Select Committee on Social Security Minutes of Evidence



Memorandum submitted the Centre for Policy Studies (CP23)

SUMMARY

  Sir William Beveridge used the phrase "the contributory principle" to mean the general idea that benefits should only be received in returns for contributions. Contributory benefits therefore differ from means-tested benefits (for those below a certain income or wealth) and universal benefits (for those with specific needs). "The contributory principle" has held the same meaning throughout the following 50 years.

  Beveridge intended that the vast majority of social security payments should be paid through contributory benefits. But contributory benefits have become a less and less important part of the social security system over the last 50 years, to the point that less than half of all benefit expenditure is spent on contributory benefits. In particular, governments have been unwilling to pay contributory benefits at a level that would pay for a person's subsistence, forcing increasing numbers of people to rely on means-tested benefits.

  The contributory principle is no longer respected by government. Governments have tightened the conditions of contributory benefits even though people have already made contributions towards them. Current policy is to extend the coverage of and expenditure on means-tested benefits.

  The contributory principle does not have a future. It is therefore essential to look at alternatives, in particular how to reduce the numbers of those dependent on benefits.

  The Centre for Policy Studies has published a pamphlet entitled The War of Independence which sets out another model of welfare delivery, based on radical integration of tax and benefits.

  It makes three main recommendations: to integrate the government departments that deal with transfers, in effect integrating taxes and benefits; to reduce the role of government in transferring income between individuals; and to exchange the current mass of complex allowances for a lower tax burden. The outcome of these reforms should be to free £5 billion for investment in public services, to take nearly 12 million people out of tax, and to reduce dependence on benefits.

What is Meant By the Contributory Principle

  1.  The phrase "the contributory principle" was used by Sir William Beveridge in his report, Social Insurance and Allied Services. He used it to mean the general idea that benefits should only be received in return for contributions. He therefore contrasted "contributory benefits" with means-tested benefits for which one would be eligible on the grounds of financial want rather than a record of contributions. He described his Plan for Social Security as:

    "First and foremost a plan of insurance—of giving in return for contributions benefits up to subsistence levels, as of right and without means test, so that individuals may build freely upon it."[17]

  2.  Beveridge thought that the "contributory principle" was not only correct in itself but suited the preference of British people to make financial provision for their own welfare rather than depend on means-tested benefits. Contributory benefits should therefore provide enough income in times of hardship that citizens would not have to claim additional means-tested help:

    "The first view is that benefit in return for contributions, rather than free allowances from the State, is what the people of Britain desire. This desire is shown both by the established popularity of compulsory insurance, and by the phenomenal growth of voluntary insurance against sickness, against death and for endowment, and most recently for hospital treatment. It is shown in another way by the strength of popular objections to any kind of means test. This objection springs not so much from a desire to get everything for nothing as from resentment at a provision which appears to penalise what people have come to regard as the duty and pleasure of thrift, of putting pennies away for a rainy day. Management of one's income is an essential part of a citizen's freedom."[18]

    "Social insurance should aim at guaranteeing the minimum income needed for subsistence."[19]

  3.  For Beveridge, if benefits were to be conditional on contributions, it followed that the government should keep national insurance contributions in a special fund from which the monies to pay benefits would be taken:

    "All the principal cash payments—for unemployment, disability and retirement will continue so long as the need lasts, without means test, and will be paid from a Social Insurance Fund built up from contributions from the insured persons, from their employers, if any, and from the state."[20]

  4.  Beveridge was at pains to emphasise the difference between money raised for social security through contributions and money raised through general taxation. In his contributory scheme, all people paid the same contributions to qualify for the same rate of benefit. He contrasted this with a tax-funded scheme in which richer people would pay more and in which the need for a record of contributions did not apply.

    "The scheme of social insurance which forms the centre of the Plan for Social Security is based on maintenance of the contributory principle, that is to say, of the principle that a material part of the total cost of maintaining income under the plan shall be met from monies contributed by citizens as insured persons, on the basis of each individual paying the same contribution for the same rate of benefit. Contribution means that in their capacity as possible recipients of benefit the poorer man and the richer man are treated alike. Taxation means that the richer man, because of his capacity to pay, pays more for the general purposes of the community."[21]

  5.  In the following half century, "the contributory principle" has continued to be used in the same sense, that benefits should only be received in return for contributions.[22] In particular, the growth in expenditure on means-tested benefits is often described as a "dilution of the contributory principle".

