Select Committee on Social Security Minutes of Evidence



  A central dilemma of modern politics is that people want high quality public services but are loath to pay increased taxation for them. National Insurance was introduced in this country almost one hundred years ago because politicians faced a near identical dilemma. The welfare state needed to be formed, but the then Liberal government thought it politically inexpedient to pay for the introduction of the welfare state by means of direct taxation. Insurance contributions were not seen by the populace as a tax. They were viewed as a proper way for individuals and families to contribute to paying their own way in the world. They were not viewed as charity.

  The Committee is faced with a paradox. There is still very widespread support for the idea of welfare insurance, yet the previous government made a whole series of attacks on the idea of individuals paying contributions directly to meet income needs in the future. The current Welfare Reform and Pensions Bill continues this attack on the insurance principle.

  Why, when a government says it wishes to extend a form of contract welfare, does it simultaneously seek to further undermine the idea of insurance? Is its game plan to replace the whole of the insurance system with tax credits? If that is so, should not this be discussed openly? The government's election manifesto committed it to more open and inclusive government.


  In giving a definition of the contributory principle it is perhaps best to consider the public's attitudes towards various ways of financing welfare.

  One of the major paradoxes of contemporary British political culture is that while we live in an age of acute resistance to increased taxation, we also live in a time of ever higher expectations of our public services. What is required to help resolve this paradox is a method of funding benefits that is both transparent and cost effective, and which is not viewed by voters as a tax.

  The contributory principle offers a solution. It does this by providing a direct link between payments and drawing benefits. For those paying for welfare, a significant advantage of the contributory principle over simple funding by taxation is the inherent transparency of making a designated contribution.

  The second of the contributory principle's main qualities is that it offers insurance based on the pooling of risks. Of course all insurance does this, but the distinctive quality of National Insurance contributions and benefits is that they are compulsory. Universal coverage means that the risk pool is as large as possible. This prevents `cherry picking' of low risk individuals by the market and consequently gives the less fortunate better value insurance than they could obtain on the market. This comprehensive aspect of National Insurance commands strong support among the public.

  Finally the contributory principle in this country is run on a Pay As You Go basis, although this is not necessarily the case, the scheme could be fully or partially funded.


  The origins of our National Insurance system predate William Beveridge. National Insurance was created at a time when British politicians were searching for the means by which to extend welfare without increasing taxes. The similarity with today's political landscape is striking.

  Faced with these competing claims, the Chancellor, Lloyd George, made a visit to Germany to look at the system established there. The trip was a turning point, because Lloyd George 'had heard enough to recognise that the so-called German invalidity insurance provided an alternative to massive Treasury commitments, and to an indiscriminate lowering of the pension age'[1]—which was the reformers' next demand.

  Given the hostility to further taxation, the demands for extending pension coverage, and the desire of Liberals to legislate in a way that helped society by enabling individuals to provide for themselves, a contributory scheme had obvious appeal. By contrast a non-contributory basis was thought likely to be ever more costly and have a detrimental effect on character.

  During World War Two, William Beveridge faced a rather different situation to that which confronted Lloyd George a generation earlier. In particular, the large numbers who were not indigent, but who were at some point in their lives likely to become so, were pressing for an inclusive scheme. In turn the scheme's comprehensiveness meant that it was bound to have a greater impact on British society than Lloyd George's innovations had.

  What Beveridge saw very clearly was that welfare impacted on character. In his view, thrift, prudence, and hard work could all be best encouraged by an insurance scheme:

    "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 objection 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' Management of one's income is an essential element of a citizen's freedom. Payment of a substantial part of the cost of benefit as a contribution irrespective of the means of the contributor is the firm basis of a claim to benefit irrespective of means."[2]


  The main developments can be summarised as follows:

    —  Most people are still only a few wage packets or salary cheques away from poverty. Those on these lower incomes are also subject to considerable income fluctuation;

    —  Recently, there has been much talk about modernising welfare to take account of the changes in family composition and labour markets. In fact, most of the changes affecting welfare in the last twenty years have been government cuts, not societal changes;

    —  A significant development during this period was the breaking of the link between the state pension and whichever of prices and average earnings had increased the most. This arrangement, only6 years old, was repealed by the Social Security Act 1980, which also linked other long-term benefits to changes in prices levels only;

    —  Perhaps the next most important changes to contributory benefits throughout the period of Conservative rule were those affecting SERPS in the 1986 and 1995 Pensions Acts;

    —  The Conservative attack on the contributory principle was thoroughgoing. Unemployment Benefit, for example, was reduced in 1980, and finally replaced by contributory JSA in 1995—a benefit with half the duration;

    —  In 1986 the qualifying age for Widows Benefit was raised; Widows Allowance was replaced by a lump sum; and the personal extension of WMA was abolished;

    —  1996-97 saw savings of £1.2bn flowing from the replacement of Sickness and Invalidity Benefit by Incapacity Benefit in April 1995.[3] Incapacity benefit, being taxable, unavailable after pension age, and featuring a stricter medical test, was vastly inferior for claimants;

    —  Throughout this whole period, changes almost invariably resulted in higher contributions and/or lower benefits.

