National Insurance Fund

HC Deb 21 October 2003 vol 411 cc216-36WH

2 pm

Paul Flynn (Newport, West)

The national insurance fund, along with the national health service, was the supreme achievement of social welfare legislation in the 20th century. It was an act of great courage by Lloyd George to face down his many enemies and introduce an insurance fund reform, which has delivered five generations from the worst effects of poverty. We contemporary politicians should be ashamed about what we have done to the fund over the past 25 years. The purpose of this debate is to list the recent damaging changes that have disfigured the vision of the pioneers. The scheme has been neglected, looted, distorted, undervalued and degraded.

When I was reading a website called "Gathering the Jewels", I was struck by an example of how people used to feel about social legislation. The website contains a poem written in praise of a parliamentary Act. Sadly, that does not happen these days, with landfill tax legislation and the aggregates levy for example, although the poet laureate might address himself to that. I will quote one stanza of the poem, in Welsh first:

• "Pwy all fesur gwerth y cysur,
• Dygir 'nawr I lawer ty,
• Yn lle tristwch du, gorlethol
• Gwelir yno obaith cry'
• Ofn y tlotty wedi ei symud-
• Llethol ofn i luaws mawr-
• A phelydrau disglair, goleu,
• Yn mynegi hyfryd wawr."

[HON. MEMBERS: "Hear, hear."] I can see that that has stirred the blood of hon. Members. This is what it was saying in that extravagant language that now feels alien and exotic:

• "Who can measure the value of comfort
• That will visit every home?
• Where once was black overwhelming sadness,
• Now strong hope is seen.
• The great fear of poverty has been lifted
• From a host of people,
• And rays of brilliant, shining light
• Heralds a lovely dawn."

If only we could get our constituents to appreciate our efforts in such terms in these pedestrian days.

David Lloyd George sold the national insurance fund to a suspicious public, particularly the well-heeled, articulate and prosperous, by saying that people would put in fourpence and get out ninepence. That is the way in which the system worked for a long period. It was very good value: fourpence was put in by the employee, the employer contributed thruppence and the Treasury tuppence. When the scheme began, it was very popular. It was reformed in 1948.

The fund is the essential part of our body of social insurance. The system operates on a pay-as-you-go basis: people of working age and their employers pay national insurance contributions based on their earnings. By doing so, they earn the right to pensions and other benefits. Because it is a pay-as-you-go system, it is never possible to identify a particular pot of money or a share in the fund as belonging to a particular contributor. That does not make the rights earned by contributions any less real. In the long run, the system can work efficiently only if all concerned believe that it will be administered fairly and openly, and that the money paid in will be used for its intended purposes. The way in which the fund has been manipulated during the past 25 years has done little to encourage that belief.

The fund works by collecting national insurance contributions, paid by employers, employees and the self-employed, to pay national insurance benefits, of which by far the most important—and the main reason for this debate—is the retirement pension. This year, national insurance benefits are expected to total about £55 billion, of which £46 billion will be for retirement pensions. What happens with the fund affects all those receiving retirement pensions. Part of the fund's job is to retain a relatively small balance, enough to ensure that it remains solvent in unforeseen circumstances, such as a fall in the number of people in employment, which would mean a fall in the number of people paying contributions.

The Government Actuary's report states annually how much is in the fund and how healthy it is. That ensures that the expected income for the coming year is sufficient to cover the cost of the benefits, and leaves what is described as a "reasonable working balance". The Government Actuary views as reasonable a balance of one sixth of the previous year's total benefits. It is important to understand that to realise the extraordinary position that the fund is in today, with a vast, unneeded surplus. In recent years, the fund has been collecting far more in contributions than it has needed to pay the benefit.

An early-day motion of February 1999 noted that the balance at the end of that year was expected to be £5.9 billion. It suggested, usefully I thought, that the unneeded surplus could be used to increase the basic pension to the level of the means-tested minimum income guarantee. That would be a useful way of ensuring that the many people who do not claim their full entitlement—the genuinely poorest pensioners—got their pension as a right and did not have to become supplicants in asking for it. Unfortunately, that was not done and the surplus has continued to grow.

The Government Actuary's latest report shows that by March 2004 the fund will have a balance of £29.3 billion, which is more than three times the recommended level. The unneeded surplus will have risen to more than £20 billion, so it is far from being a pay-as-you-go system. It is a profitable enterprise, which is fine—we are very happy with profits in classic Labour. However, the profits should be applied in a sensible way, because the source of the fund's profits is the money paid in every week by working people and their employers to meet current benefit costs. However, a significant part of that money is no longer used for that purpose; it is being salted away in Government stocks.

The main effect on the fund came with the breaking of the link between pensions and earnings. It is fascinating that the Conservative party has now espoused the restoration of that link. For five continuous years, early-day motion 1 on the Order Paper sought the restoration of the link. I have looked back through the signatures— there were usually more than 100 each time—but not one Conservative Member signed during those years. From 1980 to 1997, having broken the link, the Conservatives kept it broken. If there were a Nobel prize for shameless political opportunism, it would go to the Tory party, which claims to be the apostle of the restoration of the link.

I welcome the Tory party's espousal of the policy—as a non-Government organisation, it can be a useful pressure group to advocate new policies. I speak today in the hope that it will take up the restoration of the integrity of the national insurance fund as another brand new policy. What happened with the breaking of the link was significant and simple. National insurance contributions are calculated as a percentage of earnings, and as earnings rise, the fund's income from contributions automatically rises by approximately the same percentage.

Until 1980, the state pension also rose roughly in line with average earnings. The earnings link itself was only a statutory requirement for a brief period of five years but, in practice, pensions and earnings rose broadly in line with inflation from the war until 1980. Of course, if contributions and benefit levels rise in that way, the effect is entirely neutral. That was the happy situation until 1980, when the earnings link was broken. In what was the grandmother of all stealth taxes, contributions continued to rise in line with earnings, but benefits rose only in line with prices. That went on for 17 long years of salami cuts for pensioners. That was extremely lucrative for the fund, and led to there being so much money in the fund that in 1987 the Conservative Government decided to abolish the Treasury contribution.