The Role of Contributory Benefits in the Social Security System: Origins and Developments since Beveridge

  6.  Commentators and historians of both left and right have come to the same conclusions regarding the role of contributory benefits in Sir William Beveridge's proposals in Social Insurance and Allied Services and the subsequent social security legislation over the next half century[23].

  7.  Commentators are agreed that Beveridge intended the contributory principle to be the defining principle of the social security system. All working citizens, their employers and the state would pay contributions into a fund. Those citizens would then be able to draw contributions in times of hardship. Contributions would be set at a low level so that all working citizens could afford them; benefits would be set at a low level so that citizens would still have the incentive to take out private insurance against hardship. However benefits would cover subsistence so that means-tested benefits would only be necessary in unusual cases.

  8.  Beveridge was willing to accept the political difficulties associated with his insistence on the contributory principle. For example, by the logic of his thinking, pensioners retiring in the years soon after the Second World War would not have made sufficient contributions in order to qualify for a full state pension. Beveridge therefore thought that they should receive a lower pension, depending on the number of contributions which they had made. The full value pension would not be available until 20 years after contributions had started.

    "Moreover for one of the main purposes of social insurance—pensions for old age or retirement—the contributory principle implies contributions for a substantial number of years; in the introduction of adequate contributory pensions there must be a period of transition during which those who have not qualified for pensions by contribution but are in need have their needs met by assistance pensions."[24]

  9.  Beveridge's ambition foundered however on three main grounds: the political need to introduce full value benefits for retirement immediately, even for those who had not built up a record of contributions; the fact that many people, in particular disabled people, found it impossible to build up a record of contributions; and the cost of paying contributory benefits at subsistence level.

  10.  Despite Beveridge's argument, the post-War Government found it impossible to introduce retirement pensions at less than the full rate, even for those who had made very few contributions. In a sense, therefore, the contributory principle was never actually applied in the social security system at all, since from the start people were able to claim benefits to which they had not contributed in full. By the end of the 1950s, the Government had recognised that National Insurance Contributions would be increased in line with the needs of current rather than future expenditure; in other words, that the National Insurance Fund would pay for current needs rather than be a receptacle of contributions which would pay for future benefits, as Beveridge intended.

  11.  Only some people have been able to work consistently in such a way that they build up a record of contributions sufficient to claim contributory benefits. Others—in particular disabled people—could not. Even those with inadequate incomes and unmet needs could be, in effect, excluded from the contributory system. This had led politicians to introduce benefits which do not require a record of contributions for groups with specific needs. For example, Attendance Allowance was introduced in 1971 for those requiring considerable care and attention by day or night, and Mobility Allowance in 1976 for those unable or virtually unable to walk. Invalid Care Allowance was introduced in 1976 for those single people caring for someone in receipt of Attendance Allowance.

  12.  Beveridge had intended that contributory benefits should be sufficiently high to cover the needs of subsistence, so that means-tested assistance would only be needed in exceptional circumstances. In fact Beveridge thought that the main means-tested benefit, National Assistance, "will diminish continuously, as the rate of contributory pensions rises and fresh classes of contributors qualify for pensions."[25] However, the post-War Government fought shy of the cost of introducing contributory benefits at such a high level. In 1954, the Government accepted the recommendation of the Phillips Committee that it should abandon any long-term aim of raising retirement pensions to a subsistence level on the grounds that it would present an unduly heavy burden on the Exchequer.[26] This had the result that far more people than expected became eligible for means-tested assistance to top up their income. In 1948 there were one million people dependent on national assistance; by 1966, when national assistance was replaced by supplementary benefit, around two million; by 1978, three million; and by 1983, 4.3 million.

