APPENDIX 18
Memorandum submitted by Mr Tony Lynes
(CP 16)
I have been invited to submit a written memorandum
on the future of the contributory principle. Some of the points
to which I would like to draw the Committee's attention are discussed
in a short paper, drafted by me, which the National Pensioners
Convention submitted to the Government's pensions review on 10
November 1997 and which is attached as an annex to this memorandum.
1. SUMMARY
1.1 The contributory principle is defined
in terms of (1) dependence of benefit rights on a record of contributions
and (2) the contractual or quasi-contractual nature of those rights.
(Paragraph 2.1)
1.2 Unlike commercial insurance, social
insurance need not be self-financing, rights to benefit may be
modified by legislation, the system may be deliberately redistributive,
both between classes of contributors and between generations,
and contribution conditions may be relaxed for certain benefits
on social or other grounds. (Paragraph 2.2)
1.3 Social insurance is compulsory, subject
to contracting-out arrangements under which the contribution rebates
broadly cover the cost of the benefits forgone. (Paragraph 2.3)
1.4 Paragraph 3.1 lists some advantages
of the contributory principle; but where contribution conditions
are not relevant, benefits should be non-contributory. (Paragraphs
3.2-3.3)
1.5 Means-testing is generally felt to be incompatible
with the contractual nature of insurance. Receipt of income from
other sources may provide evidence that the contingency which
the benefit is intended to meet has not arisen, but recent means-testing
measures are seen as an infringement of the social insurance contract.
(Paragraphs 4.1-4.3)
1.6 The transfer of responsibility for the
National Insurance Fund to the Treasury reflects the view that
NI contributions are simply a tax and not relevant to the affordability
of benefits. (Paragraph 5.1)
1.7 National insurance should be a separate
financial institution. Its governing body, consisting largely
of representatives of contributors and pensioners, would be responsible
for fixing benefit and contribution rates and proposing structural
changes, subject to endorsement by the relevant government departments
and by Parliament. The roles of the Benefits Agency and the Inland
Revenue in the administration of benefits and the collection of
contributions would remain unchanged. (Paragraphs 5.2-5.3)
2. THE CONTRIBUTORY
PRINCIPLE IN
COMMERCIAL AND
SOCIAL INSURANCE
2.1 The contributory principle comprises
two elements: (1) that entitlement to benefit depends, among other
conditions, on a record of contributions paid or treated as paid
by or for the beneficiary; (2) that payment of contributions results
in the acquisition of rights and, accordingly, any modification
of those rights should take into account their contractual or
quasi-contractual nature.
Commercial insurance (I use the term to cover
all types of private insurance, whether profit-making or not)
provides the simplest examples. Entitlement to benefits under
a house or car insurance policy is established by and dependent
on payment of contributions (premiums) directly related to the
risk insured. The direct relationship between premiums and benefits
is a necessary consequence of the commercial nature of the contract:
the system is viable only if the premiums paid by holders of a
particular type of policy at least match the liability undertaken
by the insurer. Provision may be made for crediting of premiums,
e.g. during periods of unemployment or sickness, but this is,
in reality, an additional insurance for which an appropriate premium
is paid, again reflecting the degree of risk. While an insurance
company may alter the terms of a policy in respect of future premiums,
it cannot refuse to honour its commitments in respect of premiums
already paid.
2.2 Social insurance operates differently.
The principle is the same: benefit entitlement depends on a record
of contributions paid or credited. The relationship between contributions
and benefits, however, differs from commercial insurance in a
number of ways:
(1) The system as a whole need not be self-financing,
since provision can be made for deficits to be made good out of
taxation.
(2) Rights based on past contributions may
be modified by new legislation, provided that such modifications
respect the legitimate expectations of contributors and do not
undermine confidence in the system.
(3) All insurance schemes are redistributive
in that they involve the sharing of risks (only people whose cars
are stolen benefit financially from car theft insurance, though
all policy-holders gain peace of mind), but social insurance may
deliberately offer a better deal to some classes of contributors;
e.g. the low-paid, carers and others with interrupted earnings
due to sickness, unemployment etc.
(4) Contribution conditions in a social insurance
scheme may be more or less stringent, reflecting social or other
objectives. The national insurance death grant, before its abolition,
was a striking example of an insurance benefit (admittedly of
very small value) which came close to being non-contributory:
payment of contributions in a single year, either by the deceased
or by his or her spouse, was enough to qualify for the grant.
