James Daley

By James Daley

George Osborne wants to get rid of National Insurance, and merge it with income tax. And who can blame him? The UK's tax system is unecessarily complex - and most people have no understanding of the distinction between these two forms of taxation.

When national insurance was first created, just over 100 years ago, tax rates in the UK were very low - around 6%. And just as it is today, increasing taxes was politically challenging. National Insurance was effectively a way of selling higher taxation - by pegging it to a specific benefit. If you paid your NI stamp, you qualified for benefits and the state pension. If you didn't, you didn't.

A century later - during which time the welfare state has grown exponentially, and we've seen the introduction of a national health service - the link between national insurance contributions and entitlement to benefits is almost non-existant. National insurance is now just a hangover from a bygone era, and an unecessary extra layer of complexity in our tax system.

How much tax do you pay?

But unwinding it - although it is surely the right thing to do - promises to be a political headache. Most people have no idea that they are being taxed a total of 32% on a large part of their income. Splitting tax into income tax and national insurance has created just enough complexity to leave people feeling they're paying less than they actually are.

The Blair government exploited this in its early days, raising national insurance rates rather than income taxes - and discovering that it was a relatively effective way of dampening the impact of a tax rise.

Once the old system is washed away and replaced with a new more transparent one, the clarity in our tax system will be like walking into the bright sunshine with a migrane.

Apart from anything else, it will highlight the fact that the difference in tax rates for the richest and poorest is not nearly as great as it sounds. At the moment, people pay combined NI and income tax of 32% until just over £41,000. But just as the 40% tax band kicks in, NI drops away. So while there's a perception that lower earners pay 20% and higher earners pay 40%, it will soon be laid bare that low earners pay 32%, and higher earners pay just a little more at 40%.

Implementing the abolition of NI fairly will also be a challenge. Any seismic change in the tax system creates winners and losers - so there will tough choices to be made in how the new system is pieced together.

Having said all of this, I sincerely hope Osborne - or whoever ends up in government next - has the determination to push through the abolition of national insurance. It should have been done decades ago.

The reason it hasn’t happened sooner is of course that when it comes to politics and taxation, ignorance is bliss.