    —  A new round of cuts is proposed in the Welfare Reform and Pensions Bill.

  A question the Committee might like to consider is whether these cuts, affecting entitlements sometimes earned over decades, are a worse abuse of contributors than any mis-selling of pensions by the private sector.


  Given the depth of these cuts into National Insurance what is astonishing is that the few analyses of public opinion on this matter still show very strong support for the contributory principle.

  Two recent sources of information commissioned by the DSS are National Insurance and the Contributory Principle[4], an in-house report by Bruce Stafford based on representative discussion groups, and Attitudes to the Welfare State and the Response to Reform[5], which attempts to analyse a number of studies in the field.

  Strong support for the contributory principle is a consistent finding. Stafford's report summed up this support, saying that there existed a:

    strong commitment to the insurance principle'. . . . Payment of National Insurance contributions did legitimate benefit claims and an individual's right to benefit.[6]

  When asked more closely what it was about the contributory principle people supported, Stafford found that:

    respondents'. . . . accepted that the system should provide for a degree of risk-pooling and redistribution among contributors.[7]


    no-one proposed that individuals' contributions should be related to the level of risk they faced.[8]

  The principle of 'something for something' strikes a chord with the public. Attitudes to the Welfare State and the Response to Reform found that use of contributions to fund means-tested benefits was unpopular. This was underpinned by a sense that people should be able to get some return for their contributions, many seeing it as a 'right'.

  Bruce Stafford's discussion groups revealed that most respondents wanted non-earners' (with the notable exception of carers) social protection separate from National Insurance. Similarly, means-testing of National Insurance benefits was met with opposition. Specific attacks on contribution funded benefits were vehemently criticised, with one person describing the Conservative Party's alterations to SERPS as:

    one of the nastiest things I've seen done to any system.[9]

  Despite this support for the contributory principle, knowledge of how National Insurance worked and what benefits it funded was patchy and frequently erroneous. Respondents were "unaware or unsure of what National Insurance contributions paid for". Some did not know the method of funding was Pay As You Go.

  Whatever the ignorance of the system, radical reform of National Insurance was opposed. Privatisation, in particular, was rejected. When this suggestion was put to them, respondents expressed concern about the likelihood of private sector failure (Maxwell was given as an example); fear of no compensation; miss-selling of insurance—even to well-informed people; expensive insurance policies; high commission fees; and failure of companies to pay in full what were perceived as legitimate claims.

  These findings present us with a paradox. The contributory principle is popular with the public, and yet as the cuts listed previously show, it has been mercilessly attacked by politicians. We can reasonably assume that public support for funding benefits through the contributory principle would be greater still if these attacks on, and minimisation of the principle's importance had not occurred. This raises the question: how politically astute it is for the present Government to continue aligning National Insurance—a Scheme which commands strong public support, with direct taxation—a source of revenue famed for it's unpopularity with the electorate?

  Might the Committee consider asking the Liaison Committee for research funds to finance a major study on what the public thinks and wants from the National Insurance scheme.



  When in opposition, the current government accepted the way that welfare system worked influenced behaviour. This was largely based on an acceptance that individuals usually act in a way that is in their, or at any rate their family's, best interests. Much of the rhetoric of this government suggests this view has not vanished. But the challenge of tailoring welfare so that it encourages good behaviour is one that has not, as yet, been met:

    —  The contributory principle was recognised by past welfare reformers, from Lloyd George and Churchill to Beveridge and Attlee, for its positive effect on behaviour. In particular the explicit link of "something in, something out" was valued for promoting responsibility. This equation would encourage workers to maximise contributions and spread the good habits of thrift and saving. The spread of these good habits would then enable workers to build their own savings on top of that funded by National Insurance. This quality of National Insurance is especially useful for those on low incomes with high marginal propensities to spend. The longitudinal redistribution of wealth smoothes otherwise erratic consumption patterns and helps prevent acute poverty;

    —  By comparison, benefits paid by direct taxation were opaque and likely to undermine individuals' desire to shift for themselves. Benefits subject to a means test were opposed on the grounds of low take-up. The position is now being revolutionised. How we persuade people to claim their entitlement has been replaced by the quest to deter predominantly younger claimants making bogus claims;