  13.  It has not therefore been possible for governments to operate the social security system on the contributory principle over the last fifty years. In fact, the actions of government itself has weakened the contributory principle, in particular by reducing the value of contributory benefits even though people had already made contributions to qualify for the benefits under the previous higher value. For example, the Government decided in 1980 to increase the retirement pension in line with prices rather than earnings, in order to control costs. Another example would be the tightened eligibility for contributory unemployment benefit when the Jobseeker's Allowance was introduced in 1996 in order to encourage more people off welfare and into work. This has given rise to concern on the part of supporters of the contributory principle:

    "No one now believes that the current National Insurance scheme is theirs, and that the future benefits they are currently paying for are safe. Taking unemployment benefit alone, while contributors have been asked to pay more, the earnings-related supplement to unemployment benefit has been abolished, the eligibility rules have been severely tightened, and, with the Jobseeker's Allowance, the 12 month duration of benefit halved." (Stakeholder Welfare, Frank Field, IEA, 1996, p21).

  14.  The result of these factors and decisions has been that contributory benefits have become a less important part of the social security system. Social security benefits are divided into three kinds: those requiring a record of contributions (contributory or insurance benefits), those depending on income (means-tested benefits) and those available to people in particular circumstances (non-contributory, non means-tested or universal benefits). Table 1 shows the expenditure in real terms on the different kinds of benefit in the social security system since 1973–74. Graph 1 shows that expenditure on contributory benefits by 1995–96 made up less than half of total benefit expenditure, compared to nearly two-thirds in 1973–74. The difference has been made up by increased expenditure on means-tested benefits. This made up a third of total benefit expenditure in 1995–96, compared to a sixth in 1973–74.

Table 1

EXPENDITURE ON SOCIAL SECURITY BENEFITS IN £bn, AT 1995–96 PRICES, 1973–74 TO 1995–96, GREAT BRITAIN

Year 1973–74 1975–76 1977–78 1979–80 1981–82 1983–84 1985–86 1987–88 1989–90 1991–92 1993–94 1995–96

Contributory benefits 25.1 28.9 31.2 31.1 33.8 35.4 36.2 37.8 36.1 39.2 41.2 40.6
Non-contributory,
non means-tested
benefits
8.0 8.2 7.7 9.3 9.1 10.0 10.5 10.8 10.1 12.1 14.8 16.2
Means tested benefits* 6.2 6.0 6.8 6.7 10.0 14.2 16.6 16.6 15.6 20.1 26.5 28.5

  *  Not including Income Support Mortgage Interest.

  Source: The State of Welfare, Oxford, 1998




Current Developments Affecting the Future of the Contributory Principle

  15.  Current Government policy is continuing to weaken the contributory principle.

  16.  The social security measures outlined in the March 1999 Budget—to introduce a means-tested Children's Tax Credit from April 2001, to consider integrating the Children's Tax Credit with other means-tested benefits for children, and to increase the value of the Working Families Tax Credit—increase the number of people eligible for and the expenditure on means-tested benefits. In this sense these measures can be seen to weaken the contributory principle.

  17.  The Government is raising the threshold for paying National Insurance Contributions from £64 a week now to £76 a week in April 2000 and £87 in April 2001, to align it with the single person's tax threshold. So as not to affect the employees' eligibility for contributory benefits, the Government will introduce a zero-rate band for NICs for those earning between the lower earnings limit and the new threshold for NICs. This means that employees will be able to qualify for contributory benefits without actually having made any contributions at all, which is a clear deviation from the contributory principle.

Does the Contributory Principle Have a Future? Are There Other Models of Welfare Delivery, for Example Better Integration of Tax and Benefits, Which Better Reflect Today's Social Realities?

  18.  The Centre for Policy Studies has recently published The War of Independence, by Maurice Saatchi, partner at M&C Saatchi, and Peter Warburton, economic adviser to Robert Fleming. One of the assumptions behind the report is that, following its erosion over the last 50 years, it is no longer meaningful to support the contributory principle for the social security system; ie the contributory principle does not have a future. Once it is recognised that National Insurance Contributions are no longer treated by the Treasury differently to taxes, one of the main objections to the integration of taxes and benefits is removed.

