Select Committee on Social Security Minutes of Evidence

Examination of witness (Questions 247 - 259)




  247. Ladies and gentlemen, can I open the public session of evidence this morning? The Committee is undertaking an inquiry into the contributory principle. We are very fortunate in having with us this morning Professor Richard Disney, who is a research Fellow of the Institute for Fiscal Studies and also a professor of economics at the University of Nottingham, a well known author on the subject who has been thinking about this for some time. We are more than half-way through the inquiry but it was suggested to us that IFS and you in particular have a particular perspective on some of these important issues. I wonder if you would mind saying what your perspective is at the moment and then we will go into some questions that I would like to try and get through.
  (Professor Disney) I would like to make one or two introductory comments but I will avoid being long winded and academic and try to be very quick. There are one or two points that focus us, in my view. We can think of what is the contributory principle in a broad and in a narrow sense. In the broad sense, we can think of the contributory principle as a generalised test or threshold that entitles you to receive a benefit, perhaps past work history. Other tests could be possible like nationality or residency rather than a contribution history. For example, in the original post-war Beveridge scheme, sickness and disability benefits were only available to those with a history of membership of the national insurance scheme and non-contributory benefits for sickness and disability only came in later. That is what I call a very broad or rather loose test of the contributory principle. I think there is a much tighter one and there is a narrow sense. When I talk to colleagues and academics from Europe, they are quite surprised that we regard the British system as a contributory system at all because the narrower focus is to say that, if you like, the marginal benefit you get should be related to your marginal contribution. In other words, if I put one pound more into the system—I am particularly thinking of pensions here—I should expect to get a discounted value of one pound more future pension as a result of that. That is a much more narrow focus because it says that the actual amount you put in determines how much you get out. It is quite interesting that some countries such as Italy and Sweden have been moving in recent years to making a so-called actuarially fair basis, much strengthening that basis of their contributory pension system; whereas of course we have moved away from that. There is one other obvious point I want to make which we all know about. I have read some of the evidence of this Committee. It is worth reiterating that although we have a contributory principle, however tenuous, there is no sense in which contributions are accumulating in a fund except in a book-keeping sense. Unlike, say, a personal pension or a stakeholder pension where contributions are accumulated and the fund, it is hoped, earns a rate of return and the amortised value of that fund is the pension, in national insurance the money that goes in goes straight out to current beneficiaries on a pay as you go basis. One of the problems facing many European countries has been that, for demographic reasons and other household compositional reasons, the number of beneficiaries has risen and the number of potential contributors has contracted. Reading some of the evidence, there are a couple of small points. A lot of people are discussing whether research shows that people think the contributory system is more popular than other kinds of provision of social security. One reason is that many people do think there is a pot of money somewhere in the system with their name on it. That is why it is a more popular system. Other reasons include the fact that many people think, according to a previous DSS survey, that the national insurance contribution pays for the National Health Service. Another thing which I also therefore think is very important and which has not been discussed at all in some of the evidence is the inter-generational incidence. If the money that is going in is going out to pay current beneficiaries, then there is not just a question of equity within generations and smoothing over the life cycle; there is also the question of whether some generations of contributors and beneficiaries do better than some later generations of contributors and beneficiaries. Much of the evidence is that the earlier generations scoop the pot and the later generations do not do so well. Of course, as the Institute for Fiscal Studies document has suggested, the contributory principle has been steadily eroded. It has been made looser and the link between benefits and contributions has largely evaporated. What other criteria could we think about? One is obviously a contingency related benefit. Intrinsically, a national insurance type system is also a contingency related system because entitlement depends on a contingency as well as having the requisite contributions. The other basis for a social security or transfer system is having an income related system. What the IFS submission and many others have suggested is that in many areas of provision we have a somewhat arbitrary mixture of income related, contingency related and contribution based provision. We cannot see one underlying principle covering all this. My last point is should we restore or improve or enhance the contributory principle here. What does the restoration of the contributory principle mean? It could mean tightening the threshold for receiving benefits, tightening up that broad basis and making it much clearer that you have to have a certain history in order to be entitled to benefits. That would probably put more people into the means tested sector which, for other reasons, we might find contentious. Alternatively, we could move towards a much closer link between marginal benefits and marginal contributions which is what I understand the contributory principle to be. I think that is encapsulated in the refrain that I am sure has been mentioned many times of, "I have paid my contributions; therefore, I am entitled to my benefits." As plenty of studies have testified, there is very little link between contributions and benefits in the system. Government changes provisions, often retrospectively, and often to increase the marginal returns and contributions. It has not always been one way traffic; it has tended to be in the 1980s and 1990s that benefits have been cut back so that people are saying, "I paid my contribution. How come I do not receive such high benefits now?" In the 1970s particularly, we had the opposite. People put in contributions and were actually getting bigger benefits, in a sense, because of subsequent policy changes—for example, early retirees getting a much greater than actuarially fair pension, periods of non contribution like home responsibility protection being introduced, and over favourable treatment of labour market entrants. All these things were senses in which we paid more out than the individual put in. The deviations from the contributory principle work both ways. In summary, I think there are many principles that could underlie provision of social security. The contributory principle I think has more than one interpretation. Most of our benefits contain the application of several principles and there is certainly a case for considering what principles should guide social security as a whole, rather than piecemeal applications of certain criteria, in some fields of the welfare reform and application of other criteria in other parts of the field. Whether the contributory principle should be the over-arching criterion remains, in my view, and in general the view of the Institute for Fiscal Studies—though I add we have no corporate view on anything—unproven.