Before the Treasury contribution was abolished, fourpence came from the employee, thruppence from the employer and tuppence from the Government. That tuppence was taken out. That is the most significant change to the fund in the past 25 years. The Treasury contribution was 18 per cent. of the combined contributions of employers and employees—a very substantial sum. That was paid in for most of the second half of the previous century. In the first part of the century, a similar amount was paid in. The Treasury contribution stayed at 18 per cent. under both Conservative and Labour Governments until it was phased out in the 1980s. There is now no Treasury contribution as such.

Legislation provides for a Treasury grant to be paid in if the fund looks like going into the red. That happened for a brief period after the fund had been looted for the 2 per cent. bribe used to promote private pensions in that dreadful mis-selling disaster started and inspired by the then Government. That legislation still exists. However, with a surplus of nearly £30 billion in the fund, there is not much risk of that at the moment.

There is a strong case for the Treasury contribution to national insurance to be restored. Although the entitlement to benefit has rested mainly on the individual's record of contributions—one gets what one pays for—it was recognised from the start that some allowance must be made for periods when a person did no paid work; hence the system of contribution credits which, as much as anything, distinguishes social insurance from commercial insurance. The recently introduced state second pension, with its generous system of credits for carers and disabled people, is an excellent example of that, and is a justification for the Treasury paying the supplement. However, if people are to receive, on the ground of social justice, benefits for which they have not paid through their own contributions, by far the fairest way of financing those benefits is through general progressive taxation—by a direct grant from the Treasury—not taking it out of the contributions of those putting money in for their own benefit later.

Reintroducing the Treasury contribution at the level at which it stood before it was phased out would increase the fund's income by about £11 billion in the current year—enough to pay for an increase in the basic pension from £77.45 to £95.60 a week. We are talking about enormous sums. There would be vast consequences for pensioners. A Treasury contribution would also result in similar increases in widows' and incapacity benefits, without even touching the existing £20 billion surplus in the fund.

Another painful period followed the 2 per cent. bribe that was offered after the abolition of the Treasury contribution. That was one of the most shameful episodes in the career of that Parliament. In that disastrous campaign to sell dodgy personal pensions, people were invited to accept what was claimed to be a gift from the Government of £5,000. Part of that was a bribe of a 2 per cent. reduction in NI contributions, which was made at the expense of all those people—the majority—who stayed in the state scheme.

More recently, the fund has suffered massive losses through the introduction of a series of new taxes. I believe that we all admire the new laws that encourage environmentally responsible behaviour by employers. First, there was the landfill tax, then the aggregates levy and, most recently, the climate change levy. In each case, the Government decided to compensate employers as a whole by reducing labour costs, and the simplest way to do that was by reducing employers' NI contributions. That may make administrative sense. There may be a good reason for doing it that way and putting on a charge. It may be the most efficient way to do it. Regardless, the Treasury collects the money.

As a result of recent questions to discover the extent of the loss to the NI fund, I discovered that the fund will lose £1.2 billion this year in compensation for the climate change levy and £0.4 billion for the aggregates levy. I have been told that the effect of the landfill tax on the fund cannot be calculated, but it is entirely safe to assume that the three taxes together are costing the fund some £2 billion a year in reduced employers' contributions, although none of them has the slightest relevance to national insurance. Why on earth should a fund that is devoted mainly to rewarding pensioners for their contributions be looted in that way to pay for the whole country's responsibility for environmental taxes? It is entirely perverse and damaging that that should happen.

There has been a further obscure loss to the fund that is, perhaps, surprising. I believe that we would all agree that we should pay more taxes for the health service. However, when the extra 1 per cent. contribution for the NHS was introduced, the idea as promulgated was that it would simply be handed over to the NHS and that the amount of money available for pensions and other benefits would not be affected in any way.

The truth was revealed in paragraph 10 of the Government Actuary's report of February 2003. It explains that, although the extra 1 per cent. employers' contribution is payable only on earnings above the secondary threshold of £89 a week, the amount paid to the NHS is defined as a percentage of all earnings, not just earnings above the threshold. It is difficult to believe, but the result is that an extra £1 billion a year over and above the 1 per cent. contribution is being transferred from the NI fund to the NHS. Again, that is without logic or sense. It is grossly unfair to the principal beneficiaries of the NI fund.

What all that amounts to, adding up the results of all those changes, is that the current annual income of the NI fund has been reduced by some £13 billion a year and its annual expenditure increased by another £1 billion—a total loss of £14 billion a year. That is almost exactly one third of the total bill for retirement pensions. It is a vast amount that, if it were available, would easily allow the minimum income guarantee to be at the same level as the basic pension. The basic pension would then be paid.

As many hon. Members have said in the House, the great problem with the poorest pensioners is that they have lived their lives in self-respect and dignity and never taken a handout. Many pensioners will say with great pride that they have done that and never had to seek any handout from the state. When they reach retirement age, they say that they are not going to start doing it. They say that they have paid their dues—their contributions—and they see no reason why they should ask for income support to raise their income to what the Government define as a basic necessity of life.

Now we are in government, we have exchanged scripts from when we were the Opposition. I remember a Government spokesman saying that we must not talk about stigma, because that was a bad word and would discourage people from claiming income support—the same thing was said before 1997 by the Tory Government. That group of people still remains. Although we do not know the precise number, there are probably around 500,000 of the poorest pensioners living below the level of the minimum income guarantee.

Despite all the losses that the fund has taken and all that has gone on, there is still a massive and steadily growing surplus, which currently stands at £20 billion. That is over and above the working balance recommended by the Government Actuary. Is it any wonder pensioners reject the argument that says that an increase in the basic pension to the level of the minimum income guarantee is unaffordable? Is it any wonder that young people have so little confidence in a state system that says that they will be paid adequate pensions, as promised, when we see the chicanery that has happened under Labour and Tory Governments in recent years?

If the Government are looking for new ways to spend the huge surplus, there are many ways they could do it. One of the most heart-breaking situations is the suffering of Allied Steel and Wire pensioners and, to a lesser extent, those of Bell Lines in my constituency. Those people paid into their occupational pension funds and expected something at the end of it. They now feel that they will be short-changed, or that they may end up with no pension at all.

It would be far more appropriate if the Government found out what the finite amount involved is and decided—exceptionally, for a limited period—to compensate those who have lost their pensions for no reason at all. There would be a very small amount involved, compared with the sums of money in the national insurance fund at the moment.