  19.  The report proposes a radical integration of taxes and benefits as part of a programme of reform which seeks to reduce people's involvement with the state. The report puts forward three proposals for consideration:

    —  end the overlap between taxes and benefits. First, the massive overlap between tax and benefit payments needs examination. Under the present system, the government collects between £30 billion and £40 billion in Income Tax and National Insurance contributions from around 17 million households with incomes below £20,000 a year, of whom seven million earn less than £10,000 a year. Yet the government also distributes £30 billion to £40 billion in benefits to the same people. Cancellation of this overlap reduces the tax burden from 37 per cent to 33 per cent of national income;

    —  exchange allowances for lower tax rates. There are over 250 tax allowances, reliefs and exemptions which taxpayers can claim. Not surprisingly, this complex web has created a wide disparity between the gross and the net tax system. Currently, the government can raise in tax 53 per cent of national income (£434 billion) but a third of this, £134 billion (16 per cent of GDP), can be claimed back by companies and individuals through tax allowances and reliefs. This leaves the government with net proceeds of around £300 billion. This mass of complex allowances, preferences, credits, tax breaks, indexations and marginal adjustments should be exchanged for a more open, transparent system of lower tax rates; and

    —  merge government departments. Following the above two modernisations, the Inland Revenue, the Department of Social Security, the Benefits Agency, and the Contributions Agency would be merged. This merger would result in a 20 per cent to 30 per cent saving in administration costs, through the elimination of duplicated tax and benefit assessments, and a more efficient benefit payments system. All of this £5 billion saving could be used to boost investment in health and education.

  20.  The results of such a new system could be that nearly 12 million people stop paying Income Tax: about 8.6 million working people with annual incomes below £15,000, and most of the 3.4 million taxpayers aged 65 and over.

  21.  The report also sets an agenda for reform, requiring further consideration in a detailed research exercise. This has three elements:

    —  a reduction of the role of government in transferring incomes between individuals;

    —  exchanging the current mass of complex allowances for a lower tax burden; and

    —  integration of the government departments that deal with transfers.

  22.  These three changes, all detailed below, offer the scope to reduce the UK tax burden from over 37 per cent of GDP to around 33 per cent. They will invigorate the economy, restore work incentives to those on low incomes and improve the underlying pace of economic growth.

  23.  In addition to a dramatic increase in personal independence, these bold measures would release resources to finance an increase in spending on health and education.

A reduction in the role of government in transferring incomes between individuals

  24.  This fundamental reform of the tax and benefit system would enable cash payments from the government to be exchanged for protection from Income Tax payments to the government, thus reversing the trend of the past 30 years. A substantial restoration of the real value of the personal Income Tax threshold would be funded by the matched withdrawal of benefits currently paid to working households. Millions of benefit and pension supplements (or top-ups) would become redundant. In addition, occupational pensioners could elect to receive all or part of their state pension as a tax credit.

  25.  In the tax year 1998–99, there were 26.1 million individual taxpayers (the largest ever total). Back in 1958–59, there were only about 21 million. The main reason for this growth was that married couples with children received much larger tax allowances, lifting millions of them out of the tax system. The break-even point—defined as the value of earnings at which Income Tax paid is equal to the money received via a tax allowance or child benefit – was equal to more than 80 per cent of average earnings (for all occupations) in 1960 as compared to 47.7 per cent in 1997–98.

  26.  A single person earning 50 per cent of the average for all adults in full-time employment currently loses 13.2 per cent of their income in tax. A married man claiming the married couple's allowance loses 10.7 per cent of his income. These proportions rise only to 18.1 per cent for a single person and 16.8 per cent for a married man on average earnings and to 20.9 per cent and 20.1 per cent, respectively, at the level of 150 per cent of average earnings.

  27.  14.2 million individual taxpayers had total annual incomes of less than £10,000 in 1998–99, with total gross tax liabilities of £14.3 billion. With the introduction of tax credits, these liabilities are already being reduced to £12.6 billion.

  28.  A wholesale reform to raise the initial tax threshold—encompassing national insurance contributions as well as Income Tax—would not only bring a drastic reduction in the number of taxpayers, it would also eliminate millions of small payments by various government agencies to individuals.

