How to reform welfare: National insurance: Beveridge's phoney system

What is welfare reform for? The Cabinet hasn't even discussed it yet and David Blunkett's worries, as put by him in his leaked memo to the Chancellor, express a growing general anxiety. Tony Blair's speech in Sedgefield this weekend reiterating his determination to press ahead with reform didn't help. For he didn't say how, not even really why.

How important is it? In the general sweep of the economy, not at all. We spend a bare 13 per cent of GDP on welfare, compared with Germany's 30 per cent, France even more. We spend the same as the Americans and the Japanese, the least in the developed world. There is no welfare spending crisis. But the more politicians go on pretending that there is, the more voters will believe it and demand cuts. "We spend more on the Department of Social Security than we do on education and employment, health, and law and order combined. We spend more than we collect in the whole of income tax," said Blair. Scary stuff, deliberately scary stuff and if he goes on like that, he will find himself hoist on his own populist rhetoric, and judged by his failure to deliver significant cuts in social security spending - a target he cannot achieve. For example, pensions take up by far the biggest chunk, rising as the population ages, and nothing much can be done about that in a hurry.

We do indeed have a problem with welfare, but not with its overall total. We have a problem within welfare, which Blair defined well in his speech: the Tories spent an extra pounds 44bn in real terms and yet there are more poor people than ever before. Welfare isn't working as it should, that's plain. But the growing number of poor workless households is partly because of the increase in pensioners, many of whom are poor. And it's also because we have a great more unemployed than in 1979. The numbers are set to start rising again next year according to the Bank of England, so it hardly seems likely that an overall cut is achievable anytime soon.

There's no doubt the whole welfare system needs reform. Some people who haven't a hope of ever working are kept far too poor. Meanwhile many people who are not poor are still drawing large sums on the social security budget. All the money should go to those who need it, and all who could find work need to be prodded into doing so. That sounds like a platitude, common sense everyone could agree on.

But politically it will require extraordinary bravery, with a focused programme that sets out from the start what the objectives are. So far we have seen nothing much of that. For a government reputedly good at spin, its presentation on everything to do with welfare and cuts has been catastrophic. Any reform means there will be many losers as well as gainers, and the losers ought to be the vocal middle classes. Does Labour dare?

It's time to start all over, and dismantle the whole national insurance system that still pays out according to notional contributions made and not according to need. It's time to say that a phoney system started by Beveridge has had its day. National insurance pretended to be a genuine insurance fund, but there never was any connection between sums paid in over a lifetime and pensions or other benefits paid out. It never from its first day paid enough state pension for anyone to live on: those with no other income always had to be means-tested and paid national assistance or income support on top, so it never offered either the security or the dignity it promised.

Yet the system still pays out arbitrary sums to people not in need, when they become unemployed, sick, disabled, widowed or old, regardless of how rich they are. When I was widowed I was astounded to receive a widowed mother's benefit of more than pounds 120 a week, automatically, without anyone asking what I earned or whether I needed it. It was paid only on the basis of my late husband's NI contributions. (I stopped drawing it.) Benefits must become just a safety net for times of financial crisis, not a right.

National insurance was a fine idea - everyone paid in, everyone got out. It was a political device for getting the rich to pay for the poor. But it's had its day. Very few people under the age of 50 have any idea what those deductions from their pay packets mean. There is no longer an emotional understanding of its significance, or sense of participating in a wider insurance system. Taking away entitlements from those who don't need them will cause an outcry, but one the Government could face down, so long as it's crystal clear where the money is going and why.

The easiest payouts would be to poor pensioners and the severely disabled who are never going to work, for whom all idea of incentives is irrelevant. For the rest who might work, depending on who they are and where they live, more investment in welfare-to-work schemes will be needed, for training, transport and childcare. The purpose of getting these people back to work is not to save on the social security bill, but to bring them back into society so they live less isolated and impoverished lives. As America is discovering, that's a social good of itself; but it isn't cheap. After all Gordon Brown has invested pounds 3.5bn in targeting just 120,000 18-25 year olds. In Wisconsin, the pioneer welfare-to-work testing ground, it costs 60 per cent more, although they hope to save eventually on crime, health and mental health budgets. They hope for a better society as a result, as we must too.

So let's have less talk about cutting the social security budget. We can well afford it, so long as people believe it's doing good not harm. That means the Government will have to make it work better, and politicians will have to start selling the value of that spending as a very good investment for everyone.