House of Commons - Social Security

Select Committee on Social Security Fifth Report

FIFTH REPORT

The Social Security Committee has agreed to the following Report:—

THE CONTRIBUTORY PRINCIPLE

1. The contributory principle which underlies this country's system of National Insurance was the cornerstone of the post-war social security settlement, intended to provide social protection for all through a collective fund to which everyone contributed. Today that system is being eroded. The process of erosion has been gradual and has taken place over decades. It shows no signs of slowing down. Public debate at the demise of contributory benefits has been muted, despite the fact that contributions paid by individuals have risen considerably and the benefits they have paid for have been reduced in value and eligibility tightened. The Committee's inquiry into the contributory principle grew out of an unease that the system of National Insurance is disappearing by default, without proper acknowledgement or debate. One purpose of the inquiry is to stimulate a wider public debate on its future. For if the contributory principle is to survive and be re-invigorated, it will require greater public understanding and active political support. On the other hand, if the contributory principle is to disappear as the underpinning of this country's social security system, we consider it should do so only after the full implications have been properly discussed and agreed to. Our inquiry therefore set out to examine the role of National Insurance within Britain's social security system and to ask, whether, in the 21st century, benefits which are paid on the basis of contributions still have a role.

2. We announced our inquiry and issued terms of reference in April 1999. As well as receiving considerable written evidence, we held seven oral sessions at which the following witnesses gave evidence: Professor Pete Alcock, Professor of Social Policy and Administration, University of Birmingham; Dr Sheila Lawlor Director of Politeia; the Trades Union Congress (TUC); the Low Pay Unit; Child Poverty Action Group (CPAG); Disability Alliance; the Centre for Policy Studies; Ms Fran Bennett, independent social policy researcher; Mr Frank Field MP; the Institute for Fiscal Studies (IFS); the Government Actuary's Department; and Mr Alistair Darling, Secretary of State for Social Security. During the course of the inquiry two study visits were made, one to Norway and Finland in October 1999, and one to Australia in March 2000, where contrasting models for social security systems were explored. Two pieces of research were commissioned as part of the inquiry, one from Ms Holly Sutherland of the Microsimulation Unit at the University of Cambridge and one from Mr Andrew Young, Deputy Government Actuary. We are grateful to all the individuals and bodies who have assisted the Committee during its inquiry.

Definitions

3. Various definitions of the contributory principle were given to the Committee. The essential elements agreed by everyone were: an eligibility for benefits based on contributions;[1] and a funding mechanism for those benefits based on contributions.[2] Dr Bruce Stafford suggested that "growth in private insurance to cover unemployment, sickness and pensions represents an expansion of the contributory principle."[3] However, for most commentators, the contributory principle was understood as a concept linked to the 'social insurance model' of benefits, and encompassing a broader, more flexible relationship between contributor and benefit than that of private insurance:

4. In the context of this report, the term 'contributory principle' is used with reference to the social insurance model of benefits. In its evidence, the TUC identified various key characteristics of the 'social insurance model': an element of compulsion for most employees, and exclusion for others outside the labour market or with low earnings; the absence of a means-test; a system of provision for workers whose earned incomes have been interrupted by commonly recognised contingencies, such as retirement, unemployment, sickness, disability, maternity and widowhood; and, unlike private insurance, a pooling of risk.[5] Most European countries have some version of the social insurance model based on contributions as the basis of their social security system. The report also uses the term National Insurance. It is used to describe the British model of social insurance which has developed over the last century.

The objectives of a social security system

5. Underlying the discussion of the role of the contributory principle and its future is a wider debate on the purpose of social security and what it is meant to achieve. For some, the social security system should be confined to the narrow aim of poverty alleviation:

"[The Government] should be less mealy mouthed, and argue the case for scrapping the contributory principle, merging tax and National Insurance, requiring the middle classes to take more responsibility for their own lives - and in the cause of building a more civilised society, providing a generous safety net for everyone whose circumstances would otherwise inflict poverty."[

For others, social security has a broader role, beyond providing a residual system of financial support for the poor. For example, Ms Bennett suggested that a social security system should aim to:

- redistribute resources over individuals' and families' own lifecycles;

- represent a compact of support between the generations;

- protect people against risks and insecurities;

- encourage personal autonomy and independence; and

- help promote social cohesion, by binding people together in a system of mutual support.