    —  Means-tests get the whole incentives question wrong. They are a reward for not trying to earn a higher income. The duty of government is to arrange public policy so that people's basic instincts work to promote the public good. While welfare always should provide a decent safety net, the main emphasis of welfare should be in encouraging people to make a success of their own lives, and not to place the greater emphasis on rewarding failure;

    —  The vastly different effects of means-tested and contribution entitlement benefits extend much further than behaviour. Between 1979 and 1995 expenditure on contributory benefits grew by 28.5 per cent, expenditure on non-contributory benefits grew by 105.1 per cent, and for means tested benefits the growth was an explosive 286.3 per cent;[10]

    —  The contributory principle also fits in with the Government's desire for a transparent and easily understood welfare contract between the state and the individual—as was set out in the Green Paper A New Contract for Welfare: New Ambitions for Our Country. For this to work, contributions have to be hypothecated, and benefits clearly defined. If this is ensured, welfare provision will have greater public support than a tax-financed scheme and will encounter less resistance to improvement and increased coverage;

    —  A less tangible quality of National Insurance is its role in forging social solidarity in an increasingly polarised society. National Insurance supports social solidarity by pooling risk across the population so that higher earners and those with good life chances contribute more than those whose prospects are less fortunate. With a fully free-market system the private sector can cherry pick low-risk individuals and spit out the rest. National Insurance reminds us that no individual can fully attribute their prosperity to their own endeavours;

    —  Perhaps the defining quality of National Insurance in this respect is that by locking people of all backgrounds and ages into a single enterprise it engages the altruistic part of human nature and teaches each generation their debt to others on the basis that they might one day need the cover. To return to Attitudes to the Welfare State and the Response to Reform, it was found that a strong connection existed in the public's mind between National Insurance, social solidarity, and rights and responsibilities.


  Against these persuasive arguments for the contributory principle must be set several significant weaknesses:

    —  Another weakness of PAYG funding is that it sometimes allows politicians to offer generous levels of benefits in the knowledge that such benefits may not have to be paid for some time. It can therefore pit political and financial expediency against each other;

    —  The fund lacks a degree of independence which makes it easy for politicians to cut entitlement to benefit despite the payment of contributions perhaps over many decades;

    —  The need to satisfy entitlement conditions also means that many who have not contributed enough to secure entitlement will not be refunded for that which they have paid. This is not a weakness of the contributory principle as such, but a weakness of its present form. An extension of partial entitlement for partial contributions needs to be looked at.

  Each of these weaknesses can be addressed. I have attempted to do just that in my books Making Welfare Work and How To Pay For The Future.


  The future of contributory principle lies in co-existence of the need to safeguard public services and an unwillingness to pay increased taxes. All of the current debate must take account these two apparently conflicting truths. The very considerable support for insurance contributions, when they are put to the use for which they were intended, signifies a potential resolution of this dilemma. As we already have a system through which the public will willingly pay for welfare we must ask ourselves why should we want to weaken it? Without National Insurance the present government would already be in acute financial crisis due to the pressure to keep taxation low.

  Instead of a clear demarcation between taxation and National Insurance, we now see a steady integration of the two. But, a shrewd politician would remember that national insurance is a much more politically viable way of raising money—to extend benefits to those who need them—than taxation, stealthy or otherwise. The Conservative governments were aware of this relative acquiescence and tapped it frequently. They did so not to help the poor, but rather to cut taxes. Nevertheless, the point remains that a steady assimilation of National Insurance with taxation will dramatically reduce the government's room for budgetary manoeuvre.

  One of the most progressive measures in the last budget was the introduction of a 10p starting rate of income tax. This not only fits the overwhelming public wish to see lower direct taxation, but judges correctly the deeper issue of motivation.

  The budget also saw the alignment of the tax and National Insurance thresholds at the level of income at which people have to start paying 10p tax. This alignment has not been justified. It must also be considered in conjunction with the Chancellor's dubbing of National Insurance contributions as 'a tax'. When looked at this way, the 10p tax rate becomes illusory. Rather the first band of 'tax' will be levied at 20p—10p of tax proper and 10p of National Insurance. So why, one must ask, is a clearly known contribution continually referred to as a tax by one of the main proponents of low taxation?

  Several measures announced in the recent Welfare Reform and Pensions Bill have dealt another blow to the government's commitment to a contractual form of welfare based on the contributory principle. Incapacity Benefit is to be tapered off for pensioners receiving more than £50 per week; the eligibility criterion for Incapacity Benefit is to be changed from a years credit, over a working life, to a year's contributions in one of the last two years; and the widow's pension for older women is to be abolished.