  248. We have been talking to people, distinguished commentators like Frank Field, for example. His perception is that people value greatly the contributory element and the fact that they are able to feel part of the great benefit system. Your evidence seems to be saying that it is not as easy as that and the public out there are very confused. Indeed, younger generations know next to nothing about what the national insurance system is supposed to do. I know the DSS have done the Bruce Stafford study in August 1998. I think that is the most recent that I know of, but are you aware of any recent studies about exactly what people really believe, either qualitatively or quantitatively, they are getting for their money when they pay their national insurance contributions?
  (Professor Disney) There is some current work going on between the Institute for Fiscal Studies and the Department of Psychology at University College London, using focus groups to look at what people think they should do particularly for retirement and particularly how they see the state system working versus private provision. At the risk of generalising half-read conclusions, since I am not involved in that study, I think one of the issues that comes out is young people, certainly in terms of pensions, do not really expect to get a great deal out of the public system. Therefore, particularly younger women interestingly, are very concerned, rather more than younger men. It is slightly macho not to worry about having a pension if you are a young man but if you are a young woman there seems to be a good deal of concern about what is going to be delivered by the system, how things like divorce and so on would work, what sort of private arrangements would have to be made to get a reasonable pension at retirement. If you like, that sort of evidence suggests a high degree of confusion, from some of the existing evidence among established contributors to the system, who perceive they are getting something entirely different from what they are getting; and perhaps younger people deeply sceptical as to whether they are going to get anything out of the system at all and therefore thinking that they have to make some kind of private arrangement.

  249. How do you perceive the government's approach? The government seem to be saying that they are modernising the system and yet there is a huge focus and yesterday we saw some of the government's plans to move even more in a tax credit direction. Do you think that moving in a tax credit direction is inimical to the long term development future of a national insurance contributory system?
  (Professor Disney) There are two questions in there. One is: what is the government doing in my view and the second is: whether tax credit and insurance are related. I think government policy is certainly moving away from a strict application of the contributory principle in the sense I used. For example, a proposal to replace SERPS, which is probably the only residual bit of the system where, in some sense, benefits and contributions are related. That is going to be replaced by a second state pension. Much greater emphasis on in-work benefit and tax credits is a way of getting people in and out of the labour market and now of course the proposed reforms to incapacity benefit. Yes, I think you could say that the government is moving more towards a welfare system that they think is designed to encourage incentives to work. We might want to discuss in a minute the relation between income tested and contributory benefits and how that interacts with that. Therefore, in answer to your second question, if you went the whole hog, the tax credit has so far been fairly limited to working families but if you thought about extending the tax credit system intrinsically you would be moving to an income related type of provision. If we generalise that across all kinds of contingencies and then in that case it would be hard to see that you could have a national insurance contributory system, because basically entitlements would then be contingent on income and your labour market state, rather than your contribution.

