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Income tax and National Insurance should be merged in a "historic step" to simplify tax, Chancellor George Osborne has said.

Work to bring the two taxes together would take many years and start with widespread consultation, Mr Osborne said in his Budget speech.

The move was planned to simplify, rather than raise tax, he said.

So there would not be an increase in taxes for pensioners and those who receive some forms of benefits.

"It is time that we take this historic step to simplify our tax system and make it fit for the modern age," Mr Osborne said.

Long-term

The idea of merging income tax and National Insurance Contributions was mooted in a recent review by the Office of Tax Simplification (OTS).

The OTS described the idea as a "long-term project".

Such a move would create a massive amount of upheaval for the tax system in the short term.

There would need to be some cover for groups, such as pensioners, who pay tax on their income but not National Insurance.

Those who have a series of small part-time jobs which bring small amounts of income could also be severely affected by such a merger.

People who receive work benefits such as company cars might also see the tax on these rise, as there is no National Insurance paid on these by employees at present.

Previously, the government announced income tax changes in April, with the personal allowance - the point at which income tax starts to be paid - rising to £7,475.

This will go up by another £630 in 2012, pushing it closer to the coalition government's aspiration of the first £10,000 a year of earnings not being subject to income tax.

But people will feel the effect of the decision to uprate direct tax by the Consumer Prices Index measure of inflation, not Retail Prices Index (RPI) from 2012, a move that will gain the Treasury £1bn a year by the end of the Parliament.

The employee contribution of National Insurance is rising from 11% to 12% in April, as announced previously.

Reaction

Chas Roy-Chowdhury, head of taxation at the Association of Chartered Certified Accountants, described the mechanics of the income tax and National Insurance merger as a "minefield".

"It is a lot easier said than done," he said.

Key considerations would include how to prevent people who retired early being charged extra tax, he said, and how to replace the employers' National Insurance contributions.

And Tony Bernstein, senior tax partner at HW Fisher and Company chartered accountants, said: "At the very least, this is an admission that National Insurance is a tax.

"But in real life, merging National Insurance and income tax will be almost impossible to achieve in a simple fashion. Politically, will a much higher headline basic tax rate combining income tax and National Insurance contributions be palatable?"

Treasury committee chairman Andrew Tyrie said: "This has been a beguiling idea which successive chancellors have looked at very closely and then in the end rejected, largely because it hits the incomes of certain groups in unexpected ways.

"Maybe the time has come to implement it."