tax system. Otherwise, a person could earn £20 for each of three jobs, totalling £60 a week, but in case of sickness may receive only £20 to replace their main earnings. It would also mean that where total earnings from various jobs take employees over the LEL, they would make NI contributions.
Accommodating fluctuations in income
Presently, fluctuating pay may lead to NI deductions one week and none the next if earnings fall below the LEL. Contributions, however, do not count for benefit purposes if continuity is broken. Crediting in would mean that continuity could be maintained.
The cost of inclusion
the cost of extending benefit entitlement to the low paid has been estimated at £25 million for SMP, around £120 million for SSP, £25 million for the extension of Maternity Allowance (on all earnings), £20 million for Incapacity Benefit, and £28 million for JSA.[31] These figures, however, are overestimates as they assume that everyone will be entitled to the flat rate benefit, and not a proportion of it.
We believe that the exchequer has numerous options for funding this extra cost:
— The estimated increase in NI contributions resulting from the introduction of the minimum wage at the level recommended by the Low Pay Commission is £350 million per annum
— The Upper Earnings Limit could be raised to the higher level of tax threshold. This would raise £1.8 billion. Abolition of the ceiling would raise £4.2 billion.
Extending the credit system creates a more flexible NI system, one which will provide security for all workers, especially the low paid and women, and help them to combine work and family life.
The proposal for three months' unpaid parental leave, as outlined in the Employment Relations Bill, for example, if taken under the present system, would break continuity of contributions for entitlement purposes. We would suggest that this is another case where credits would be helpful.
Similarly, the government wishes to encourage lifelong learning and the continuous updating of skills to promote employability. There is currently little in-work provision for low paid and part-time workers, and continuity of contributions is lost if people leave work to undertake training. A flexible credit system could be used to ensure that they do not lose out.
In essence, we need to "rebase" the NI system not just for the sake of those who currently lose out ie women and low earners—but also to promote the kind of labour market we want in the future. Thus the new system must be training friendly, part-time work friendly, multiple-job friendly and family friendly.
May 1999
21 Dilnott and Webb, Reforming NI contributions, Fiscal Studies, Vol 9, No 4, IFS, November 1988 Back
22 ibid Back
23 LFS Spring, 1997 Back
24 TUC, Low Paid and Excluded, March 1998 Back
25 Women and Social Security, Department for Social Secuirty, 1998 Back
26 Hansard, 8 June 1998 col. 468 Back
27 McKnight, Elias and Wilson, Low Pay and the National Insurance System, EOC, 1998 Back
28 TUC, The New Divide: Part-time workers pay in the 90s, 1995 Back
29 McKnight et al, op cit Back
30 Equal Opportunities Commission, Evidence to the Education and Employment Committee, Second Report on Part-time Work, Vol 2, 1999 Back
31 TUC, Low Paid and Excluded, March 1998 Back
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