The Myths and Legends of Hypothecated National Insurance

NHS Funding

There are pressing reasons for understanding a bit about how our tax system works and very specifically what National Insurance is. NI is used as successive governments’ tax increase of choice because of a widespread and mistaken belief that it is a direct payment to the NHS. The Liberal Democrats had it in their 2017 manifesto, Gordon Brown put 1p on NI to ‘pay for’ the NHS, Frank Field (Labour) gave evidence on NI to the Lords Committee on the long-term sustainability of the NHS and his website says he is working on this issue with Oliver Letwin(Conservative) and he wants to restore a ‘something for something’ society.

Frank Field’s website says:  ‘Polling last year found that while 42 per cent of the public would support an increase in tax to pay for a larger National Health Service budget, this figure climbs 11 points, to 53 per cent, once the public are asked about an increase in NI contributions.’

One of the most recent additions to this proposition was in an ‘exclusive’ from the Daily Telegraph (18 March 2018 paywalled):  “It is understood there is now broad agreement within the Cabinet that extra money must be provided for the health service. Some ministers have privately suggested an across-the-board rise in National Insurance to provide new ring-fenced funding for the NHS. However, The Telegraph understands that officials are drawing up plans for a more targeted tax rise on older workers as part of a new 10-year funding plan for the NHS championed by Jeremy Hunt, the Health Secretary. One idea under discussion is to make the 1.2 million pensioners who keep working past 65 to pay NI contributions. The move would raise £2 billion per year which could be spent on the health service. Scrapping universal free prescriptions for the over-60s is also under discussion.”

The Telegraph article incorporates many of the issues frequently raised when talking about how to pay for the NHS. These arguments have muddied the waters about how public funding is allocated giving rise to political decisions being made on the spurious grounds of ‘affordability’, ‘sustainability’ and ‘no money’. And it has led to campaigns and petitions calling for 1p in the £ tax or the hypothecation of NI to ‘pay for the NHS’.

Here we make the argument that this is not only misleading but it will undermine rather than support the NHS.

A political consensus – can we afford the NHS if the public won’t pay more?

Earlier this year, thousands of NHS campaigners marched and rallied across the country in protest at the de-funding, cuts and privatisation of the NHS. Anyone who isn’t an NHS campaigner could have been forgiven for missing it, it was given so little press attention.

In contrast, two days later the BBC gave headline space on its flagship news programme, Radio 4’s Today, and on BBC One’s Breakfast, to the Liberal Democrats’ perennial call for NI to be increased for the NHS. They are also calling for NI to be converted into National Health and Social Care Insurance – which they refer to as a hypothecated tax.

Simon Stevens has argued for different funding sources too:

“Would intergenerational fairness support a further increase in the share of public spending on retirees, at the expense of children and working-age people? Should it be easier for families to flexibly fund social care by drawing down resources tied up in housing, pension pots and other benefits?”

A little bit of history (but not too much)

Funding was a key issue in all the prototype versions of the health service that finally became the NHS. The debate about how to pay for the NHS was based around three elements, all of which are reflected to greater or lesser degrees in other healthcare systems around the world today.
These were (and are):

  1. The Exchequer should pay a proportion via government run national insurance.
  2. Local authorities should pay a proportion from the rates (council tax).
  3. People should make a contribution from their own pockets -usually as some form of insurance.

Combinations of these are used across the world in a system known as the Bismarck Model.

NI already existed for working people in the UK before the creation of the Welfare State. It gave an entitlement to unemployment benefit, seeing a doctor and some pension benefits. But Prime Minister Clement Attlee supported Aneurin Bevan’s desire to break the connection with insurance to bring in something quite different for the NHS – and unique in a Western democracy. The NHS was to be paid for in full by the Exchequer. It has caused complaint and consternation ever since about its affordability – ‘growing and ageing populations’ have always been seen as a threat to its survival. Yet it has been consistently one of the lowest cost universal healthcare systems in existence. And that has been largely as a result of this direct funding method.