Kevin Brennan (Cardiff, West)

My hon. Friend's argument is compelling and reveals a lot. Is he aware that one of the arguments advanced about why Allied Steel and Wire workers, and others in the same position, cannot be compensated is that the Government do not stand behind private pensions? He has, however, revealed to us this afternoon that the Government of the day raided the national insurance fund to subsidise dodgy private pensions, rather than the rock-solid private pensions that workers were told—indeed, compelled—to join when they went out to work. Would not it be much better to use any surplus in the national insurance fund to compensate those workers, thereby restoring confidence in occupational private pensions?

Paul Flynn

That is entirely right. We know the Government's objection to having a bottomless pit of compensation that might go on and on. However, the law could be changed to ensure that the disaster of Allied Steel and Wire would not be repeated in future. If there is any cause precisely associated with the social insurance fund that must be at the top of everyone's list, it is the one I am talking about. That is far more relevant than the green taxes, which have no connection with the national insurance fund at all.

After the sad effects of the past 25 years, we must make a move to restore people's faith in social insurance. A group known as Catalyst published a pamphlet called "Better Pensions: the state's responsibility". It suggests one possible way of restoring faith in our social insurance system. It proposes the appointment of a national insurance commission consisting largely of representatives of contributors and pensioners, which would be responsible for fixing benefit and contribution rates and proposing structural changes to the benefit system. The Government and Parliament will still have the final say, but if the Government want to impose changes to benefits or contributions that are contrary to the views of the commission, they would have to lay before Parliament a full statement of the reason, which could then be debated by the House.

That proposal is similar to one that was published a while ago by Tony Lyons in a booklet called "Our Pensions". He made a persuasive suggestion that the whole national insurance fund should be placed at arm's length from Government, so that they are not tempted to interfere with it when dealing with matters that are entirely extraneous to the fund. The fund should be divided into two sections: one that is invested and one that is kept as a static fund. Managers of the fund should be rewarded on the successes of their investments and on the contributions that they manage to pay out. That is where we stand.

David Lloyd George introduced a marvellous and brave law, but we are now far away from the bright new dawn that was then envisaged. There are dark clouds over the pension industry and pensions themselves. There is a way out, and that is to rebuild confidence in the social insurance principle, so that people know that if they put money in they will get it out at the end. Instead of getting ninepence for fourpence, sadly, the deal for many people is that they put in ninepence and get fourpence. All parties in the House should combine to restore the full confidence that the national insurance fund enjoyed in the past, and to recreate it on a fair, just and reasonable basis.

2.27 pm

Mr. Steve Webb (Northavon)

One of the joys of these extended Westminster Hall debates is that they provide the opportunity to think and reflect. We should all thank the hon. Member for Newport, West (Paul Flynn) for giving us the chance to do just that this afternoon and congratulate him on a thorough presentation and documentation of what has been happening to the national insurance fund since David Lloyd George—who is his forebear as much as mine—introduced it 100 years ago.

I broadly agree with the hon. Gentleman's analysis of the problem and of where we have got to, but I part company from him when it comes to where we should go from here. I agree that national insurance has become, to all intents and purposes, another tax. It raises a pot of money that Governments feel free to dip into for whatever purpose suits them at the time, and a lot of what goes into the fund does not earn any entitlement anyway. Employer contributions, which are of course greater than employee contributions, earn no rights whatsoever, but are just a payroll tax. Class 4 national insurance contributions accrue no benefit rights; they are just another tax. Much of what goes into the fund is tax by any other name. The examples that the hon. Gentleman gave of what is done with the money—relieving employers of payroll burdens for green taxes and that sort of thing—is further evidence that we simply have a pot of money with an historic boundary around it, which is increasingly hard to justify.

I also agree that there are plenty of good things that we could do with the money. We can all think what we might do if we had £20 billion. There is sometimes the sense that this is free money and that we can spend it without it costing us anything—I do not accuse the hon. Gentleman of that. We need to remember that every pound spent from the national insurance fund using up that surplus is another pound on aggregate Government borrowing. If Government raised another tax and spent that money, it would have the same effect. I am not sure that we can spend that pot of money in any meaningful sense. The money is being raised through a direct tax and if we put the Treasury supplement back in, we would have to raise other taxes to pay for it. It is certainly not free money, and we must be careful not to give that impression.

If national insurance has effectively become a tax like any other—I suspect that that is the way that we have gone—what do we do about that? The hon. Gentleman's principled position is that one restores the original intent of the national insurance fund and recreates social insurance. My problem with that is that social insurance has become a system of exclusion. Social insurance today involves a set of rules that stop a set of people from getting benefits.

By and large, men pay national insurance; virtually all who work earn above the lower earnings limit, therefore virtually all accrue pension rights. A number of women do not do so. Many women who have two part-time jobs below the lower earnings limit accrue no pension rights at all. The rights of carers are limited. Although the state second pension gives rights to carers when their child is up to five years of age, a mum who is not earning, or not earning up to the lower earnings limit, and whose child is six gets no protection.

National insurance today excludes a subset of people, predominantly women, and predominantly the low-paid. Do we really want to reinforce that structure, or do we want to develop a new one? We should move away from a situation where people's retirement pensions are linked in a complicated way to their record of national insurance contributions during their working lives. All that does is create a lot of infrastructure and administrative cost to keep a small number of people out. That is what national insurance does—it excludes a minority.

Henceforth, we should have a citizenship-based pension whereby each year one accrues a right to a year's worth of state pension—or a 40th, or whatever the percentage is—on the basis of having been a citizen of the country. The effect of that would be to bring in women who work part-time, are low-paid or carers and so on. That would ensure that people are getting a good pension in their own right, rather than excluding people.

The reason I suggest that now when it would not have been the right system 100 years ago is that Lloyd George's model for the pension was that what was needed—this was particularly true post-war with the Beveridge model—was that the pension should be enough to support the man and his dependants, not to support women in their own right. In other words, it did not matter that women were excluded from national insurance because they did not need pensions—they depended on their husbands. We do not want to reinforce such a structure.

We want a citizenship model that allows people to earn pension rights through being a citizen. Therefore, social insurance ceases to be relevant to the basis of entitlement for pensions. Under that system, men and women are treated equally and we do not have a bureaucracy to keep contribution records only to exclude a small number of people. It is an inclusive agenda and once everyone is getting a citizenship pension, the political cost to any Government of mucking about with it is much greater.

