National Insurance contributions: an introduction

National Insurance contributions – NICs, for short – are paid by employees, employers and the self-employed, and are used to fund contributory benefits: the state pension, contributions-based jobseeker’s allowance, contributory employment and support allowance, maternity allowance, and bereavement benefits. In turn entitlement to contributory benefits is based on someone’s National Insurance payment record.[1]

The majority of receipts from NICs are paid into the National Insurance Fund, which is separate from all other revenue raised by taxation. The Fund operates on a ‘pay as you go’ basis; broadly speaking, this year’s contributions pay for this year’s benefits. Retirement pensions account for over 90% of benefit expenditure from the Fund.[2]  The Government has no powers to use NICs to fund anything else.[3]

A fixed proportion of NI receipts are not paid into the Fund but go to the National Health Service. In January 2019 the Government Actuary’s Department (GAD) estimated that NICs would raise just under £133 billion in 2018/19, of which £107.4 billion would go into the NI Fund and £25.4 billion would go to the NHS.[4]

Because monies coming into the Fund are used that same year, the annual balance on the Fund is a measure of these two flows of money – rather than representing a fixed amount of capital. From one year to the next, annual receipts and annual payments are liable to fluctuate considerably. A working balance is necessary to deal with these short term fluctuations as the Fund has no borrowing powers.[5] For many years the GAD has recommended a balance for the Fund of at least 16.6% (two months or one sixth) of projected benefit expenditure, as “the minimum level recommended with a view to ensuring that a reasonable working balance is maintained.”[6]

Historically this working balance or surplus has been held in gilts, but more recently these funds have been held in the Debt Management Account Deposit Facility.[7] In effect, these arrangements reduce the overall amounts that the Government needs to borrow for the year in managing the public finances. These funds are being held in this account on loan – much as with the purchase of gilts – so governments are not in the position to use this facility to extract money from the Fund as an extra source of revenue.[8]

The Social Security Act 1993 permits, in certain circumstances, for the Treasury to make a ‘Treasury Grant’, a payment up to a specified percentage (at most 17%) of estimated benefit expenditure, to maintain the Fund’s working balance for the year. Each year the GAD produces an assessment of the projected balance of the Fund relative to benefit expenditure for the coming year, to help inform decisions relating to the size of any Treasury Grant. In its most recent annual report on the Fund, published in January 2019 the GAD concluded that it was not anticipated that the Treasury would need to make a payment for 2019/20.[9]

The structure of this paper

The first part of this paper gives an introduction to National Insurance system: the base and rate structure of NICs (section 1), the operation of the NI Fund (section 2), and the connection between a person’s contributions into the Fund with their entitlement to receive benefits paid out of the Fund – the ‘contributory principle’ as it is known (section 3).

The second part of this paper – sections 4 to 6 – provide a narrative of the major reforms made to NICs since the late 1990s, and, in particular, the consideration that successive governments have given to the case for merging NICs with income tax.

It has been argued that despite the operation of the NI Fund, and the contributory link between payments made and benefits received, NICs is no different in kind to other national taxes, and that fully integrating NICs with income tax would be fairer, simpler and more efficient.  The issue has been considered, off and on, for almost twenty years.  Even though there have been a number of changes to bring NICs and income tax into closer alignment, there remain considerable difficulties to a full-scale merger and to date no government has made substantive proposals to this effect.

Notes : 

[1]    For details see, HMRC, What National Insurance is for, retrieved November 2019

[2]    GAD, Report by the Government Actuary on: The draft Social Security Benefits Up-rating Order 2019, January 2019 (Table 5.2)

[3]    Part XII of the Social Security Administration Act 1992 contains the statutory authority for the Fund; section 163 specifies that payments out of the Fund may only be made to finance a list of specified benefits.

[4]    GAD, Report by the Government Actuary on: The draft Social Security Benefits Up-rating Order 2019, January 2019 (Appendix D)

[5]    HMRC, Great Britain National Insurance Fund Account – 2018 to 2019, HC 14, October 2019 p6

[6]    Dept of Social Security, Social Security Bill 1992 – Report by the Government Actuary on the financial provisions of the Bill, Cm 2097 26 November 1992 para 9

[7]    see, Debt Management Office,National Insurance Fund Investment Account, retrieved November 2019

[8]    On this issue see, What happens to the money from NICs?, Full Fact, 1 March 2019

[9]    GAD, Report by the Government Actuary on: The draft Social Security Benefits Up-rating Order 2019, January 2019 pp8-9