How Britain can rebuild welfare with the power of individual contributions

Nigel Wilson

THE TWO great legacies of post-war socialism were the NHS and the Beveridge system of welfare. Designed for a different world, with a younger population and lower life expectancies, both are seen as politically untouchable, impossible or at least very difficult to reform.

Periodic attempts to introduce internal market mechanisms to drive efficiency in the NHS have been painful and not necessarily effective. The bill keeps going up: £110bn in 2011-12. This is about 8 per cent of GDP, about half the US figure: the NHS is good value, even if not very efficient. And the Olympic opening ceremony proved that the NHS, on its 65th anniversary, is still the nearest thing the UK has to a national religion.

Welfare, meanwhile, on which we spend £159bn, has evolved piecemeal and not necessarily in a good way. Smart policy thinkers in this space – like Frank Field MP – have been ignored. Successive governments have politicised welfare, either demonising claimants or farming them as a core voter base. Universal Credit is the latest attempt: a harsh policy, bedevilled by poor execution, particularly in respect of its IT systems.

But against the economic backdrop of a stubborn £100bn government deficit, an ageing population, low levels of saving, widening inequality, and an increased cost of living, we need more thorough-going reform. It is just wrong that our over-priced, under-supplied housing drives huge housing benefit costs – almost £20bn annually. The poorest are effectively losing bedrooms due to the asset-price effects of QE, while retired homeowners have £1 trillion of housing equity that could be used to provide income. Meanwhile, Legal & General’s Deadline to the Breadline research shows how working families on average incomes are unable to save more than three weeks’ worth of income.

The nub of the problem is that the contributory principle enshrined in Beveridge has been systematically eroded and replaced with universal means-testing. Just £7bn in working age contributory benefits is paid out of National Insurance. This over-reliance on universal, means-tested benefits discourages prudence, and delivers uncertain outcomes and high effective tax rates on carefully accumulated savings when disaster strikes. National Insurance is just stealth tax by another name: and it is a major tax, raising £84bn in 2012, more than twice the £39bn take from Corporation Tax.

We need instead to develop solutions that share risk better between the state and the individual. Fairer, more efficient and cheaper contributory benefits for most, with the state focusing on the long tail risks of chronic sickness or disability and unemployment. There is much to be learned – even re-used – from the constructive reform of pensions that Steve Webb has led for the current government. So what do we need to do?

First, we need to de-politicise welfare and obtain the widest possible cross-party consensus around evidence-based policy proposals. Adair Turner’s Pension Commission under the Blair government, which underpins much of the recent reform, provides the template.

Second, the remit of such a Commission needs to include how best to combine a fair state National Insurance system, which provides an underpin, with an enhanced and suitably incentivised top-up, which can be through the public or private sector. This is really just taking the principles of pension auto-enrolment – which has been a huge success, with 92 per cent staying in – and applying them to broader welfare.

Third, the issue of incentives and disincentives needs to be tackled. In pensions, a regressive system of tax relief at the marginal rate gives an over-generous subsidy – 70 per cent, or £25bn out of the £35bn paid in pension tax relief goes to higher-rate taxpayers. This is a system designed by the rich, for the rich, and will have to change in the next wave of pensions reform. By contrast, in the world of means-tested benefits, any provision people have made for themselves counts against them – hence the egregious effective rates of tax that can be paid once benefits interact with assets or savings. We need to develop a fair system, where soft (or hard) compulsion about paying into a top-up fund for contributory benefits is matched by carefully calibrated incentives that favour those for whom the top-ups are likely to matter most. In practice, this means middle-range earners. These incentives can be paid for by utilising part of the pension tax subsidy given to higher-rate taxpayers.

Fourth, we can consider how such a system could be used to deliver reduced National Insurance contributions on the part of employers – particularly, for example, those in startups or SMEs – so we therefore align benefit reform with support for job creation.

And fifth, we need to consider how to use the “plumbing” that has been put in place for auto-enrolment. Systems which connect every employer in the country to a pensions provider will soon be in place. These can be easily adapted to accommodate welfare top-ups, avoiding the usual IT problems encountered by government projects.

This can work in practice. Legal & General’s modelling suggests that, providing it is universal or close to universal, a contribution of 0.5 per cent of an employee’s salary (or just over £10 per month for the average earner) could deliver a benefits package broadly equivalent in value to their current means-tested benefit entitlement in the event of sickness or unemployment.

Finally, utilising auto-enrolment and bringing in private sector competition for contributory benefits can reduce costs for consumers and taxpayers. There is an instructive comparison to be made between the National Insurance Fund, where £4.6bn of a total of £79.3bn of payments – almost 6 per cent – are described as “administrative costs and transfers”, and modern digital workplace pensions, where the charge cap is now 0.75 per cent and competitive charges in reality are below 0.5 per cent in the best cases.

Reform on this scale needn’t be as politically difficult as people think. There are many good international models we can learn from or plagiarise: for example Australia and parts of Europe. And politically it may be easier than at any time since the Second World War. The British Social Attitudes Survey, and other polling data, suggests that the generation that has grown up with student loans – now totalling £50bn – understands the contributory principle very well. Less than 30 per cent of people want higher welfare spending. But we all want welfare that is fair and efficient. The government that could deliver it would be pushing at an open door.

Nigel Wilson is chief executive of Legal & General Group.

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