As the hon. Gentleman graphically demonstrated, because the present system in so complicated—no one really understands how it works—Government after Government and scheme after scheme can dip a billion here and there out of the national insurance fund and get away with it scot free as it has no political visibility. A citizenship-based pension that is nothing to do with complex social contribution rules, with people knowing that they as citizens have a right to a certain level of pension, would be a much better way of doing things.

Having said that, I accept that hypothecation—that is not what Lloyd George would have called it—has an important part to play. Hypothecation makes taxation more acceptable. People are more willing to pay any given level of tax, or any tax increase, if they know where the money is going, and it is going on something that they want it to be spent on. That is why the Liberal Democrats have increasingly come to the view that we should hypothecate the entire national insurance pot to the national health service.

There may be all sorts of arguments against that. Once a pot of money has been hypothecated to the health service, what do we do if we have a bad year and there is no national insurance? Do we cancel operations? We have a model. The Treasury does not set its goals from one financial year to the next; it sets them over the cycle. It says that that is necessary to satisfy certain economic rules over the cycle, not in each financial year. If one hypothecated the entire national insurance pot to the health service, one could have the independent commission that the hon. Gentleman suggested. It would set the national insurance rates so that over the cycle the national health service would have the funds that it needed for the spending plans that Parliament had set.

If, for example, the public wanted an improvement in the health service, politicians could say, "We will put your national insurance up," and by statute that money would be ring-fenced for the health service. Evidence shows that if the public believe that money is going where they want it to go, they will be more willing to accept an increase. A policy that lowers the political cost of putting more money into public services has to be good for those hon. Members who are positive about progressive taxation and an active public sector.

The Chancellor's increase in national insurance last year for the benefit of the health service was a watered-down version of what I am discussing. I used e-mail to poll hundreds of my constituents about the extra penny on national insurance and about two thirds said that they liked the idea provided that the money went to the health service. I did not ask them to say that—it was an unprompted response.

The principle of hypothecation is good. It reduces the political cost of providing enhanced public services. In a modern setting, the principle of hypothecation must not be to reconstruct state pensions based on an insurance model that excludes those who are too poor to pay insurance. It must be the basis of payment for the national health service—a different sort of national insurance.

The hon. Gentleman mentioned a couple of areas on which he would spend the surplus. We share a lot more common ground on that point. We share the view that the value of the basic state pension is wholly inadequate and that it is not good enough to re-link it to earnings from its present inadequate level. Keeping the state pension at its current percentage of average earnings will leave it substantially below the means test indefinitely, if the test is earnings linked. If it is price linked, the poorest households will lose out. We must increase pensions before considering indexation rules.

I am relaxed about whether that increase is made through a national insurance rise or a tax rise because the structure of national insurances is such that employee contributions are still effectively capped. Paying for a state pension rise through national insurance, which is capped, is less progressive than paying by income tax, which is not. I agree with the hon. Gentleman about the ends of an enhanced basic pension but I am not sure about the means. I am not sure whether clear and honest direct taxation is not more progressive than a contribution system in which those earning above £30,000 pay no more than those earning below.

The hon. Gentleman mentioned the position of people whose company pensions have been inadequately wound up and asked where we can find the money for them. I agree that we must find the money, but I question whether the national insurance fund is the right place. One would be asking employed earners—primarily those who are not in private schemes—to compensate those in private schemes. They might feel that that is unfair. If the general taxpayer funded the system, it would be fairer. Anything funded by national insurance is by definition funded from a subset of the population. It is not clear why that subset— those earning in particular income bands in particular employment—should pay, rather than taxpayers as a whole. That distinction does not help us any more.

I back what the hon. Gentleman said about compensation for people in schemes that are wound up owing to inadequate funding. It is unacceptable for the Government to say that in a few years they will protect people but that those who fall foul of a wind-up tomorrow will be completely abandoned. The Government are worried that there would be an element of retrospection if somebody whose pension fund had been wound up were compensated. However, compensation is by definition retrospective. Somebody cannot be compensated for an event until it has happened; it would not be compensation if somebody were paid before an event. Governments have always compensated people when things go wrong for example as a result of the legislative framework being incorrect.

To give an analogy—I am not straying from the topic, Mr. Deputy Speaker—when people had blood transfusions that were not properly checked for Creutzfeldt-Jakob disease, the Government said, "That is not right. We are going to do something." The action was retrospective in that it occurred after the event, but it was compensation and properly so. Likewise, given that people are sometimes forced to join pension schemes as a condition of employment, when the Government introduced the Pensions Act 1995, which states that if a scheme goes belly up people have got practically no rights, they took responsibility for it.

Retrospection is not an issue. Compensation should be paid and the hon. Gentleman is right about that. I do not care two hoots whether the compensation is from the national insurance fund or anywhere else. The Department for Work and Pensions has identified surplus funding for the coming few years in unallocated spending, and that is where I should like the money to come from.

The hon. Gentleman is right that we have come a long way from the founding principles of national insurance. The question is whether we rebuild that structure or build something new. My concern about rebuilding is that we live in a world in which women should be treated not as their husbands' hangers-on but as people in their own right. I do not want to rebuild a structure that treats women as second-class citizens. I would base the pensions system on citizenship rather than on contributions, which would help women, carers, the low-paid and the disabled, but preserve the idea of hypothecation—a ring-fenced tax for a ring-fenced purpose—and apply it in the 21st century to the health service as it was applied in the 20th century to pensions. The hon. Gentleman has done us a service by raising the issues because there is too little scrutiny of what happens to the national insurance fund. The House owes him its thanks this afternoon.

2.41 pm

Mr. Howard Flight (Arundel and South Downs)

I add my congratulations to the hon. Member for Newport, West (Paul Flynn) on securing this valuable debate. I thank him for his analysis of the history of national insurance. I should like to focus on a few historical points before examining the political issues more closely in relation to this and previous Governments' uses of national insurance funds and, more generally, taxation.

I spent a period of my life studying the economic history of the 19th and early-20th centuries. As the hon. Gentleman outlined, national health and unemployment insurance was introduced by the National Insurance Act 1911 with mutually owned bodies and friendly societies operating the health aspects of the scheme and with contribution levels laid down by Parliament.