In 1952 Bevan wrote ‘In Place of Fear’ a remarkably modern set of essays showing that the questions about funding, who gets access, what should be provided are perennial and instantly recognisable across the years. He writes one of the best explanations of why NI was not chosen as the method of payment:

“When I was engaged in formulating the main principles of the British Health Service, I had to give careful study to various proposals for financing it (…) what was to be its financial relationship with national insurance; should the health service be on an insurance basis? I decided against this. It had always seemed to me that a personal contributory basis was peculiarly inappropriate to a national health service. There is, for example, the question of the qualifying period. That is to say, so many contributions for this benefit, and so many more for additional benefits, until enough contributions are eventually paid to qualify the contributor for the full range of benefits.”

So, to answer Bevan’s question, what is the NHS’ “financial relationship with National Insurance” in 2018?

Given the number of people who respond on social media to questions about funding the NHS by saying, ‘I pay for it already with my National Insurance’ – it looks as though the question is answered in popular consciousness, if not in reality.

It might surprise people to learn that the National Insurance Fund (NIF) today is used to calculate employment related and pension benefits, as it did before 1948. It doesn’t include paying to see a doctor! This Fund supposedly contains £30 billion of spare money. You may have seen the petition to parliament asking for the release of the money to save the NHS. John Prescott, former Deputy Prime Minister, was the person who discovered this ‘secret’ in 2015. But, like many things which have an eternal life on social media, it isn’t quite true.

Bevan talks about ‘the qualifying period’ for NI. NI still has qualifying periods for the various benefits it covers.

According to the government website the list below is what NI is for. Each of the benefits listed have different numbers of contribution years needed to be able to claim them. For example, it takes a minimum of 10 years contributions to earn entitlement to any state pension at all and 35 years to earn full entitlement. State pensions aren’t like private pensions. There is no personal money pot built up. Instead your contribution to society through your earnings is a social contract. There is an expectation that, having contributed through your working life, the government of the day will honour the contract when you retire.

Benefit  Class 1: employees  Class 2: self-employed  Class 3: voluntary contributions 
Basic State Pension  Yes  Yes  Yes 
Additional State Pension  Yes  No  No 
New State Pension  Yes  Yes  Yes 
Contribution-based Jobseeker’s Allowance  Yes  No  No 
Contribution-based Employment and Support Allowance  Yes  Yes  No 
Maternity Allowance  Yes  Yes  No 
Bereavement Payment  Yes  Yes  Yes 
Bereavement Allowance  Yes  Yes  Yes 
Widowed Parent’s Allowance  Yes  Yes  Yes 
Bereavement Support Payment  Yes  Yes  No 

The NHS is conspicuous by its absence from the list above.

In the late 1970s over 65% of all unemployment benefits were based on contributions from previous employment with 35% being means tested. Today it’s almost the mirror image and contributory benefits are now just over 42% of the total.

Why do people say that National Insurance pays for the NHS?

Most people will remember Gordon Brown, when he was Chancellor of the Exchequer, saying he would put 1p on NI to ‘pay for the NHS’. There is that claim from John Prescott that he had ‘found’ £30bn in the NIF ‘for the NHS’. And the Liberal Democrats – along with Labour’s MP Frank Field – insist that NI should be changed to fund the NHS and Social Care as a hypothecated tax.

Is it any wonder that people believe that’s how the NHS is paid for, with so many politicians saying it is, or should be?

There is, in fact, a difference between the NIF and the National Insurance Contributions (NICs) collected. And the difference illustrates the confusion that exists about the tax system. At this point it is worth pointing out that, despite any statements to the contrary, NI is just a tax.

The Government Actuary’s Department has estimated that NICs will raise just over £125 billion in 2017/18, of which £101.8 billion will go into the NIF and £23.7 billion will go to the NHS.