6. This is a debate which is an underlying theme of our report and one to which we return towards the end of our report.

How the National Insurance system works

Contributions

7. National Insurance benefits are funded by a system of compulsory contributions, paid by employees, employers and self-employed people.[8] Until April 2000, employees paid contributions of 10 per cent on earnings[9] between a 'Lower Earnings Limit' (currently £67 a

week) and an 'Upper Earnings Limit' (currently £535 per week).[10] These earnings limits are uprated in line with prices. Employers pay contributions of 12.2 per cent on employees' earnings above a threshold ('the Secondary Threshold') which is linked to the income tax personal allowance level.[11] There is no upper ceiling. Self-employed people pay a flat rate contribution,[12] plus a separate profits-related contribution.[13] Voluntary contributions are also possible to assist people to qualify for basic Retirement Pension and Widows' Pension.[14]

8. Employees' contributions entitle them to the range of contributory benefits, including Jobseeker's Allowance, Incapacity Benefit, Retirement and Widows' pensions. The flat rate contributions of self-employed people entitle them to all benefits apart from Jobseeker's Allowance.

9. Over 20 million employees each year pay some National Insurance contributions - though not necessarily sufficient to qualify for benefits - and employers' contributions are paid by over 1 million employers. Around 2.3 million people pay National Insurance contributions in respect of self-employment (some 300,000 pay both in respect of self-employment and employment). About a quarter of a million people were expected to pay Class 3 (voluntary) contributions in April 1999-2000.[15]

The National Insurance Fund

10. All national contributions are paid into the National Insurance Fund, except for a small percentage which is allocated to the National Health Service.[16] In the year 1999-2000, net contributions received by the Fund are expected to be £50.4 billion[17]. The benefits due under the National Insurance scheme are all paid for out of the Fund. The National Insurance Scheme is financed on a pay-as-you-go basis, as Professor Disney of the Institute of Fiscal Studies explained:

11. A working balance in the Fund is maintained because the Fund has no borrowing powers and because changes in the contribution levels in response to the needs of the Fund take time to implement. The Government Actuary has confirmed that it is prudent to plan for a minimum working balance of one sixth (16.7 per cent) of annual benefit expenditure.[19] In recent years the balance in the National Insurance Fund at the end of the financial year has grown to represent a substantially larger proportion of annual benefits expenditure. See Table 1 below. The actual surplus in the Fund - representing the accumulating excess of contributions over benefits paid out - stood at around £5.9 billion.[20]

Table 1

Balance in the National Insurance Fund at the end of successive financial years
Balance at 31 March	1998	1999	2000	2001
£ million	9,608[21]	12,277[22]	13,786[23]	16.650[24]
As a percentage of benefits payments in previous financial year	22.5	27.6	29.7	35.3

12. Historically, the National Insurance Fund has been financed by three partners: individual contributors, employers and taxpayers, the latter through a Treasury grant. In 1981 policy began of gradually reducing the Treasury grant, leading to its abolition after 1988-89. The Treasury Grant was then reintroduced in a reduced form in 1993 because "this arrangement did not prove flexible enough to meet unexpected demands."[25] Since 1998-99, no Treasury Grant has been necessary to fund benefits. In 1999-2000, 44 per cent of contributions to the Fund were made by individual contributors and 56 per cent by employers.[26] If the structure of contributions remains unchanged in future years, it is expected that the proportion of the Fund financed by employers will increase. This is discussed further in paragraph 58.

13. In 1999-2000, £46.2 billion was paid out of the National Insurance Fund in benefits[27]. Figure 1 below shows the relative proportions of the National Insurance Fund which were spent on different benefits in that year. By far the largest proportion of the National Insurance Fund spent each year goes on retirement pensions.

Figure 1

Estimated payments from the National Insurance Fund for benefits 1999-2000[28]

*	Other: Contributory JSA, £507 million; Christmas Bonus, £120 million; Maternity Allowance, £40 million; Guardian's Allowance and child's special allowance, £2 million.