Interestingly, substantial pension arrangements and health finance had previously been provided by friendly societies and trade unions. Although there is debate about how serious the situation was, the concern was the big jump in life expectancy at the end of the 19th century, when cholera and typhoid were finally conquered. It was feared actuarially that those bodies would go bust, and the focus was therefore on what to do about it. Members will know that both Churchill and Lloyd George went to Germany to study what Bismarck had done. The subsequent campaign stated that,

A Healthy Empire needs Healthy Bodies". The provision was promoted not as a socialist measure, but as part of the heady imperialism of those days. Indeed, Lloyd George spoke about putting Britain ahead in this field on a level with Germany; we should not emulate them only in armaments". It was a competitive imperial strategy.

Until 1948, our system was a bit like German health insurance today in that membership was not compulsory. As late as 1960, I can remember asking why one of my grandfathers got a state pension and the other did not. The gist of what I learned was that the one that did not had an income in the 1920s and 1930s when he was not obliged to participate in the system, as was generally the case, and the other one did not earn as much. As the hon. Member for Newport, West will know, for more than the first half of the previous century, it was not a universal scheme at all. Some changes in the 1960s brought everyone in to qualify for state pensions, even if they had not necessarily paid their contributions.

I was never clear whether the original intent was that that should be funded like an insurance scheme, or whether it should be a pay-as-you-go system from day one. There was some controversy on that question at the time, but the fact is that it has become a completely pay-as-you-go system, not a funded one, with individuals paying money, at least in theory, into a general pot. Governments have for a long time treated that in reality as just another form of tax revenue, but with entitlements to what one can draw in benefits. Those are partly determined by contributions, but another category of welfare benefits is not determined by contributions. Since the 1960s, we have had a complete mish-mash in terms of what entitlement across the broad range of welfare benefits rests on. Some go back to the Churchill and Lloyd George measures and some date from Wilson's measures, when the concept was brought in—by accident, as I have always understood it—of rights to welfare.

In the community, there are very different views. If one talks to people of 50 or over, including me, they broadly still think that it is an insurance scheme, where we have paid our national insurance and are entitled to our benefits, and they get extremely annoyed when Governments fiddle around with it. They might greatly support the hon. Member for Newport, West in the argument that Governments have raided the scheme. However, people in the younger age group broadly see the scheme as just another form of taxation levied under different rules. In that sense, the whole accounting is something of an illusion. It needs to be done, but it is really going through the motions while the Treasury get at a particular source of taxation. Some people in both main parties have argued for merging national insurance and income tax, and I have spent a fair amount of time during my life examining such proposals. Largely on pragmatic grounds, I have concluded that that would be a bad idea, not to mention the problems that transition would cause for entitlement if any Government sought to do that.

I have sympathy with the hon. Member for Newport, West on the point that the integrity of what was originally intended has been undermined and made into grey territory. Talking about unused money in the fund is an accounting illusion, and it is not on politically to revert to a truly integral arrangement. If one were to do that, it would be necessary to consider a funded arrangement, for it to stand alone. National insurance receipts are treated today very much as part of general tax revenue. They are not invested and there is no separate fund. When national insurance was introduced, the Liberal Government were anxious not to raise income tax, and were looking at a way of solving a problem that had emerged with the financial difficulties that the friendly societies and some of the trade union welfare arrangements had encountered as a result of improved life expectancy.

In place of the Liberals, we have today a Labour Government in a very similar situation. They do not want to raise income tax, for fear of alienating voters, so we have had the politically convenient measure of increasing national insurance contributions by 1 per cent. without any ceiling, which is patently simply a tax on earnings and employment. Business leaders, as well as my colleagues and I in the Conservative Treasury team, have attacked the Government for those increases, which have been levied since last April. At the time they were introduced, people had forgotten about the tax increases that were already in the pipeline following the previous Budget and had quite a major shock when they opened their April pay packets.

It is absolutely clear that, because NICs are levied on business and personal taxpayers, the perception is of a tax on jobs and pay. Indeed, for the first time in a long time, disposable incomes after tax are falling, with the overall tax take in the current year, specifically boosted by national insurance, up by 7 per cent. and about £27 billion in aggregate.

The evidence suggests that it was slightly an unwise form of tax at a wrong time. Last week, Britain's biggest bank advised that it was going to shed 4,000 jobs, at least partly as a result of increased employment costs, which were put up by the national insurance rise. When the figures are not interfered with by changing to a different system, they show that we have a background of an 85,000 fall in private sector employment in the past year, matched by a larger rise in public sector employment. Therefore, increasing the costs of employment is, as expected, serving to reduce jobs.

We should not be surprised by that negative impact. The Treasury said in 2000: Lower National Insurance Contributions will act to promote employment opportunities and businesses will benefit from the cut in employer's national insurance contributions, which will enable them to employ more people. In the last general election campaign, the Prime Minister gave his word and spoke against any increases in national insurance charges. When asked whether any reasonable person would suppose that the Labour Government might increase national insurance charges, the Prime Minister replied that "they shouldn't" so suppose.

The hon. Member for Newport, West commented on recent Conservative announcements on state pensions. The thinking that lies behind those announcements, which is perhaps a little different from his thinking, is that the Government have got the country into a nightmare situation in which all incentives to encourage private sector pension saving, such as the stakeholder initiative, no matter how well intended, are completely negated by the pension tax credit.

More than half of the nation would be foolish to save for a private pension. They would have to save about £180,000 to be in a situation equal to that which they would enjoy under the pension tax credit. Yet, for the good of the economy as a whole, and as the Government's own target has set out, there is the desire to increase the proportion of private sector pension provision as a proportion of the total.

People are greatly discouraged from saving privately for pensions because they do not like the idea that, by 75, they will have to part with all their savings, buy an annuity and take a chance on whether it is a good time to do that and whether inflation or interest rates are rising.

The only solution to those two massive problems is to get the basic state pension up to the minimum income support level. That would mean that both measures would no longer be necessary. In that context, we concluded that the only way in which that could be done is by restoring the earnings link to allow basic pensions to rise. It will take some time to do that and it would be too expensive to do it more quickly. For the sake of clarity, that is the fundamental objective. The key to restoring better levels of private sector pension saving is a basic state pension that means that there is no longer a need for the pension tax credit, or to force people to buy annuities.