What is accounted for in the NIF, as explained above, is the estimated amount of contributions needed to pay for the contributory benefits including pensions. Any excess over that amount is supposed to ‘go’ to the NHS, but it isn’t equivalent to the amount of funding the NHS needs. It is simply accounted for in the Consolidated Fund at the Bank of England which is a record of all the Government’s spending and receipts.

This brings us to the central issue of why politicians insist on making the link between the NIF and the NHS. At its most basic it is because politicians believe that if the public think that the tax is being spent directly on something they want and have a direct interest in (working benefits, pensions, health) they are less likely to complain when that particular tax is increased. And why do they believe it? Because countless polls tell them so. They also like going to the polls saying that they will not increase income tax – that’s a huge vote loser. But a manifesto commitment on ‘income tax’ can be neatly circumvented by increasing the other income tax – NI.

Is National Insurance a hypothecated tax?

A true hypothecated tax is one in which the tax is ring-fenced for a named service and pays for all that service. This system effectively enforces a spending cap on the service being paid for as it limits spending to an equivalent of the tax levied. That’s very difficult to do when necessary spending is required before the taxes are received. It’s also difficult to define the ‘whole’ of a service.

The NIF appears to be hypothecated. Its rules say that the Fund must always contain enough contributions to meet all its obligations as listed above. To this end it must have a reserve in hand (John Prescott’s £30bn ‘secret’). But the Treasury also makes grants available to the NIF to make sure it keeps to its rules when it doesn’t have enough contributions coming in. A further adjustment is made between the balances in the England & Wales account and the Northern Ireland account to make sure they both represent the right amounts for their relative constituencies. Yet more adjustments are made because the Department of Work and Pensions and the Department of Business, Skills & Innovation both make payments out of their own budgets for the benefits accounted for under the NI scheme so transfers are made between them to equalise the accounts.

There is also an excess of receipts required to fulfil the contributory principle over the course of the accounting year and that doesn’t go into the Fund at all. It is not a genuine hypothecated tax. It is a bookkeeping exercise.

If NI is just a tax and it isn’t hypothecated, what’s the point of it?

Historically people had a direct link between their NI contributions and the benefits that accrued to them as a result. Pensions retain that historic link, with a defined minimum and maximum number of ‘contribution years’ required. In and out of work benefits for those covered by the NI scheme also have minimum contribution periods. It is the contributory principle that makes NI difficult to abolish. Income tax is simply recorded as an annual amount, no matter what the source of the earned or unearned income. NI, on the other hand, is recorded as the number of consecutive weekly contributions. It is the appropriate number of full years in a given period that defines eligibility for the benefits.

People who take breaks from paid employment for any reason and therefore have a break in their contributions may receive a letter asking if they wish to make a voluntary payment to cover the missing contribution period. That couldn’t happen with income tax. Getting rid of NI therefore leaves a problem of how to calculate eligibility for contributions-based benefits.

NI hides the true levels of income tax

The headline rates for income tax are currently set at 20%, 40% and 45%. This looks as if we have a very fair system where the lowest earners only pay half what higher earners pay. However, if NI is added to income tax the picture looks very different.
NI (tax!) starts below the personal allowance level.

Income bracket  Income tax rate   NI rate  Total tax 
£8164 – £11,500  0%  12%  12% 
£11,500-33,500  20%  12%  32% 
£33,500-£150,00  40%  2%  42% 
£150,000 +  45%  0%  45% 

People often call NI a regressive tax because it doesn’t increase with higher earnings but what is far worse is that it masks the real differentials between the rates of taxation. The lowest rate is quoted at 20% and the higher rate at 40% which leads people to reasonably believe that lower earners are not carrying the burden of tax but as the real figures are 32% and 42% respectively then it is a far less fair system.

So, when campaign groups call for a penny on income tax to fund the NHS or that there should be further increases in NI they may not be aware of how serious the impact is on lower paid workers.  In 2016-17 a fraction over 31p in every £ of tax collected was income tax. NI accounted for just under 22p. The rest is accounted for by other taxes.

