Select Committee on Social Security Fifth Report


The relationship between tax and National Insurance

20. National Insurance contributions are increasingly described by the Government as a form of taxation.[41] The transfer of the Contributions Agency (which collects contributions) from the Department of Social Security to the Inland Revenue, and recent steps by the Chancellor to align the conditions for payment of National Insurance contributions to income tax (see below) suggests an attempt to equate the two. However, there are important differences. The base of the charge is far narrower for National Insurance, which is based on earnings. Income tax is charged on all income, including income from savings, investments, and pensions. The period of assessment is also markedly different. Income tax is based on an assessment of income over a year, whereas National Insurance contributions are assessed fully and finally on earnings for each pay period, usually a week or a month. The structure of the charge differs, in that individuals' tax thresholds vary depending on the various allowances and reliefs they qualify for, whereas the threshold for paying National Insurance Contributions is standard for all earners. And whereas income tax is charged without an upper ceiling, employees' National Insurance contributions are only charged up to the Upper Earnings Limit.

21. Another difference is the system of accounting for money paid. National Insurance contributions go into a specific Fund. Mr Field said, "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."[42] The Government Actuary took a similar view, pointing to the greater scope for parliamentary accountability:

     "From the point of view of parliamentary control I would say that the National Insurance Fund has a very important function because it does focus through the uprating process, the annual review and the reports that we do in connection with that, on whether there is a proper approach being taken to the benefits uprating, whether they are being considered adequately in relation to the income, and that gives Parliament quite a good influence in principle over the way in which the scheme is developing in a way which would be much less so if there was not a Fund and this was all general budget expenditure."[43]

22. Professor Alcock argued that, "as a form of taxation upon employees, National Insurance contributions have been considerably more regressive than income tax with liability starting at much lower rates of earnings and reaching a ceiling well below the higher tax band level for income tax."[44] Because liability for National Insurance is calculated on a full and final basis weekly or monthly, those on fluctuating or intermittent earnings can find themselves liable for contributions, even though their earnings over a year fall below the tax threshold. Yet the benefits they get in return may be minimal due to an inadequate total of contributions in the year. The Government has sought to overcome this problem by aligning the threshold for paying contributions to those for income tax. From April 2000, a 'primary threshold' (at £76 a week) has been introduced which has raised the earnings level at which employee contributions begin. This threshold will rise to the level of the personal tax allowance in April 2001. For the purposes of entitlement to benefits employees will be 'zero-rated' - that is, treated as though they had paid contributions on earnings from the previous contributions threshold, the Lower Earnings Limit. The Upper Earnings Limit is also being raised in two successive years above price inflation. People earning above the Upper Earnings Limit pay proportionately less of their earnings in National Insurance contributions than those with earnings below the limit.

The history of National Insurance

The system devised by Beveridge

  23. The contributory principle was central to William Beveridge's plan for a comprehensive social security system after the Second World War. 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."[45] The quotation summarises the key features of Beveridge's plan. His overall concern was to prevent poverty through provision of a subsistence income, rather than the creation of a system which replaced wage levels. The idea was that flat rate benefits would provide a floor, on which the contributor could build. Beveridge's view was that "the State in organising security should not stifle incentive, opportunity, responsibility; in establishing a national minimum it should leave room and encouragement for voluntary action by each individual to provide more than that minimum for himself and his family."[46] Contributory benefits were to be something better and more worth having than means-tested "national assistance", which he felt should be "less desirable than insurance benefits; otherwise the insured person gets nothing for their contributions."[47] Beveridge expected that national assistance would be a minor part of the social security system, necessary mainly during a period of transition to cater for older people who would not qualify for contributory retirement pension: "the scope of assistance will be narrowed from the beginning and will diminish throughout the transition period for pensions. The scheme of social insurance is designed of itself when in full operation to guarantee the income needed for subsistence in all normal cases."[48]

24. Beveridge's plan was never fully realised. Political pressures meant that, at the outset, the Government decided to pay out the full retirement pension, before the 20 years had elapsed which were needed for the National Insurance Fund to mature.[49] Benefits were paid out of contributions collected. As a result, rather than acting as a funded insurance scheme as Beveridge intended, NI operated on a 'pay-as-you-go' basis with the cost of current benefits being born by current contributions paid.[50] From the start, benefit rates were also lower than the subsistence rates envisaged by Beveridge. In 1954 the Government accepted the recommendations of the Phillips Committee that it should abandon any long-term aim of raising retirement pensions to subsistence level on the ground that it would present an unduly heavy burden on the Exchequer.[51] As a result, National Insurance benefits have never achieved the comprehensive coverage envisaged by Beveridge, being supplemented in many cases by means-tested benefits and contingency-based benefits.