Mr Dismore

  250. Can we look at the contrast or relationship between contributory benefits and means tested benefits? There is a blurring between the two. One of the arguments that was put to us, for example, by Frank Field last week is that means-testing can reduce financial incentives to work and contributory benefits, through earning and contributing, strengthen that relationship. Do you think that is an analysis that you would agree with or do you think that we need to look much more at the contributory principle in that light?
  (Professor Disney) It is an analysis I would agree with except I think it bears little relation to our current national insurance system. It is true that if we had a system where benefits were linked to contributions there would be stronger incentives to save. There might or might not be stronger incentives to work, but we do not really have a system in which there is any relationship between your contributions and what you are going to get out of the system. Therefore, I find it hard to believe that that has any effect on incentives one way or the other. The whole area where incentives are important is the issue of benefits to people in work, which traditionally have lain outside the national insurance system because the old Beveridge principle was if you were at work you had sufficient income and there was no need for money from the government. We have gradually moved away from that towards a tax credit system. Therefore, the kind of contribution principle there is irrelevant because all these incentives about how to get people into work and whether you should offer a certain level of working family tax credit deal with an aspect where there is not a contributory principle operating anyway, namely in-work benefits. You can have disincentive effects without income testing. The simplest disincentive effect is if I am unemployed and I get a large benefit from the government, which is no longer the case, but say it was, and then I move to work, then I would lose all that benefit. That is a disincentive and it is a disincentive driven by contingency rather than by income testing. This is definitely something IFS would emphasise. It is a danger to confuse the axis income testing versus contributory benefits with the axis disincentive to work versus to save or work. Contributory systems can have big disincentives in them. You could design income tested systems which had lesser disincentives in them. I am not sure; I think that conflates two issues at once.

  251. You mentioned JSA and you have commented on JSA in your paper. Is it not the position where with a contributory JSA system you could have a couple where one is working and one is claiming and, because it is a personal benefit, not a family means tested benefit, therefore the benefit is kept for the partner who is not working and the other one still has an incentive to work?
  (Professor Disney) That is true and there has been some evidence that if you purely income tested unemployment benefit that would affect the spouse's working behaviour. JSA is not very large. It is circumscribed by a large number of requirements vis a vis seeking work and so on. Many of the unemployed are receiving income tested benefits anyway. That is true. The principle there is applied but how important JSA is in the whole scheme of unemployment benefits is problematic.

  252. Can I ask you about the point that Frank Field was also making to us about the willingness of people to make self-provision and that means-testing effectively undermines people's willingness or incentive to save for their old age or whatever?
  (Professor Disney) Means-testing does discourage you from saving. The only qualification I put to that is that the people most affected by means-testing would probably not have saved much anyway. Most of the saving for retirement that goes on goes on by people who in general would not qualify for means tested benefits anyway. It is certainly true that if you means test you will reduce saving. If I was investing in a stakeholder pension or something and I knew that the money I put in would ultimately increase my pension, that would have a bigger effect on my saving. You always make that comparison, I agree, but when you look at national insurance my point is it is neither one thing nor the other. It is not clear to me that by putting more money into national insurance I deliver that much in the end. That is the sense in which it is not a self-saving system in the way that you could think of a pension system being.

