With a clear majority, the House of Lords has voted against the proposed changes to Employment and Support Allowance (ESA), the successor of Incapacity Benefit. The opponents of the changes, inside and outside of Parliament, had a good point. But many objected for the wrong reason, repeating generic anti-cuts phrases. The problem with the coalition’s plans is not that they are cuts. The problem is that they would erode the contributory principle in the British welfare state, largely a farce already, even further.

ESA comes in two varieties, contributory and means-tested. Contributory ESA is more generous and independent of a recipient’s income or savings, but it is conditional on a past record of National Insurance payments. The coalition aims to limit entitlement to contributory ESA to a period of one year for recipients who are deemed capable of returning to work eventually. Those recipients would then have to apply for the non-contributory version, and subject themselves to a means-test, if they are still in need of support.

What’s wrong with that? According to the Comprehensive Spending Review, it will lead to savings of around £2bn by the end of the term, and those who are truly in need still have the means-tested strand of ESA to fall back upon. But regardless of the immediate consequences, there is a problem of design here.

There are, simplistically speaking, two types of welfare design. The first is the Bismarckian or contributory system, in which entitlements are primarily assigned on the basis of past contributions. The second one is the needs-based system, in which entitlements are assigned via a means-test or a similar mechanism. In other words, contributory systems provide a strong link between what you pay into the common pool and what you are entitled to take out of it, while needs-based systems do not. Payments into need-based systems are not distinguishable from payroll taxes, even if they are nominally labelled ‘contributions’. For payments into contributory systems, on the other hand, there is some justification in the use of the term ‘contribution’.

There is much to be said against contributory systems, especially from a liberal perspective. But compared to need-based systems, their advantage is that they are not penalising work and saving too harshly. While you pay into the system, you build up a future entitlement with each payment. While you receive payments, you are not subject to a means-test, with its punitive withdrawal rates.

In principle, the two can run side by side, with the contributory tier being the ‘business class’ and the means-tested tier being the ‘economy class’ of the welfare state. Originally, the British welfare state was indeed a bit like that, but there is always a temptation for politicians to undermine the contributory principle because it allows short-term savings to be made in a relatively painless way. However, eroding the principle creates adverse dynamic effects, because it gradually converts contributions into just another payroll tax. The introduction of an arbitrary time limit to contributory ESA would take us even further down that road.

The coalition should have gone after payments which are neither contribution-based nor means-tested instead, while going easy on what little there is left of contributory elements.