(5) Social insurance may involve deliberate
redistribution over time and between generations. This is most
visible where pensions and other long-term benefits are financed
on a pay-as-you-go basis: current contributions confer entitlement
to future benefits but do not pay for them. When new benefits
are introduced, contributions may be credited for past years although
the cost of the benefits was not reflected in the contributions
paid in those years.
Social insurance, therefore, is an extremely
flexible instrument which can be used in pursuit of a wide range
of social and economic aims.
2.3 A fundamental characteristic of social
insurance, which underlies many of the differences noted above,
is the fact that it is compulsory. Although, in the UK, contracting
out of the state earnings-related pension is allowed, the resulting
contribution rebates have until now been intended broadly to cover
the cost of the benefits forgone, so that the redistributive element
in the contribution system is not affected. That principle, however,
has not been applied rigidly. The rebates have always been pitched
on the generous side and, for the six years 1987-93, an additional
2 per cent rebate was paid to those newly contracting out, mainly
at the expense of other contributors. A more radical departure
seems to be envisaged in the Government's current proposals, as
the pensions Green Paper explains: "Once stakeholder pension
schemes are well established, we plan to ensure that all moderate
and higher earners would be better off contracting out of the
state second pension . . . " (Cm 4179, p 80).
3. THE ROLE
OF CONTRIBUTORY
BENEFITS
3.1 The British social security system has
never been wholly contributory. The contributory principle is
more appropriate for some benefits than for others. Its advantages
(which are as relevant for the 21st century as they were for the
20th) include the following:
(1) In the words of the 1942 Beveridge Report,
"benefit in return for contributions, rather than free allowances
from the State, is what the people of Britain desire". People
like to feel that, when they need to claim benefits, they have
a right to do so, based not only on their past contributions but,
in the case of those of working age, on their willingness to pay
contributions in the future when in work.
(2) Viewed as a form of taxation, compulsory
contributions are more acceptable than other taxes, precisely
because they confer rights to benefit.
(3) If benefits were wholly tax-financed,
they would inevitably be pitched at the lowest possible level.
If the system is to provide more than a bare minimum, it is essential
that those who are called on to meet the cost should see a clear
connection between their payments and the benefits to which they
will be entitled.
(4) The fact that benefits are based on contributions
makes it more difficult—though by no means impossible—for
governments to reduce benefits earned by past contributions. This,
too, can make payment of contributions more acceptable—but
only to the extent that governments, in practice, respect acquired
rights.
(5) Contribution records provide evidence
of recent attachment to the labour force where benefits are intended
to replace earnings during temporary interruptions of employment.
(6) Contribution records also provide a basis
for calculating earnings-related benefits. Payment of higher benefits
to higher earners would be difficult to justify in a non-contributory
system.
3.2 A limitation of the contributory system
is that, by restricting benefit entitlement to those who satisfy
contribution conditions, it may exclude people equally in need
of benefits but who, for reasons beyond their control, have neither
paid nor been credited with the required amount of contributions.
This limitation can, to a large extent, be overcome by means of
contribution credits awarded to people in defined situations:
sickness, unemployment, full-time caring responsibilities etc.
If all gaps in contributions were to be filled by credits, however,
the contributory principle would cease to have any meaning. Where
the intention is to make a benefit payable to all those in a given
situation, regardless of their contribution record, it is simpler
and more honest to finance it out of taxation.
3.3 Child benefit is an obvious example.
It is payable whether the parents are currently in paid work or
not, and the need for it is in no way dependent on their past
history of employment or payment of contributions. To impose contribution
conditions would create unnecessary anomalies. Child benefit and
the family allowances which preceded it have, therefore, always
been non-contributory. On the other hand, the post-war national
insurance scheme recognised the need for a supplementary family
allowance during periods of unemployment, sickness etc., and this
was provided, in the form of "child dependency increases",
as part of the contributory national insurance system (over the
past 20 years, these increases have been steadily reduced and,
in the case of short-term benefits, abolished—an interesting
example of the ways in which government action can undermine the
contributory principle without any overt change of policy).
4. MEANS-TESTING
AND THE
CONTRIBUTORY PRINCIPLE
4.1 It is generally assumed that benefits
earned by contributions should not be subject to a means test.
