The combination of being in government and of facing a large deficit means the list of tax increases and spending cuts Liberal Democrats have been calling for over many years has been mostly exhausted. Capital gains tax is up, pension tax breaks for the richest has been curbed, the ID cards database is gone and so on.
It is good that so many policies are now in place and there are plenty of political battles still to come in the second half of this Parliament, especially over mansion tax. However, it means that the scope for the party to say ‘here is how we would do things differently’ or even ‘here is how we would find the funds for our priority projects’ will be increasingly limited unless the party does come up with new policies that free up money.
So here is one suggestion, that would raise around £1bn per year: put a £15,000 limit on the total amount people can hold tax-free in ISAs (Individual Savings Accounts).
There are two problems with the current tax breaks for ISAs. First, by having an annual ‘use it or lose it’ allowance, the ISA tax breaks disproportionately benefit those who can afford to put in the full tax-free amount every year. If you are very well off you can shelter £11,280 from tax this year, and then the same again (or more, as the allowance is usually increased each year) next and then the year after and so on for ever.
In other words, if you can afford it, you can build up huge levels of tax-exempt saving. What’s more, if you take some of the funds out at any point because you need them, you then lose that part of your allowance. That makes the rules doubly beneficial for the most well-off who can cope with the events life throw up without having to call on their ISA savings.
With pensions there is a lifetime limit on how much you can put into a pension scheme and still receive tax relief; there is no such limit for ISAs. Instead, with ISAs we have a tax system that ends up benefiting more and more the most well off.
The second problem with ISAs is an economic one. The predecessor to ISAs, TESSAs, was introduced by John Major because at a time of economic over-heating he wanted to get people to switch from consumer spending to saving, providing a tax break to encourage this. However, the economy is now in a very different situation.
There is a problem of low long-term pensions savings, but the introduction of the new auto-enrollment pension schemes is the answer to that. There is a problem too of high consumer and housing debt, but paying off that debt rather than saving into ISAs is the better route for people to take. There is also a problem of consumer spending being too sluggish during the current choppy economic recovery, which is what makes the generous ISA allowances currently so ill-suited to our needs.
The solution? Introduce a £15,000 limit of the total ISA holdings people can have. That is a generous enough number not to get in the way of the sorts of levels of savings that most people can look to put away, and means people can benefit from ISAs for short-term saving needs. But for richer people it would encourage them to spend rather than save, which is what the economy needs. For both groups, limiting ISAs does not make pension saving less attractive nor does it hinder paying off existing debts. It would also be a much fairer solution than the current rules, which give more to those who already have the most.
The Social Market Foundation estimates that it would save the government around £1bn a year, money which can then be put to better use. It is a simple and sensible policy we should adopt.