  29.  A radical reform of the tax and benefit system, so that the total starting income threshold for Income Tax and National Insurance payments was raised to about £15,000 per annum, would result in a loss of tax and National Insurance revenue of between £30 billion and £40 billion under the present system. In principle, it should be possible to cancel out an equivalent value of cash payments of benefits and pensions, without withdrawing support from individuals and families who are genuinely dependent. In the first instance, this reform would be strictly revenue-neutral, entailing a parallel reduction in cash-paid benefits and Income Tax receipts. However, in time it should be expected to improve the efficiency of the economy and to raise the underlying pace of GDP growth.

  30.  By implication, most working individuals with annual incomes below approximately £15,000 would simply cease to be taxpayers. Hardly any Income Tax payers aged over 65 would remain. Social security benefits would continue to be paid to able-bodied people who are out of work but seeking employment. For those working part-time or in low paid jobs, the range of income over which social security benefits are phased out would no longer overlap with the threshold for payment of Income Tax. By separating the ranges of benefit withdrawal and Income Tax payment, the problem of very high marginal deduction rates would be greatly diminished. People would typically receive benefits or pensions, or pay Income Tax; but seldom both at the same time.

Exchanging the current mass of complex allowances for a lower tax burden

  31.  Under the present system, the government has the capacity to levy gross tax charges on companies and individuals amounting to a staggering 53 per cent of GDP. Taxpayers are obliged to navigate a web of allowances, reliefs, and exemptions in order to claim back 16 per cent of national income, bringing the net tax take to 37 per cent of GDP. Apart from the expense and intrusion of such an arrangement, this system allows too much scope for "hidden" tax increases whereby the impact of "tax increases" is diluted by being presented as alterations to allowances. Thus, GDP continues to creep up imperceptibly.

  32.  A detailed study of an alternative, simplified system is needed, in which the web of allowances is simply exchanged for lower tax, by raising the starting threshold for Income Tax. The result would be a dramatically more transparent and open system, comprehensible to all.

Integration of the government departments that deal with transfers

  33.  A number of other advantages would flow from this radical rearrangement of the tax and benefits system. The administration of personal Income Tax by the Inland Revenue would be merged with the Department of Social Security and the Benefits and Contributions Agencies, allowing a comprehensive pooling of tax, contribution, benefit and pension data. The recurring costs of administering the system would fall dramatically due to the simplification of tax allowances and the elimination of duplicated tax assessments and benefit payments. The combined caseload of these offices could be reduced by 20 per cent to 30 per cent, perhaps more.

  34.  The integration of tax, National Insurance, benefit and pension records would also improve the detection of benefit fraud. A deliberate structural break in the administration of benefit payments would purge the longstanding abuses of the system. For example, by re-registering the National Insurance numbers of all adults, redundant numbers could be deleted from the system and any payments to them discontinued. This could yield far greater savings than costly and socially divisive snooping initiatives. A further reduction in the cost of fraudulent claims could be achieved by introducing "smart" National Insurance cards to replace benefit order books and electronic transfers to replace giro cheques. Social Security Secretary Alastair Darling highlighted the importance of cutting down the "manipulation and forging" of order books and giro cheques in a speech on 1 December 1998. Today's payments security technology is more than capable of rising to this challenge.

  35.  The annual savings from this reorganisation and rationalisation of the tax and payments system, coupled with a sharp reduction in benefit fraud, could release £5 billion of extra funding for health and education. However, there would also be dynamic gains from such a thorough overhaul of the system. Not least, the higher starting threshold for Income Tax should be expected to restore earnings incentives and promote employment and GDP growth.

14 May 1999


17  Social Insurance and Allied Services, 1942, paragraph 10. Back

18  ibid, paragraph 21. Back

19  ibid, paragraph 27. Back

20  ibid, paragraph 20. Back

21  ibid, paragraph 273. Back

22  For a recent example, Beveridge or Brown, Sheila Lawlor, Politeia, 1998. Back

23  For example Reform of Social Security, Cmnd. 9519, 1985, vol. 3; The State of Welfare – the Economics of Social Spending, ed. H Glennerster and J Hills, Oxford, 1998; Beveridge or Brown, Sheila Lawlor, Politeia, 1998; The Five Giants, Nicholas Timmins, Fontana, 1996. Back

24  Social Insurance and Allied Services, paragraph 73. Back

25  ibid, paragraph 267. Back

26  The State of Welfare, p120. Back

 
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