The Resolution Foundation have published a report under the title “ISA ISA Baby” which argues that the tax reliefs available on ISAs are too generous and should be limited. I disagree and suggest that the report is slanted by the politics of envy. My detailed comments are:
The Report does point out correctly that the savings rate in the UK is too low and is less than in most G7 countries. It is a particular problem among the low paid or those living on state benefits and results in such people not having a financial cushion to cope with emergencies or temporary problems such as sickness or unemployment. Why is the savings rate so low? I would suggest it is because our social security system is so generous that people have come to realise that there is little point in saving when they can fall back on the state when needed. Another contributory factor is the low return on savings achievable when interest rates have been kept so low by QE and government policy to erode the value of their own borrowing. This has been the madness of economic policy in the UK until recently.
Part of the problem is that the wages of typical working or middle class families have been eroded in real terms in recent years. Galloping price inflation particularly in basic commodities such as food has exacerbated this trend. It is beyond the scope of this article to delve into the reasons for this in detail but low labour productivity and the available of cheap labour from immigration are two factors to bear in mind. But as the Resolution Report says “Low savings are, in part, merely a symptom of this economic stagnation”.
It is simply unrealistic to expect those on low wages or living on state benefits to save. A recent analysis showed that some 36 million people – 54.2 per cent of all individuals – paid less tax than they received in benefits according to the analysis of Office for National Statistics (ONS) data for 2020/21. The UK population is way too dependent on state benefits.
The Government encourages savings by providing tax reliefs in various forms including ISAs and by direct subsidies such as the LISA and Help to Save schemes. The Resolution Report argues the latter are more effective ways of encouraging saving. But I suggest that it is the lack of surplus income over the basic cost of living and hence the inability to save plus cultural reluctance to look more than a few weeks ahead when reliance on state benefits is endemic which are the key problems.
The Resolution Report says that “extension and widening of Help to Save could be paid for by reducing the generosity of ISAs, which largely benefit the already wealthy. For example, capping the overall lifetime value an individual is allowed to save into an ISA at £100,000 would only affect a small minority of people (thus minimising administrative and economic costs). This is a typical “we can soak the rich because they won’t notice kind” of argument. It’s the politics of envy in essence. They argue this would “reduce the cost” of the lost tax from ISAs but the UK population is already taxed too highly and imposing more tax on the wealthy will just increase the disincentives to invest in UK companies. This is the politics of madness.
The number of people with very large ISAs (worth more than £1 million) is in fact relatively small at about 1,500 after the market falls last year. If you look at the holders they are typically those who have invested in equity ISAs (not cash ISAs), have been investing the maximum allowed over many years since ISAs and PEPs were launched in the 1990s and have been both patient and wise investors. Why should such people be discouraged? They have often backed British companies when they needed to raise money, particularly in smaller AIM companies. This has turned out to be a very sound economic policy which has meant that the UK has one of the most vibrant smaller companies markets.
But the success of some ISA millionaires has been widely publicised and this has provided a great incentive for people to save via investing in equity ISAs. If people see they can become relatively rich by using ISAs they are much more likely to save in that way, otherwise they will invest in a bigger house on which there is no tax of course. We need more investment in businesses not in property. Reducing the attractiveness of ISAs because a few people become wealthy from using them is counterproductive.
In reality some of the main beneficiaries of the ISA system are the young. The Resolution Report says “…. there were around 2.4 million ISA holders under the age of 25. This group were the most likely to be active savers with approximately 79 per cent making a deposit in 2019-20”. That shows that the tax incentives were working well in a segment of the population who were otherwise unlikely to save but instead spend any surplus cash.
ISAs have helped to encourage everyone to invest in businesses although cash ISAs are somewhat dubious in my view. ISAs have been a great success in helping to encourage an investment philosophy and if the tax relief was reduced all that would happen is that instead of investing the money it would be spent on luxuries, foreign holidays, or more put into pension schemes.
Would supporting Help to Save be more beneficial? Help to Save is basically a hand-out to anyone who can fill out a form. It is like anything that is given without strings or obligations. It only provides a minor encouragement to saving and does not encourage good habits of frugality or saving. Only about 250,000 people have opened a Help to Save account which shows it is not very attractive, mainly because of the limitations imposed.
I have to declare an interest in this subject as I am an ISA millionaire, as is my wife whose portfolio I also manage, even after last year’s somewhat dismal investment performance. The Resolution Report does not just suggest limiting the annual allowance (currently £20,000) but putting a cap on the overall value of a ISA. This would have most peculiar consequences. Most of the value held in an ISA is likely to have arisen from capital growth and dividends received rather than additional contributions. Would investors be expected to sell their holdings if they went over the limit, when the value of holdings can be very volatile? Limiting new contributions if a cap was exceeded would not make much difference to the value of overall ISA holdings and be complicated to operate.
In summary the Resolution Report has not adequately considered the consequences of imposing limitations on ISAs. And we need less tax, not more.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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