Economic and social changes

  25. Economic and social changes have also undermined the assumptions on which National Insurance was based. There have been substantial changes in the labour market. As the DSS commented: "Generally speaking, the National Insurance system was geared to a world in which men had full-time regular working patterns, with only brief spells out of work, and the overwhelming majority of women did not take paid employment, but were expected to rely on pensions built up on their husbands's contributions."[52] Today that world has gone. Full-time, largely male, jobs in large scale manufacturing have been replaced with more 'flexible', often part-time, jobs primarily in new service industries, employing many women. In the 1950s, just over half of all jobs were in manufacturing, compared to around one in five today. In the 1950s less than five per cent of workers worked part-time; today part-time workers account for 25 per cent of the workforce. Self-employment has also increased, from 8 per cent in 1978 to 12 per cent recently.[53] Professor Alcock pointed out that the decline in manufacturing had been a major cause of the massive increase in unemployment in Britain which put enormous pressure on the National Insurance scheme.[54] The result of these changes has been that more and more people are failing to qualify for National Insurance benefits, due to unemployment, intermittent work records, or low pay.

26. The growth in part-time, often low-paid, employment has focussed attention on the exclusion from National Insurance protection of workers who earn below the Lower Earnings Limit (currently £67 a week). There are currently around 2.45 million workers earning below the Lower Earnings Limit. The Low Pay Unit pointed out that developments in the labour market mean this figure is likely to remain, if not increase.[55] Four out of five of those earning below the Lower Earnings Limit are women and this kind of low paid work is much more likely to be long term for them than for men. Ninety-five per cent of women earning below the Lower Earnings Limit are part-time workers, the majority over 25 and with young children.[56]

27. Beveridge's National Insurance scheme assumed that women out of the labour market and caring for children would be supported by their husbands. In fact, the last three decades have seen a rise in separation and divorce and a growth in the number of parents bringing up children alone. Many of these lone parents do not qualify for National Insurance benefits, and have therefore been dependent on means-tested benefits. DSS expenditure on Supplementary Benefit and its successor Income Support grew from £1 billion in 1980-81 to £4 billion in 1998-99.[57]

28. Disability Alliance drew attention to the fact that "over the last 20-30 years the whole pattern of life for disabled people has changed as the old institutions and psychiatric hospitals have closed down and disabled people have moved to independent living in the community. [There are now] longer life expectancies and better survival rates for people with severe disabilities."[58] Many of such people have, at best, limited work records. The increasingly competitive labour market also meant that people in poor health found it difficult to enter the market.[59] Invalidity Benefit caseloads grew steadily until 1995 reaching 1.8 million, due mainly to people remaining on benefits longer, rather than a higher number of new claims.[60] These changes increased the need for carers, many of whom found their own ability to work and pay National Insurance contributions reduced as a result. The lack of an insurance benefit specifically for carers means that even those who have previously worked and paid contributions do not qualify for National Insurance help.

29. Finally, an aging population has put pressure on pensions. The Secretary of State reminded us that: "[Beveridge] wrote his report at a time when the average life expectancy of a man after retirement was one year.[61] People are now living for 20 or 30 years in retirement."[62]