  This government's original Green Paper on welfare reform, New Ambitions for our Country: A New Contract for Welfare, was published in March 1998. As the title suggests this Green Paper promised to centre welfare reforms around the principle of the contract. This approach was adopted for many of the good reasons that can be adduced in favour of the contributory principle. Strong support for the principles underpinning this document was a 'key finding' of the Department of Social Security's Attitudes to the Welfare State and the Response to Reform. The entire cabinet approved the text of the Green Paper too, part of which read:

    The development of the contract will lead to greater trust—with a clearer contract, people can have greater confidence that they will get proper protection in return for the contributions they make.[11]

  New Ambitions For Our Country: A New Contract for Welfare also extolled the virtues of greater transparency and simplicity of welfare. Placing the contributory principle at the heart of welfare is a highly effective way of doing so. It must be admitted that almost everyone finds the welfare state perplexing. Attitudes to the Welfare State and the Response to Reform found that the complexity of the system was deeply confusing, and that simplification was sorely wanted. A clear and regular statement of contributions to date, entitlement conditions, and available benefits would make National Insurance more accountable, strengthen the link between paying and receiving, and help keep the scheme at arms-length from an all too often rapacious state.


  The word modernisation is much overused and abused. National Insurance does need adjustments, but the surprise is how well it still serves the needs of claimants. Instead of an all-embracing notion of modernisation, the focus of reform should specifically address the following five areas:

1.  Changes in the labour market

  With the growth of part-time work and other irregular work patterns consideration needs to be given to partial entitlement based on partial contributions. Consideration also needs to be given to finding a way to bring in those who fall below the Lower Earnings Limit (LEL). Many of these people are those who need the benefits of National Insurance the most. Furthermore, the numbers in these groups have grown, effectively making National Insurance more elitist. While it may not be possible to secure full entitlement for this group, partial entitlement based on some record of contributions is possible and desirable.

2.  Meeting new needs

  New needs have arisen that need to be brought within the scheme, and are indeed ideally suited to be covered by a form of National Insurance. One such need is long-term care. I have set out how this might be met by a form of National Insurance in How To Pay For The Future.

3.  Making a clear division between need and insurance

  There is a need to distinguish between the kind of coverage which insurance gives to individuals and families, on which they are able to build their own efforts, and the meeting of need primarily through a means-tested form of welfare. In setting the rates of benefit to cover need, governments have to take account of how rising national income affects what most people regard as a minimum. Setting insurance rates raises different issues. Here the views of the contributors should play a part in the determination of benefits. Yet no such survey has ever been undertaken. Hence the suggestion to the Committee to begin this exercise.

4.  Greater transparency

  The Select Committee's own recommendation in the previous Parliament of issuing annual statements on all National Insurance contributions would help to achieve the Green Paper's objective of making welfare payments more transparent, as well as increasing the contributor's feeling that the scheme is genuinely theirs. This leads to the final proposal.

5.  Increasing the contributors' ownership of the insurance scheme

  After the experience of SERPS few would disagree that some way of securing entitlement has to be found. A way of returning the contributory principle to the arms length from the state at which Lloyd George thought it should be would help safeguard the welfare of future generations. Given the vast number of changes typically occurring between contribution and claim for national insurance funded benefits, it will be hard to make this guarantee absolute. It will require a non-governmental National Insurance Corporation. The suggestion is that a non-governmental National Insurance Corporation should be established. A brief outline of such a scheme is given in How To Pay For The Future and Making Welfare Work.

October 1999

1  E P Hennock, 'British Social Reform and German Precedents' in The Emergence of the Welfare State in Britain and Germany, ed. M J Mommsen, Croom Helm, 1981, p.68. Back
2  W Beveridge, Social Insurance and Allied Services, HMSO, 1942, p.11. Back
3  House of Commons Library, Statistical Section. Back
4  B Stafford, National Insurance and Contributory Principle, Department of Social Security, Social Research Branch, in-house report 39, August 1998. Back
5  T Williams, M Hill and R Davies, Attitudes to the Welfare State and the Response to Reform, Department of Social Security, Research Report No.88. Back
6  B Stafford, National Insurance and Contributory Principle, Department of Social Security, Social Research Branch, in-house report 39, August 1998, section 2.4. Back
7  Ibid., section 2.3. Back
8  Ibid., section 2,3. Back
9  B Stafford, National Insurance and Contributory Principle, Department of Social Security, Social Research Branch, in-house report 39, August 1998, section 3.6. Back
10  House of Commons Library, Statistical Section. Back
11  Cm 3805, paragraph 11.6. Back

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