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Britain has a savings problem. We’re not putting aside nearly enough for a rainy day or retirement. One survey found that almost half of Britons have less than £1,000 in savings, and one in six have nothing at all.
Given this background, it’s strange that politicians seem so keen on attacking one of the few mechanisms we have for encouraging savings. Isas – Individual Savings Accounts – are a popular way for millions to put money away without worrying about taxes on their gains.
Unlike most tax minimisation schemes, which are only available to those who can afford accountants and lawyers, they can be used by everyone. In 2021-22, an immense £67bn was deposited into 12 million accounts, and over 22 million people hold such accounts. In recent weeks, as the financial year came to an end, many took the opportunity to squirrel away some cash and make investments.
Yet for the critics – and the Resolution Foundation in particular – rather than allowing normal families simple, easily accessible tax benefits, Isas are “expensive, inefficient, and ineffective”. Last year, the Foundation called for Isa pots to be limited to £100,000. Ironically, this recommendation was made in a report complaining about Britain’s lack of savings.
This misunderstands the value of Isas. These accounts are not only useful for encouraging individual saving, they also have broader positive economic implications.
A central reason that Britain’s economy is stagnant is that we are underinvesting in productive capital, such as buildings, equipment and training, which would enable us to produce more and earn higher incomes. By encouraging saving, Isas encourage investment, and less spending on consumption goods and services, like TVs or holidays. Economically, at least, thrift can sometimes be a virtue.
The Resolution Foundation claims that there is little evidence that Isas have increased savings, arguing that they simply divert saving from other, taxed products. But it is hard to imagine that getting rid of Isas would have no effect on savings; people respond to incentives, and to taxes in particular.
This is particularly true as taxation on savings is high and people would be strongly motivated to duck it. That could mean spending their income, or finding other, less taxed investments – creating economic distortions.
The economist Sam Bowman calculated that £296,000 invested and returns re-invested at a 5pc rate of real return would be worth over £1m after 30 years. By contrast, if you impose a 33.75pc tax (the higher rate tax), it would come out at just £438,000. Without Isas, Bowman says, there would be a strong incentive to put more money into the family home – an investment that attracts no capital gains taxation – further inflating Britain’s broken housing market.
The Resolution Foundation worries that Isas are “poorly targeted” because they provide more tax relief to those with higher income. This speaks to a tendency to obsess over the immediate impact of every policy on income inequality. It leads to ideas that damage growth because, heaven forbid, some people might get richer faster than others.
But it is entirely unremarkable that higher-income earners get more Isa relief; they have more to save. The key point is that Isas don’t need to be redistributive to encourage savings. We already have a highly progressive tax system (the top 1pc of taxpayers pay around 30pc of all income tax) and the welfare state to address inequality. Even if you wanted to raise taxes, nobody in their right mind would suggest the first priority should be taxes on people’s savings.
As for the annual “cost” of £4.9bn in lost tax revenue, this framing is deeply contentious. We should reject the notion that the state is entitled to our money and that any tax relief or reduction is “giving back”, rather than letting us keep more of our hard-earned income. This is particularly true if the abolition of Isas meant less savings; that theoretical tax revenue would never actually materialise.
The other criticism of Isas – that they don’t encourage enough investment in Britain – is also misguided. Some British wealth managers are pushing the idea that Isas should be limited to UK stocks. The Government has responded, in part, by creating a British Isa, an extra £5,000 allowance to invest in UK shares.
If, however, it is tempted to go further, and restrict investments in the main Isa, it should reconsider. Limiting investment options flies in the face of the most basic financial advice: diversify your holdings. Most of our financial risk depends on the UK economy (e.g., salary, state pension, public services). Having some overseas holdings can be advisable; after all, over the last ten years, US equities have considerably outperformed their British counterparts.
Such a move would also do nothing to tackle the reasons for Britain’s lack of investment.
We live in an open economy, and trillions of dollars in capital are available globally for companies that can produce a reasonable rate of return.
More of this capital would flow to British companies if we reduced the tax burden from its post-war high, cut red tape and made it possible to build, and fixed our broken regulatory state. Forcing people to invest domestically is not the answer.
Isas are a British policy success story. We should be wary of those seeking to disrupt the way millions have chosen to arrange their long-term financial affairs; it’s not only deeply unfair but also counterproductive. The goal should be to have more people saving for their retirement and investing in the British economy. It won’t be achieved by attacking Isas.
Matthew Lesh is the Director of Public Policy and Communications at the Institute of Economic Affairs
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