Peter Saunders is professorial research fellow at Civitas
Our National Insurance system was established nearly 70 years ago on the principle that everyone who is capable of working should make contributions to pay for their retirement and tide them over in periods of sickness or unemployment. The architect of this system, William Beveridge, believed that relying on taxpayer-funded benefits should be a last resort: ‘The plan for Britain is based on the contributory principle of giving, not free allowances for all from the State, but benefits as of right in virtue of contributions made by the insured person themselves.’
This ‘contributory principle’ was a deeply moral one. It was, and still is, widely supported by the British public because it taps into an instinctive sense of fairness. We believe people who are in need of help should be assisted, but we also believe that people should be expected to make provision for themselves and their dependents whenever they can.
In the last 70 years, however, this contributory principle has been badly corroded. Today, people who have made no NI contributions are often treated by the welfare state as if they had, and those who really have accumulated entitlements get very little advantage for their efforts. Unemployment and sickness benefits are paid at the same rate regardless of your contributions record, for example, and from 2016, retirees receiving the non-contributory Pension Credit will get almost the same amount as those whose lifetime contributions have made them eligible for a full state pension.
To make matters worse, many of us have no idea what our NI contributions are funding, and many erroneously believe our contributions are accumulating for our future when they are actually being paid out to existing claimants and pensioners in a giant Ponzi scheme. The government’s unfunded future state pension liabilities currently stand at £3.8 trillion (260 per cent of our annual GDP), but this terrifying burden on the next generation is not included in the National Debt (currently about £1 trillion). Yet the OECD has warned these future claims could bankrupt the whole system.
National Insurance has long ceased to have anything to do with ‘insurance’. It has become little more than a cumbersome second layer of income tax, except it is more opaque than income tax, and it costs employers millions of pounds to administer. Economists at the Institute of Fiscal Studies think it should be merged into the income tax system (creating a basic income tax rate of 32 per cent with the employer’s 13.8 per cent contribution becoming a payroll tax). Eligibility for the state pension and welfare benefits would then depend, not on real or imaginary contributions, but on a simple residency test.
This makes a lot of economic sense. But where would it leave the crucial contributory principle?
In my new report for Civitas, Beyond Beveridge, I argue that if pensions and benefits were to be paid out of general taxation, rather than from contributions, they should be means-tested (although entitlements based on contributions up to the time National Insurance is scrapped should of course still be honoured). The key point is that contributions establish entitlements, but it is wrong to expect taxpayers to fund payments for people who do not need them. Means-testing the state pension could eventually save as much as £40bn per year, and many economists believe it is going to have to come at some point anyway.
Means-testing would in turn require enrolment in the new work-based pensions to be made compulsory for all workers (at present, it is possible to opt out) to guard against moral hazard problems.
All this sounds a bit grim, but there is a silver cloud, for compulsory workplace pensions could gradually be developed into much broader ‘personal welfare accounts’ which would give people control over their own contributions that they never had under the NI model.
These personal welfare accounts could be used, not only to save for a retirement income, but also for funding short periods of unemployment and sick leave, insuring against future nursing home costs, providing loans to pay for higher education fees, and financing parental leave.
At the moment, minimum contributions into workplace pensions have been set at 11 per cent of salary (combining the employee’s and employer’s contribution, and adding the value of government tax relief). This is clearly too low to guarantee self-reliance in retirement, still less to fund additional functions like sick pay or student loans. Hard-pressed workers cannot be expected to pay any more than this – unless their tax burden is reduced pro rata.
But tax cuts could be funded by channelling the mounting savings accruing to the government from means-testing the state pension into reducing taxes on wages. If, initially, the employer Payroll Tax came down from 13.8 per cent to 12 per cent, and the basic rate of income tax dropped from 32 per cent to 30 per cent, total contributions into workers’ personal welfare accounts could rise to around 15 per cent while leaving take-home pay unaffected. Proceeds from future privatisations of state-owned bank assets could also go to boost workers’ personal welfare accounts.
The good news is that gradually, welfare functions currently carried out by the state, using money taken from the working population, could be clawed back by workers retaining more of their own money and beginning to control these things themselves.
National Insurance has all but collapsed as a system for delivering genuine, contributions-based self-reliance. But an evolving system of compulsory personal welfare accounts could fulfil the promise of Beveridge’s original plan. The crucial difference is that contributions made into your own account remain under your control and are therefore secure against the predations of future governments.
With the state pension debt now approaching £4 trillion, the deceitful and immoral game of generational pass-the-parcel, which has been played by successive governments since World War II, cannot continue. But if we dismantle the National Insurance system, the contributory principle at the heart of Beveridge’s thinking must not be lost. Personal welfare accounts offer the best opportunity for realising Beveridge’s flawed but deeply moral plan for Britain 70 years after he produced it.