Inter-generational Fairness – a concept designed to persuade people that you don’t get what you don’t pay for

Over recent years there has been a change in the general understanding of what the economy actually means. Politicians talk as if the economy consists of the private sector and its wealth creation with government wholly dependent on the taxes raised from that wealth creation. Government expenditure is framed as money lost or wasted or a drain on the economy. The tax ceiling is used as a whip to limit government who must be vigilant against overspending or allowing ‘debt’ to get out of hand. It also tends to focus on income tax and NI to the exclusion of other taxes.

This is the narrative that explains why services need to be reduced or more paid for them by the public. It creates an obligation on those who cost most to be asked to contribute more for the sake of ‘fairness’ and ‘not burdening the state’. It makes means testing into a harsh system of proving you really need state help before you can get it. It reflects Frank Field’s ‘something for something’ idea that you don’t get what you don’t pay for. It is the political and moral opposite of the NHS.

Far from ensuring intergenerational fairness, this system forces the burden of payment for the NHS on to people in paid employment who are paying NI as this tax is not paid on unearned income nor by various other income groups.

The idea of expanding NI to retirees and of extending its range, making it more progressive, also ignores the contributory element. The regressive nature of NI is directly attributable to its contributory nature. Once you have paid ‘enough’ to meet the contributions threshold there is no justification for levying any more, as there is no more additional benefit to be ‘earned’.

This is the landscape that gives rise to the NHS Five Year Forward View with its voucher scheme for maternity and personal budgets for disability and now for the Liberal Democrats arguing for a National Health and Social Care Insurance for older people. Asking pensioners to pay NI when they already made their contributions to earn the status of pensioners is clearly nonsense and anything but fair, but you can change that argument if you change the purpose of the tax.

An insurance-based health and social care system

The Liberal Democrats report says:

“we .. believe that an NHS funded by national taxation continues to be the best option for delivering our healthcare system, and so we decided early in our discussions that we would not explore options for an insurance-based health system as a means of raising additional revenue.
…. thanks to great strides made in tackling pensioner poverty, after housing costs pensioner households are far less likely to be in poverty than households of working age, particularly those with children.
For this reason, we suggest policy makers consider ending the exemption from paying NICs for people who continue working past the state pension age. NICs could either be equalised with the rates paid by the rest of the workforce, or introduced at a lower rate.
(…) this is the age group who are the biggest users of health and care services and, as described in the section on income tax above, on many measures this group of workers are proportionately better off than younger generations.”

Like many of the issues we have examined in this blog these statements appear to superficially make sense regardless of whether or not you agree with them. But health and social care now form part of a single government department and the NHS and local authorities are being brought together within integrated systems with combined budgets.

Despite saying they would not explore options for an insurance-based health system, the Liberal Democrats’ focus on paying some form of insurance for health and social care actually means converting NI to a stateinsurance scheme. They are calling for Theresa May to back their scheme. This would transform our Bevanite state-funded NHS into a Bismarckian system. Currently healthcare is free at the point of need and social care is means-tested, which brings an element of uncertainty to what exactly is to be covered by this insurance.

If this were simply an argument about tax there are, of course, many other forms of tax. It takes experts to calculate the changes in government receipts and the effect on households when tax thresholds are raised or lowered. That is what would be being considered if this was about changing our tax structures or raising taxes in general.

But this is not an argument about tax. This is an argument over the role of the government.

While it may appeal to many to call for increased taxes to ‘fund’ the NHS what we really need is to understand how public funding works. The root of the problem does not lie in our tax system. It lies in public policy decisions.

If you are asked to sign a petition or support calls for a hypothecated NHS & Social Care NI or for 1p in the £: just say ‘no’.

For further reading:
Post crash economics and ‘Professor’ George Osborne
Jeremy Hunt calls for increase in tax to pay for Trident

First published on the Public Matters blog