May I say a little about NICs and health spending? Again, such is the myth about NI that one can say whatever one likes. I recollect that the 1 per cent. increase was presented as hypothecated to the health service. However, when the Chancellor of the Exchequer presented the actual figures in the relevant Budget, it was broadly shown that half of the increase would go to finance the health service and half would go to finance tax credits. Precisely how much of the extra NIC levy is in any meaningful way financing additional health spending is not clear. The reality is that it was a smokescreen for levying more tax on income and employment to pay for higher Government spending in aggregate.

Here lies the problem. The sudden and dramatic shift to tax and spend three years ago is failing dismally to deliver improved public services. Indeed, on the Government's own Office for National Statistics figures, 83 per cent. of the 50 per cent. increase in public sector spending since 1997 has gone on public sector inflation, which has risen from 1.6 per cent. to 6.5 per cent. and is now nearly 7 per cent. It is that failure that will be the main determinant of the next general election result.

For too long, health funding has been used as a political badge of honour or banner, rather than seen as a serious subject that affects the good of the country. Major reforms, not just ideological rhetoric, are needed to enable better delivery of health services. Above all, the Government should be concerned about output and delivery, not just spending. One could vastly increase spending and not get any material improvement in output.

In this territory, the Liberal Democrats seem as bad, or worse. Earlier this year, the then Liberal Democrat spokesman on Treasury issues, the hon. Member for Truro and St. Austell (Matthew Taylor), committed his party to a permanent ring-fenced tax for the NHS, without mention of the necessary reforms to enable the NHS to deliver better services. He said that he wanted to replace NICs with an NHS contribution tax to fund the NHS. I was not entirely clear from the contribution of the hon. Member for Northavon (Mr. Webb) whether that is still Liberal Democrat policy, after its changes.

Paul Flynn

May I clear up one point? The hon. Gentleman says that the reason why his party now supports restoring the link is not that it wants what pensioners tell me that they want. Pensioners want a guarantee that their income will not decline with inflation. They want reassurance that, whatever happens, their income will continue at least at its present level. However, I understand that the hon. Gentleman's main reason for restoring the link is to boost the private pensions industry, which benefited so well from the previous Tory Government, particularly from the 2 per cent. bribe and the way in which the state earnings-related pension scheme was cut in half. Personal pensions were actively promoted with the result that at least 6 million people were mis-sold pensions. Would he not embark on a disastrous road in making another attempt to support the private pensions industry, which is inefficient, wasteful and very costly to administer compared with the NI fund?

Mr. Flight

Of course, restoring the earnings link does just what it describes. The point that I was making was different from the sweet but inaccurate little caricature that the hon. Gentleman sketched. There is consensus across all parties that if private sector pension saving in whatever form is not increased—the Government's target is to move from 40 per cent. to 60 per cent.—the outlook for the overall economic welfare of our people and the ability to deliver welfare will be threatened. The economy will become bogged down like that of Germany with excessive levels of taxation, and will be unable to grow fast enough to produce the necessary growth to finance improved welfare. Therefore, the question is: how can the country move in the right direction? The present major barriers to increasing private sector pension saving are emerging as, first, the pension tax credit—no matter how well intended it is, it is a major disincentive—and, secondly, the obligation to buy an annuity.

No one denies that there were serious problems with private sector pension saving, but the hon. Gentleman would be mistaken if he did not realise that this country, prior to 1997, was to some extent the envy of the world in having achieved greater pension saving and greater participation in private sector saving, which was roughly at 70 per cent., than any other economy, and in having the economic advantages that went with that. The issue of tackling the proper selling of pensions, how they should be invested and managed, and other measures are being addressed and broadly enjoy cross-party support. If the hon. Gentleman believes that we can all have better welfare without the economy growing to a level that can finance that, he is deluding himself.

I close by going back to the issue of the debate. It has raised the major question: does our country stay with our rather mongrel national insurance arrangements, which in many ways are, on one side, merely another form of taxation but, on the other, a measurement of entitlement? Do we consider moving back towards what was originally intended, or even to a funded arrangement, or do we look in the other direction of merging national insurance and income tax?

My conclusion is that there should be a little more integrity, but the arguments against—in either direction—are rather more powerful than the criticisms of the present arrangements. Although the points of principle raised are perfectly justified, I certainly do not see an easy or powerful path without problems that would take us back to where national insurance came from in the beginning. However, I will certainly heed the hon. Member's words, and I think that the concept of a funded arrangement is well worth looking at.

Mr. Deputy Speaker

I call the Financial Secretary to the Treasury to reply to this fascinating and well-informed debated.

3.2 pm

The Financial Secretary to the Treasury (Ruth Kelly)

I pay tribute to my hon. Friend the Member for Newport, West (Paul Flynn). I greatly enjoyed his contribution. It was passionate and poetic, and I congratulate him on it. He has shown a long-standing interest in the subject, and I commend him for that.

It is probably worth starting with a few words of background about the national insurance fund. It was established in 1911, reformed in 1948 and it assumed, broadly, its current form in 1975, when the national insurance industrial injuries and the national insurance reserved funds were merged with it. It lies at the heart of the national insurance system, which was inspired by William Beveridge in his 1942 report and introduced by the post-war Labour Government in 1948. The Beveridge report set out the principle on which the fund is based. I quote from it: Every citizen of working age will contribute … according to the security that he needs … benefit in return for contributions, rather than free allowances from the State, is what the people of Britain desire. In debates on the 1946 National Insurance Bill, James Griffiths MP said: I have no hesitation in saying—I have said it before outside and I will say it now in the House—this scheme is the best and cheapest insurance policy ever offered to the British people, or to any people anywhere."—[Official Report , 6 February 1946: Vol. 418, c. 1751.] That is what it has been ever since: an insurance policy for every working family, ensuring that they have a right to benefits when they cannot work because of unemployment, incapacity or age, financed by contributions to the fund by employees, employers and the self-employed. As has been mentioned in the debate, it is based on a pay-as-you-go principle, which means that those working today are supporting those claiming contributory benefits today.

