The Financial Secretary to the Treasury (Mr. Stephen Timms): I beg to move,

The Chairman: With this it will be convenient to consider the draft Social Security (Contributions) (Amendment No. 2) Regulations 2009.

Mr. Timms: I bid you an especially warm welcome to the Chair, Mr. Streeter. This is the first occasion that I have served under your chairmanship. We will all benefit from the firm but fair approach for which you are renowned.

I am pleased to introduce the orders, both of which deal with the various national insurance contribution rates and thresholds, hence the reason for taking them together. I confirm that the provisions under the regulations and the order are compatible with the European convention on human rights. All the changes were announced at the time of the pre-Budget report on 24 November.

Let me start with the Social Security (Contributions) (Amendment No. 2) Regulations 2009. I bring to the Committee’s attention a couple of minor typographical errors in the preamble to the first instrument. The document refers incorrectly to section 122(1), whereas it should read section 5(6). There is a corresponding error a couple of lines further on in respect of the equivalent Northern Ireland legislation. We considered whether the statutory instrument should be withdrawn, but on advice from House authorities concluded that was unnecessary because the errors do not invalidate or affect its meaning. The errors will be corrected after the debate and before the final instrument is made.

In the 2007 Budget, the then Chancellor announced a package of reforms to modernise the tax and benefit system. Part of that was changes to national insurance contributions to align the upper earnings limit with the level at which higher rate income tax becomes payable, with effect from 6 April this year. The upper earnings limit is being increased accordingly from £770 to £844 per week. The regulations also increase the class 1 lower earnings limit from £90 to £95 per week. The lower earnings limit is legislatively linked to the level of the basic state pension and is the level of earnings at which entitlement to contributory benefits begins.

Lastly, the regulations increase the class 1 primary and secondary thresholds from £105 to £110 per week, which is broadly in line with prices. Earnings between the primary threshold and the upper earnings limit are liable to main rate employee contributions of 11 per cent. Earnings above the upper earnings limit are subject to the additional employee rate of 1 per cent. Employers pay contributions at 12.8 per cent. on all earnings above the secondary threshold.

Steve Webb (Northavon) (LD): The Minister said that higher rate taxpayers such as us in this room will pay additional national insurance above the current upper earnings limit across a fairly wide additional band. Will he clarify what impact that will have on the state second pension accruals of people who have not contracted out, and what the public expenditure consequence will be?

Mr. Timms: I do not have such figures with me, but I shall be happy to drop the hon. Gentleman a line to give him that information.

The second instrument sets the national insurance contribution rates and thresholds for self-employed people and those paying voluntary contributions. For self-employed people, it raises the small earnings exception below which the self-employed may claim exemption from class 2 contributions. The exception will rise in April from £4,825 to £5,075 per year, an increase broadly in line with prices. Many people choose to pay those contributions to protect their benefit entitlement. The rate of class 2 contributions for 2009-10 will rise from £2.30 to £2.40 per week, which again is broadly in line with prices.

The order also sets the profits limits between which main rate class 4 contributions are paid. The lower limit at which those contributions become due will increase broadly in line with inflation, from £5,435 to £5,715 per year. At the other end of the scale, the upper profits limit will continue to match the upper earnings limit for employees. It will rise to align with the point at which higher rate tax is payable as part of the package announced in the 2007 Budget. The upper profits limit will increase to £43,875 for the 2009-10 tax year. That ensures that the self-employed pay main rate class 4 contributions on much the same range of earnings as employers liable for class 1 contributions. That contributes to the fairness of the national insurance system.

The order also deals with the weekly rate of voluntary class 3 contributions, which help those with insufficient contribution records in any given tax year to make up a qualifying year for benefit purposes. The rate of class 3 contributions will increase from £8.10 per week to £12.05 per week from April, which is clearly well above the rate of inflation. That is a consequence of changes made in the Pensions Act 2008 to allow contributors who meet certain conditions to pay class 3 contributions outside the existing time limits to improve their basic state pensions. It was made clear when an amendment was introduced in response to an initiative by Baroness Hollis in the other place that the measure was to be overall cost-neutral, and that that would require the weekly class 3 contribution rates to be increased accordingly.

The review of contribution rates is accompanied by a report from the Government Actuary setting out the effects of the order and regulations, and the draft uprating of benefits order laid by my right hon. Friend the Secretary of State for Work and Pensions. What are the effects on the national insurance fund? There is no expectation that the fund will need a Treasury grant for the 2009-10 tax year.

Northern Ireland has a separate national insurance scheme from Great Britain, but the two are closely co-ordinated and maintain parity of contribution rates. The draft order and regulations cover both Great Britain and Northern Ireland, and I commend them to the Committee.

Mr. David Gauke (South-West Hertfordshire) (Con): It is a pleasure to serve under your chairmanship for the first time, Mr. Streeter.

I am grateful to the Minister for setting out some of the background to the two measures. As he stated, an understanding of the order begins with the 2007 Budget, in which the then Chancellor proposed an alignment of the starting points of income tax and national insurance contributions, and the upper earnings limit and the starting rate of higher rate income tax. To do that, the Government considered it necessary to amend primary legislation.