Government policies towards National Insurance

  30. The policies of successive governments since Beveridge have also had a substantial effect on the structure and coverage of the National Insurance scheme. The changes can be characterised as an expansion of the system during the 1960s and 1970s, followed by contraction in the 1980s and 1990s. During the 1960s and 1970s, the limits of flat rate benefits were recognised by the gradual introduction of earnings-related benefits into both short-term benefits, and most importantly, long-term benefits through the establishment of the State Earnings Related Pension scheme (SERPS). The plight of carers was recognised in two ways. Home Responsibilities protection made it easier for people with caring responsibilities to qualify for Retirement Pension, and, in 1975, a non contributory, non means-tested benefit, Invalid Care Allowance, was introduced. The 1970s also saw the development of the system of credits, bringing more people into the National Insurance scheme without monetary contributions. A number of other non-contributory, non means-tested benefits were also introduced in the 1970s, aimed at people with long-term illness or disabilities with poor or non-existent contribution records. Non-contributory Invalidity Benefit (which ultimately became Severe Disablement Allowance) was an earnings-replacement benefit aimed at people unable to work and ineligible for contribution-based Invalidity Benefit (which later became Incapacity Benefit) due to a lack of contributions. Disabled people with care and mobility needs were offered Attendance Allowance and Mobility Allowance.

31. However, from 1980 onwards, the National Insurance system was cut back. Mr Field observed, "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." The 1980 Social Security (No. 2) Act reduced children's allowances paid with benefits (later abolished completely); removed the earnings link for the uprating of pensions; abolished earnings-related supplements on short-term benefits; and introduced an abatement of Unemployment Benefit to take account of occupational pensions.[63] Other changes during the same decade included substantial reductions in the value of SERPS, the transfer of payment of Sickness Benefit and Maternity Allowance to employers (with reimbursement from the State, later reduced and eventually largely discontinued in the case of Statutory Sick Pay); and a series of measures to tighten eligibility for and reduce entitlement to, Unemployment Benefit. Two major reductions in contributory benefits took place in the mid-1990s. In 1995, Invalidity Benefit was replaced with Incapacity Benefit, which tightened the medical test for eligibility whilst cutting the age-related additional allowance for most claimants; abolishing the earnings-related supplement; and making the benefit taxable.[64] In 1996, Unemployment Benefit, paid for 12 months, was replaced with Jobseeker's Allowance, payable for only 6 months.

32. Our survey of the history of National Insurance since Beveridge has led us to conclude that the National Insurance scheme has been undermined, both directly as a result of successive governments' policies and indirectly as a result of economic and social change.

National Insurance: the current debate

33. Many of the contributors to this inquiry were agreed that the National Insurance scheme is in serious trouble. Professor Ruth Lister commented, "On current trends... the future for the contributory principle and for the social insurance scheme in the UK must look bleak."[65] Growing numbers are excluded from National Insurance, and, while benefits have reduced significantly in value, National Insurance contribution rates have risen from 6.5 per cent in 1979 to ten per cent today. Mr Field warned of the potential for resentment among people who contribute, when greater rewards go to those who do not:

    " there is an inherent instability in a system which is asking people to contribute and then actually rewarding people, who do not contribute or cannot contribute, with more money than those who have contributed, and you can only get away with that in a world where the electorate is either very trusting or not very concerned."[66]

34. Far from withering away as Beveridge had intended, means-tested benefits now represent a large and growing proportion of benefit expenditure. At the start of the post-war welfare state, just over 60 per cent of social security expenditure went on contributory benefits; and 13 per cent went on means-tested benefits.[67] Today, contributory benefits make up around 47 per cent of spending, and means-tested benefits have grown to 33 per cent of the total.[68] The considerable growth in means-tested benefits is due partly to the failure of increasing numbers of people to qualify for National Insurance benefits at all, and also the necessity for many of those who do qualify, to claim means-tested benefits to 'top-up' the low level of their contributory benefit to give them a basic amount to live on. It is also due to the gradual introduction, since the late 1960s, of new means-tested benefits. Rate rebates were introduced in 1967 and rent rebates in 1972. Rent deregulation and higher council tax levels caused rapid increases in (renamed) Housing and Council Tax Benefits, which contributed to an additional £10 billion on these two benefits between 1980-81 and 1998-99.[69] Family Income Supplement (later re-named Family Credit) was introduced in 1971 as a means-tested top-up for families in low-paid employment. Between 1979 and 1999, the proportion of benefits which families received which were means-tested rose from 19 per cent to 52 per cent.