The national insurance fund provides security for those contributory benefits. It is ring-fenced and cannot be used for other Government expenditure. It is reviewed every year by the Government Actuary, who reports to Parliament on the effect of any changes to contributions or benefits and on the state of the fund. The Government Actuary also reports on the prospects for the fund every five years. The latest quinquennial review is due to be published shortly. The accounts to the fund are audited by the National Audit Office and published annually. The national insurance fund is, therefore, a clear and transparent mechanism for demonstrating the link between national insurance contributions and contributory benefits.

My hon. Friend has pointed to what he calls the fund's vast, unneeded surplus. I take issue with some of his comments. The fund is clearly in a healthy state. Income from contributions is more than enough to cover expenditure on benefits. As my hon. Friend pointed out, the Government Actuary's latest report shows that the balance at the end of 2003–04 is likely to be nearly £20 billion. That number needs to be set in context. During the current year, the fund's income is expected to be £63 billion and expenditure on benefits about £60.5 billion, 80 per cent. of which will go on retirement pensions. The difference, which is added to the balance, is only about £2.5 billion. Last year, the difference was £3 billion, and that is a small proportion—about 4 per cent.—of the amounts flowing through the fund.

As my hon. Friend said, the then Government were sufficiently confident of the state of the fund in 1989 to abolish the Treasury supplement. However, by 1993— just four years later—legislation had to be introduced to provide for a Treasury grant to prevent the fund from running out of money. That clearly illustrates how wrong it is to take a short-term view of the fund.

Paul Flynn

I think that my hon. Friend is defending a situation where contributions were going up at a high rate—the rate of the level of earnings—which led to increases in prices. Funds were built up between 1980 and 1987 by that method, but using such a system was fraudulent for the beneficiaries. However, following the introduction of the fund in 1911, the rate of money going in and coming out was roughly the same and matched inflation. I do not think that my hon. Friend is defending the Conservative position, but there is no question but that the surplus is unneeded. The surplus is defined. I have watched, as many others have, the surplus go from £5.9 billion in 1999 to £20 billion now, over and above the contingency fund. Surely, the surplus is not needed.

Ruth Kelly

In no sense am I trying to defend the decisions taken with regard to benefit levels during the 1980s. However, even when there is a positive surplus in the fund, it is tempting to think that it will persist indefinitely. In fact, events can mean that the surplus disappears quickly; between 1989 and 1993, in the space of just four years, the surplus that had led the Conservative Government to abolish the Treasury supplement disappeared so dramatically that they had to introduce legislation to allow a Treasury grant to supplement the income of the fund. I am arguing that, although a surplus might appear very large at any point time, it is not right to assume that it will not be needed for the purposes of the fund in future.

Paul Flynn

There was a call for Treasury funds in the early 1990s because of a self-imposed double whammy from the then Government. There were two losses to the fund. The 2 per cent. loss in contributions was caused by the bribe to persuade people to take out personal pensions. The reason for the shortfall was, therefore, because of a loss of income to the fund, which was to the great advantage of the private pensions industry. Those were peculiar circumstances, which are unlikely to be repeated.

Ruth Kelly

We will not have to wait long to discover the Government Actuary's view of the current surplus in the fund. Events—some of them, perhaps, inspired by the Government, in which instance there were obviously aggravating factors—can mean that the surplus turns around very quickly. I am cautioning against viewing a surplus above the 16.7 per cent. margin that the Government Actuary specifies as unnecessary and available to be spent.

There is a more significant point. The balance on the fund is not wasted. The hon. Member for Northavon (Mr. Webb) made that point. Any surplus in the fund is used to buy gilts, which provide security for contributory benefits and reduce the Government's need to borrow elsewhere. It is a mistake to think that there is a pot of money that could be used to fund spending on another purpose.

Mr. Flight

The point that the Minister has just made—if there is a surplus, it goes to fund other Government activities by buying gilts—is in essence the mechanics under which the illusion of a separate fund is maintained, because the overall economic effect of national insurance revenues is that they come out just the same as any other form of tax, even though they are accounted for separately.

Ruth Kelly

I do not think that that is the case. The money that is built up in the fund is based on a system of contributions; the hon. Member for Northavon made it clear that people earn entitlements built up through the national insurance fund. The fund, and the availability of the capital in it, is protected and ring-fenced for contributory benefits. Because of the gilt system, the borrowing requirement is reduced elsewhere as well.

This debate touches on our pensions policy in general, and whether it is right to restore the link to earnings or to follow a different approach. Many challenges face us now and in the future. The most important of them are to combat pensioner poverty and to ensure that all of today's workers can provide a decent income for themselves in retirement.

More of us are living longer. Birth rates are falling. At current trends, in the middle of the century, pensioners will outnumber children: there will be a mere 10.1 million children, compared with 14.6 million pensioners. By 2020, 40 per cent. of our population will be over 50. There will be more older people with fewer working age people to support them. That has serious implications for the Government and for society as a whole.

When people decide to retire—they should be allowed to retire later, if they so wish—they currently have to face a retirement of about 20 years. As the century progresses and life expectancy increases, retirements may last up to 20 per cent. longer. People must consider how they plan to achieve their required income in retirement. They have to ask themselves whether they are on track to achieve their target level of income. Will they need to work longer or save more? The Government must put in place systems to ensure that our pension system remains sustainable, and that services are in place to serve an ageing population.

Our reforms are about tackling poverty and helping people to plan and to save for their retirement. For the past three years, we have increased the basic state pension by significantly more than the legal minimum requirement. We have guaranteed that for the rest of the current Parliament we will increase the basic state pension by 2.5 per cent., or the retail price index if that is higher. That stands in marked contrast to previous Conservative party policy. When it was in power, it increased the basic state pension only once, to compensate pensioners when it introduced extra VAT on fuel. The Conservatives left millions in poverty: they expected pensioners to live on just £68.80 a week. My hon. Friend the Member for Newport, West and other hon. Members will be aware that we also introduced the £200 winter fuel allowance and several other mechanisms to help pensioners.

Paul Flynn

The Government have certainly increased pension levels beyond the rate to which they would have risen had the link been restored in 1997. Is it not a matter of regret that the perception of pensioners is different from that? The lack of transparency in the fund and the fact that it does not exist as a separate unit has led to confusion in the public mind. If there were a simple, transparent system, where people put money in and got something out, it would be greatly appreciated.