I served on the Public Bill Committee that considered the National Insurance Contributions Act 2008. Various amendments were made to the measure, one of which abolished a safeguard on changes in the upper earnings limit, namely the ratio between the primary threshold and the upper earnings limit. Instead, the affirmative procedure now applies to the upper earnings limit, hence the order and the regulations. During the passage of the 2008 Act, I was concerned that it could be possible to raise substantially the upper earnings limit of national insurance through secondary legislation, or indeed, to abolish the upper earnings limit—Labour party policy during the 1992 general election. Whereas a substantial change, or any change, to income tax requires primary legislation and the procedures must go through the Finance Bill, theoretically it would have been possible to do that merely in secondary legislation. I put that point on several occasions to the Minister’s predecessor, the right hon. Member for Liverpool, Wavertree, and she gave repeated assurances that the reason for changing the system from having a ratio to a new system of affirmative procedure was purely to facilitate the alignment between the upper earnings limit and the starting point of higher rate income tax. I would be grateful if the Minister could reassert that that is the Government’s policy.

In the course of the proceedings of the Act I argued that assurances took us only so far. It would be helpful if the Minister could reassure the Committee that the Government have no intention of using that weakened safeguard to increase the upper earnings limit well above the starting rate of income tax. I note the comments made by the Minister that it remains part of the policy of alignment, but I seek further clarification.

An aspect of the 2007 Budget that I suspect comes more readily to the minds of members of the Committee—I also suspect that historians of the Government will pay it much attention—was the proposal by the then Chancellor to abolish the 10p rate of income tax. That policy resulted in 5.3 million households being worse off, many of them at the poorest end of society, for the purposes of no more than political positioning. That is relevant to these proceedings because on 13 May 2008 the Government were forced to introduce an emergency package of measures to try to compensate many, although not all, of the 5.3 million households that had lost out.

As a consequence of that package, personal allowances were increased, but the Chancellor stated that people on higher earnings had not particularly lost out as a consequence of the abolition of the 10p rate and should therefore not benefit from the increase in personal allowances, so the threshold for higher rate income tax was lowered in that proposal on 13 May 2008. Consequently, the alignment at the bottom level between the point at which people started paying income tax and the point at which they started paying national insurance contributions no longer applied. As is clear in the explanatory notes, that is accepted.

I am not clear, so I ask my question in a genuine spirit of inquiry, precisely where the Government are on the alignment of the starting point of the higher rate of income tax and the upper earnings limit. Is it Government policy that the two work together? If so, how do the changes in the threshold for higher rate income tax fit in? Have the Government changed their intention as far as the upper earnings limit is concerned? Is there alignment and will it continue? Can the Minister clarify Government policy and reassure the Committee what their intentions are?

I turn briefly to the Social Security (Contributions) (Re-rating) Order 2009. I had the pleasure of serving on the Committee that dealt with the equivalent 2008 order. One point that was raised in that Committee was that the various changes to contributions aim broadly to replicate changes in prices—as the Minister said. I am sure that he will correct me if I am wrong, but the reference point for prices in these circumstances is the level of the retail prices index in September of the previous year, which was, I believe, 5 per cent.

Because we are looking at cash terms, and increases tend to be rounded to the nearest 10p or so, it is never a precise replication. For example, the increase for class 2—self-employed persons—contributions, from £2.30 to £2.40, is an increase of 4.34 per cent. As the Minister said, class 3 is somewhat different because of the Pensions Act. We are seeing an increase of just under 50 per cent. in that case. As for class 4, the contribution for self-employed earners is in addition to class 2, and the levels are increased by 5.15 per cent. The upper level is increased by 9.57 per cent., because of the changes in the upper earnings limit.

The point made last year by the Liberal Democrat spokesman, the hon. Member for Taunton (Mr. Browne), and I was that the rounding mechanism is imprecise. As a consequence, it is possible that over a number of years, the rounding will always mean that the increase may be above or below the relevant rate of inflation. There is an argument for looking at the rate of inflation over a period of time, because what might be the correct increase in any one year may cumulatively prove to be incorrect and move us away from an accurate reflection of changes in prices. That point was made to the Minister’s predecessor and I put it to him again today.

I referred a moment ago to the fact that RPI is used as the relevant mechanism. Since September 2008 we have seen a dramatic fall in RPI; it was 5 per cent. in September and the most recent figures suggest that it is now 0.1 per cent. That has costs and benefits to the Exchequer. My question to the Minister is what will happen if, as is widely predicted, RPI is a negative figure in September 2009? Will it mean that social security contributions could be reduced? The same test applies to benefits that are paid out, but it might be helpful for the Committee to know what the Government’s policy would be in the event that we have a negative RPI figure. I am not aware that we have had a negative RPI figure for as long as we have been doing things in this way, but if we do, what will happen? It would be helpful to know if benefits and contributions would be reduced, and if not, why not?

Subject to those questions, we have no objections to the particular changes. I am grateful to the Minister for highlighting the typographical error. It would be wrong for me to say that I had spotted it—I do not want to mislead the Committee. We do not have objections to the measures going ahead on that basis and, subject to those comments, we support the orders.

Steve Webb (Northavon) (LD): This is my first opportunity of serving under your chairmanship, Mr. Streeter. It is a great privilege and I hope it is the first of many such privileges.

I was interested in the comments made by the hon. Member for South-West Hertfordshire. The record will show that he has just asked whether if inflation is negative, contributions and benefits will be cut and if not, why not? I understand him to be saying that in the event of his assuming power at some point he would be trying to cut the state retirement pension as one of his first acts.