Means-testing is felt to be incompatible with the contractual
nature of insurance. Moreover, if the purpose of a benefit is
to guarantee a minimum level of income, it seems inappropriate
to deny that minimum to those who fail to satisfy contribution
conditions. The main means-tested benefits, such as income support
and housing benefit, have therefore never operated on a contributory
basis and are financed out of general taxation.
4.2 It would, however, be wrong to assert
that means-testing can have no place in a contributory benefit
system. Receipt of income from other sources may constitute evidence
that the contingency which the benefit is intended to meet has
not, in fact, arisen. For example, benefit entitlement may be
subject to an earnings limit, as was the case with retirement
pensions until 1989 when the earnings rule was abolished. The
purpose of the rule was not to exclude those with income above
a certain level from drawing a pension (income other than earnings
was not taken into account) but to set a limit to the amount of
paid work a person could do while still being treated as retired.
Similar earnings limits still apply to increases of contributory
benefits for both adult and child dependants. The justification
for these limits is that a person earning more than a certain
amount is regarded as self-supporting and therefore not a `dependant'
(in the case of a child, it is the other parent's earnings or
private pension that are taken into account; it is assumed that
the child is dependent on the earning parent, not on the benefit
claimant).
4.3 More controversially, rules have been
introduced to prevent payment of contributory benefits to people
in receipt of other privately-financed benefits. Contributory
jobseeker's allowance is reduced by any amount over £50 a
week received from an occupational or personal pension scheme,
on the questionable assumption that anyone of whatever age receiving
such a pension cannot be regarded as a genuine jobseeker. The
Government now proposes to introduce a similar restriction of
entitlement to incapacity benefit, which would be reduced by half
the excess over £50 a week received from a pension or permanent
health insurance scheme. The rationale of this restriction is
not that the person concerned cannot be regarded as incapacitated,
but simply that the existence of non-state benefits makes payment
of incapacity benefit unnecessary. It is an undisguised means
test, which has understandably aroused grave concern among the
Government's supporters. Measures of this kind are seen not only
as a disincentive to private insurance but as an infringement
of the social insurance contract, in contrast to the SERPS contracting-out
arrangements under which those opting for private insurance pay
reduced NI contributions.
5. FINANCE AND
POLICY CONTROL
5.1 The British social insurance system
is unusual in that the National Insurance Fund is administered
directly by a central government department—until recently
the Department of Social Security but now the Treasury. The transfer
of responsibility to the Treasury has aroused fears that the distinction
between contributions and taxes may be blurred and the distinction
between contributory and non-contributory benefits undermined.
It is certainly rather odd that, in theory at least, the Secretary
of State for Social Security remains responsible for fixing benefit
rates while the Chancellor of the Exchequer decides the contribution
rates. The formal transfer, however, merely reflects the way in
which the system has in practice operated for many years. As a
DSS official wrote in the letter quoted in the Annex to this memorandum,
national insurance expenditure "is no different from expenditure
financed by tax receipts, only the method of finance is different".
NI contributions are regarded simply as a tax, changes to which
are announced by the Chancellor in his Budget (he frequently refers
to reductions in contributions as "tax cuts"). Decisions
about the affordability of benefits are taken without any regard
to the fact that they are financed by contributions and that (as
the NPC pointed out—see Annex) when benefits are increased
people expect to pay higher contributions.
5.2 The alternative which I would advocate
is that national insurance should be a separate and largely autonomous
financial institution, with a governing body consisting largely
of representatives of contributors and pensioners which would
be responsible for fixing benefit and contribution rates and for
proposing structural changes, such as the introduction of new
benefits or the modification or abolition of existing benefits.
Any such changes would have to be endorsed by the relevant government
departments, including the Treasury, and by Parliament. The governing
body would be required to have regard to the financial equilibrium
of the system, both short-term and long-term, to the reasonable
expectations of contributors as to the benefit rights acquired
by their past contributions, to the available evidence as to the
benefits and rates of benefit for which contributors would be
willing to pay, and to the broader economic implications of its
actions. Its primary responsibility would be to ensure both the
effectiveness and the financial viability of the social insurance
system and to justify its actions and proposals in terms of these
objectives. A reform of this kind would help to restore public
confidence in the system; and this, in turn, would discourage
any attempts by future governments to take it over.
5.3 The changes proposed in the preceding
paragraph would mainly affect policy-making and financial planning.
The role of the Benefits Agency in the administration of both
contributory and non-contributory benefits would remain unchanged,
as would that of the Inland Revenue in the collection of contributions.
17 May 1999
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