Had the Government restored the link, which would have cost them nothing because of the large increase in 2001 and low interest rates, that would have been to their enormous benefit politically. It would also have given some satisfaction to pensioners to realise that the totem policy of restoring the link had been achieved at virtually nil cost to the Government between 1997 and now.

Ruth Kelly

It is worth reminding hon. Members that the pension credit was introduced only this month. If the present situation is compared to the 1997 system, one sees that, on average, pensioner households will be £1,250 a year better off in real terms as a result of Government measures, including the pension credit just introduced. That is about £24 extra a week. The poorest third of pensioners will have gained about £1,600 a year in real terms. If people had to choose between that and a rise in the basic state pension linked to earnings, they would choose to have the extra average £24 a week. Of course we can debate the matter, and I know that my hon. Friend holds his views close to his heart.

Paul Flynn

My hon. Friend is being very generous with time in allowing me to intervene. Will she address the position of the very poorest pensioners: those who are entitled to income support to raise them to the level of the minimum income guarantee, but who do not claim it?

Ruth Kelly

Yes. We have a take-up campaign to try to get people to claim the benefits to which they are entitled. However, one of the aspects of the pension credit is the Pension Service system, which means that the pension credit becomes an entitlement for pensioners and that they no longer have to use the old-fashioned means-tested system. As they approach the age of 65, pensioners will start to receive the credit as a matter of course for a period that is fixed for up to five years. The system and the culture surrounding it are changing, so that pensioners will view that credit increasingly as part of their normal retirement income.

Restoring the link between pensions and earnings would be unaffordable, unsustainable and unfair. It was not long ago that the Opposition spokesman for work and pensions, the hon. Member for Havant (Mr. Willetts), called restoring the earnings link a wild and uncosted policy".—[Official Report, 8 June 2000; Vol. 351, c. 440.] It is hard to believe that that is now the policy of the official Conservative Opposition. He has also said that his Government in the 1980s had taken the "crucial" step of ending the link between the basic pension and earnings and resisted the seductive politics, but dangerous economics that had bedevilled state pension arrangements in other countries".— [Official Report, 8 July 1993; Vol. 228, c. 516.] That was something that he was keen to pronounce not very long ago. As my hon. Friend the Member for Newport, West, said, if there were a Nobel prize for shameless political opportunism, the Conservative party would certainly win it.

Mr. Flight

I rise merely to comment that since then my hon. Friend the Member for Havant (Mr. Willetts) has costed that and found that it is affordable. He has set out precisely how we would pay for it.

Ruth Kelly

If the hon. Gentleman explores his party's policies and scrutinises them more closely, he will see that the hon. Member for Havant proposes, for example, to abolish the new deals for lone parents and for young people, which institutions such as the National Institute of Economic and Social Research have said pay for themselves.

The policy is completely uncosted, but more than that, it is unfair. Under the Tory plan, as the shadow Chancellor has conceded, nothing will be done to help the poorest pensioners, who will fall further behind and see any increase in the basic state pension knocked straight off their pension credit. That also fails the basis test of fairness towards poorer pensioners. We believe that the foundation of the state pension system on pension credit, the minimum income guarantee and increases in the basic state pension is a much fairer way to proceed.

We are also looking after the interests of future pensioners. The state second pension, which was introduced in April 2002, reformed the state earnings-related pension scheme. That, too, follows the theme of aiding the poorest. It allows greater accrual rates for the lower paid—those earning less than £11,200 a year are being treated as if they had earned that amount.

The accrual rate applying to earnings up to £11,200 is double the rate that applied under the state earnings-related pension scheme. For the first time, carers, people with disabilities and those with broken work records are helped to build the state second pension. When that is compared to SERPS, it provides extra help for retirement for around 20 million people.

Mr. Webb

Surely, it all depends what it is compared with. Mothers who receive child benefit get complete protection in the basic state pension but, under the state second pension, once their children are five, they do not. Mothers with children over five would have done better with all that money on a decent basic pension, rather than on a state second pension, under which they do not qualify for credits.

Ruth Kelly

Even the hon. Gentleman does not dispute the fact that some 20 million people will benefit from the state second pension and many groups of people in the circumstances he mentioned would not benefit from the basic state pension.

We have not only been active on the state pension. To return to the point that was raised by my hon. Friends the Members for Newport, West and for Cardiff, West (Kevin Brennan), we must protect the position of occupational pensions. Good occupational pension schemes play a major part in boosting income in retirement. We are taking action on that, too.

The most important question that was raised is: how do we protect the pensions promise? One of the proposals that we intend to take forward in the pensions Bill is to help to protect people in occupational pension schemes, if they are at risk of insolvency. For the first time in this country, our reforms will introduce the pensions protection fund to protect victims in such situations.

I understand hon. Members' concerns about the workers at ASW. Indeed, I met a delegation from there. My right hon. Friend the Secretary of State for Work and Pensions made it clear that we will consider any sensible, reasonable scheme put forward to help those people. The last thing I want to do is raise false expectations in people who have suffered a major blow to their hopes of a decent retirement income. We are very sympathetic to their concerns. However, the pensions protection fund is an insurance fund that looks forward to protecting people in future, rather than capturing that group of employees. We would, of course, always welcome suggestions on how we might help them.

The other strand of our pensions savings policy is informed choice. If people are to save, they need clear information, so that they can make informed choices. The Pension Service already provides forecasts for the state pension on request. Now it is going further. Having started with self-employed people last May, we are extending the automatic issue of state pensioner forecasts, so that people can see clearly what pension they will receive in retirement. We also want to extend the coverage of combined pension forecasts, which for the first time bring together information on an individual's state and occupational or private pension entitlement, to allow people to see more clearly what pension they can expect to receive when they retire.

I believe that, when people see their forecast income in black and white, they will take action and save more where they need to. We are committed to ensuring that people have the information that they need when they need it, through as many channels as possible.

Our policy is to target the poorest pensioners who need help the most. That will enable people to make informed decisions about how much they save, how and when they work, and it will introduce much greater flexibility to the system, as well as protect the pensions promise. That is the way forward and it contrasts with a Conservative policy that is unaffordable, unsustainable and unfair.

Mr. Deputy Speaker

We have finished a little early and the Minister for the next debate has not arrived, although the initiator of the debate is in his place in plenty of time. Therefore, I will suspend the sitting until 3.30.

3.24 pm

Sitting suspended