35. There are conflicting signals regarding the present Government's attitude towards National Insurance. On the one hand, a series of measures has eroded the contributory system still further, reducing both access to benefits and the amounts payable. The Welfare Reform and Pensions Act 1999 tightened the eligibility conditions for Incapacity Benefit, and introduced an abatement of Incapacity Benefit to take account of occupational pensions - effectively introducing a means-tested element. Widows' Pension, including a SERPS element for older widows, was payable to widows aged 45 and over without dependants. It was abolished and replaced by Bereavement Allowance, paid for six months to both widows and widowers, without a SERPS component.

36. On the other hand, the Government has sought to reform the structure of National Insurance contributions in a way which reduces the financial burden on low-paid workers, whilst ensuring that they continue to qualify for contributory benefits.[70] Coupled with the raising of the Upper Earnings Limit in two successive years by more than price inflation, the system is now less regressive in its effects. The Chancellor has also brought into the contributory system an estimated 16,000 women who earn over £30 per week but less than the Lower Earnings Limit, who will have access to contributory Maternity Allowance. A further 11,000 women who are self-employed, will also benefit from enhanced access to Maternity Allowance.

37. Professor Lister's pessimistic conclusion was that, "Although there is not a completely consistent pattern emerging from the individual benefit reviews, on balance the net effect is likely to be a further diminution of the role played by contributory benefits in the social security system."[71]

38. The Secretary of State for Social Security has argued, "Today the important difference in social security is not whether they are insurance based or means tested, but whether or not they provide enough help to get people back to work and improve their lives."[72] The question we sought to answer was: is the contributory principle and the benefits to which it gives rise worth fighting for? Do the values which underpin National Insurance stand up against current social, political and economic realities?

41   See, for example, discussion by Mr Tony Lynes, Appendix 18 para 5.1. Back

42   Ev p 126 para 1. Back

43   Chris Daykin, Q. 285. Back

44   Ev p 11 para 5.16. Back

45   Social Insurance and Allied Services, 1942, para 10 Cmd 6404, quoted by Centre for Policy Studies, Ev p 99 para 1. Back

46   Social Insurance and Allied Services, 1942, para 9 Cmd 6404. Back

47   Social Insurance and Allied Services, 1942, para 369 Cmd 6404. Back

48   Social Insurance and Allied Services, 1942, para 23 Cmd 6404. Back

49   See Dr Sheila Lawlor, Ev p 16 para 9; Centre for Policy Studies, Ev p 100 para 10. Back

50   Professor Pete Alcock, Ev p 3 para 2.5. Back

51   Centre for Policy Studies, Ev p 101 para 12, citing The State of Welfare - the Economics of Social Spending, ed. H. Glennerster and J. Hills, Oxford, 1998. Back

52   DSS, Ev p 179 para 56. Back

53   DSS, Ev p 179 para 56. Back

54   Ev p 6 para 3.20. Back

55   Low Pay Unit, Ev p 65 para 1. Back

56   See Low Pay Unit, Ev p 65; Professor Lister, Appendix 1 Para 10, TUC, Ev p 46 para 87, and Low Pay and the National Insurance System: A Statistical Picture, McKnight, Elias and Wilson, Equal Opportunities Commission,1998. Back

57   DSS, Ev p 181 para 66. Back

58   Ev p 88. Back

59   Professor Alcock, Ev p 7. Back

60   DSS, Ev p 180 para 64. Back

61   Note by Witness: The average age a male born in 1942 in England and Wales could expect to live to, if the 1942 mortality rates were to prevail throughout his life was 62.1 years. (Source: Government Actuary's Department) Back

62   Q. 328. Back

63   DSS, Ev p 184 Annex A. Back

64   TUC, Ev p 35 para 18. Back

65   Professor Lister, Appendix 1 para 15. See also, Fran Bennett Q. 29, Professor Disney Q. 254, Centre for Policy Studies, Ev p 99. Back

66   Q. 214. Back

67   Non means-tested benefits represented just over a quarter of benefit expenditure at that time, and is now about a fifth of all benefit expenditure. See DSS, Ev p 180-1 paras 60, 67-8. Back

68   DSS, Ev p 180-181 paras 60, 63 and 65. Back

69   DSS, Ev p 180-181 para 66.  Back

70   See paragraph 22. Back

71   Professor Lister, Appendix 1 Para 6. Back

72   The Guardian 16 May 1999. Back

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