  253. What about take-up of contributory benefits? It is higher.
  (Professor Disney) Absolutely. Take-up is partly stigma, choice, things we worry about. Take-up is also partly a question of how much benefit you are entitled to by taking up. One of the reasons that take-up—I am not saying the only reason—was low was that for many people, say, the difference between the basic state pension and income support was 50p. As the minimum income guarantee gets indexed to earnings, assuming that will continue, and the basic pension gets indexed to prices, in a sense the incentive to take-up gets that much larger, at least from the point of view of an economist. I do not know about the world out there but the take-up rates ought to increase because the attraction of taking up is going to increase.

Mr Leigh

  254. You are saying that the contributory principle, as far as retirement pensions are concerned, if not dead, is the living dead. Are you saying that we should just recognise that or what?
  (Professor Disney) Yes, I would say it is pretty much dead. Forget the living bit, personally speaking.

  255. We should just recognise that and admit it to people, really?
  (Professor Disney) I think we should admit to people that there is not a little pot of money with their name on it unless they have invested in some kind of stakeholder pension or personal pension and therefore it is not entitling them to anything.

  256. It is a kind of benefit or present you get when you become 65?
  (Professor Disney) It is a device for raising money because people do not like paying taxes. They think that if they pay contributions somehow they have a greater entitlement than if they paid income tax. The question we have to ask is: you can make the argument, "I have paid contributions all my life. I ought to get more pension." Why not make the same argument: "I have paid income tax all my life. Why do I not get a pension I deserve?" To me, they are almost identical statements and it is only because people are persuaded either that they are financing their own benefits, or perhaps indeed that the national insurance contribution is paying for other things like the National Health Service, that people are prepared to pay this. It is dangerous because it is giving people a misplaced sense of security because they are thinking that by paying these contributions they are getting a pot of money at the end and all the past 20 years have shown us that nothing is guaranteed in the system at all. It is giving people a security which is quite illusory.

  257. You think this might help because if you were honest about this to people, that their so-called contributions are meaningless and they will get some little pension from the state but it will not be based on contributions; it will not be a living wage, you think this could be helpful because it will encourage people to make prior provision? Is that what you are saying?
  (Professor Disney) As I suggest, this focus group analysis may be suggesting that young people may be thinking, "The future pension I am going to get out of the state is not that large, so I have to make private provision." I am in favour of transparency in everything really. I can see politically, if people are more prepared to pay one tax than another, it seems understandable to encourage them to do that, but the principle there is an illusion. Maybe it would be better to say, "Look, this is the sort of pension you are going to get when you retire. Your contributions may or may not entitle you to more pension. It depends on the government of the day. Really, if you want to be secure, you should go out and make some private provision as soon as possible", suitably regulated and so on. That is a separate committee, presumably.

  258. From the various surveys that you have been involved with, you think that people have enough confidence in the private pension industry?
  (Professor Disney) No, I do not think they have because I think a number of governments and indeed different parts of the pension industry have in some ways sought to undermine other parts. We have a very complicated system of private provision. This slightly detours from this Committee, I recognise, so I will not go into it but I think private provision is immensely complicated. People do regard it as a risky option but they say, "I do not have any security from the government option either because I do not think, if I am young, I am going to get much out of the system, so I have to make some provision. Should I buy a stakeholder pension, a money purchase scheme, a personal pension or do something else?" It is an incredibly difficult decision to make. We have not helped make that decision.

  259. You think we are deluding ourselves if we think that there is a great principle behind the national pension system and pooling of risk?
  (Professor Disney) There are some principles. I do not want to be completely iconoclastic. One is the principle that not everybody should be risk rated and that the scheme should be mandatory. In other words, by having social insurance, we accept that some people will do a bit better than other people out of the system within a generation. Women live a bit longer but we should not penalise them, if you like, by making them pay higher contributions. You can think of various social insurance aspects which a private system would not do and you can also think that the way in which you finance and run your pension scheme has implications for which generations do best. Again, you can use your public pension to ensure that one group of people, when they retire, do rather better than another group which a private system presumably could not, because it would just have to deliver whatever the stock market delivered. I am not saying that there is nothing intrinsic to publicly provided insurance other than what is in a private insurance system. I think that is wrong. There are things that are different but there are other things which I think are just confusion.

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