Contribution conditions

14. About 12.9 million claimants are at any one time expected to receive benefits financed from the National Insurance Fund.[29] Entitlement depends on satisfying the contribution conditions (as well as other conditions of entitlement) for the particular benefit. The contribution rules are complex, requiring the contributor not only to have paid contributions on a certain proportion of earnings, but also to have paid the contributions during a particular tax year, or, in the case of widows or retirement pensions, over a certain number of years of a working life.[30] For example, for a person on average earnings, it takes about nine weeks of earnings to achieve a qualifying year for pension purposes.[31] Professor Pete Alcock commented:

15. There is very little direct financial relation between what an individual puts into the Fund and what they get out. Most National Insurance benefits are paid at a flat rate whereas contributions are earnings-related. The Government Actuary commented: "Over time the link between the benefit and the contribution of the individual has been loosened so that now it is very clearly on a pay as you go basis and contributions are set to meet the benefits in that year rather than the benefits of the individual in the future."[33]

Credits and Home Responsibilities Protection

16. The contributory system is not wholly based on earnings; since the mid-seventies the qualifying conditions have been relaxed so that people can receive credits which supplement paid contributions and assist in qualifying for National Insurance benefits. About 10.5 million people each year are credited with National Insurance contributions.[34] Credits alone are not enough to earn entitlement to benefit; a person must also have worked and paid contributions on earnings in the relevant year. Credits are awarded in a variety of situations. They include credits for approved training; credits for people starting work after completing training or education; caring (if Invalid Care Allowance is in payment), unemployment (if satisfying the conditions for Jobseeker's Allowance), incapacity and maternity.[35] People in receipt of Working Families Tax Credit get credits for the purposes of SERPS (State Earnings Related Retirement Pension).[36] Professor Disney observed:

17. Home Responsibilities Protection was introduced to make it easier for people with certain caring responsibilities to qualify for the basic state Retirement Pension and Widows Pension. It works by excluding years of very low earnings and child care from the length of the working life over which the pension is calculated. There were 5.3 million people recorded as having Home Responsibilities Protection in 1995-6.[38]

Distinctions from other types of benefits

18. National Insurance benefits can be contrasted with two other types of benefits, means-tested benefits and 'universal' benefits paid on the basis of certain contingencies. Means-tested benefits take into account a person's income and capital when assessing eligibility. They are paid out of general taxation. In 1999-2000, an estimated £32.1 billion was spent on means-tested benefits.[39] The third category is benefits subject to neither a contribution nor a means test, but dependent instead on satisfying a specified contingency, for example, having care or mobility needs (Disability Living Allowance or Attendance Allowance), caring for a person with such needs (Invalid Care Allowance) or having a dependent child (Child Benefit). In 1999-2000 an estimated £21 billion was spent on non-contributory, non means-tested benefits, funded by general taxation.

Distinctions from European social insurance models

19. The National Insurance model in Britain differs in several respects from other models of social insurance in Europe. The key difference is that most European models (which vary considerably) are designed around the notion of wage-replacement and thus offer earnings-related benefits. The level of contributions paid has a direct relationship to the protection provided. In Norway and Finland, for example, flat rate basic benefits were supplemented, in most cases, by substantial earning related elements. In contrast, as Professor Alcock pointed out, the primary aim of National Insurance as originally devised by Beveridge "focussed on the prevention of poverty rather than the protection of wage levels."[40] Thus most benefits in Britain are paid at a modest flat rate, with the expectation that people with higher earnings will take out private or occupational social protection to protect their living standards.

1 See, for example, Sheila Lawlor, Ev p 15 para 1, Fran Bennett, Q. 178. Back

2 See TUC, Ev p 34 para 5. Back

3 Appendix 2 para 11. Back

4 Q. 1. Back

5 TUC, Ev p 33 para 4. Back

6 Peter Kellner, Evening Standard 24 May 1999. Back

7 Fran Bennett, Ev p 113 para 5.1. See also Disability Alliance, Ev p 87 para 2.1, and CPAG, Ev p 76 para 2.7. Back

8 A more detailed description of the rules governing the six classes of National Insurance is given by the DSS in their memorandum to the Committee, see Ev p 170-2. Back