The debate on savings policy often focuses on retirement provision and the so-called £27bn savings gap. But it is too simplistic to argue that, as people are not saving enough to enjoy retirement, they need to put more in their pensions.
Policymakers sometimes ignore more subtle factors that shape savings needs and habits. For many people, rainy-day saving should take priority over pensions.
Rainy day saving is important because it can help develop a savings culture. It gives people greater independence throughout their life and can enable them to cope better with change and improve their prospects later in life.
Governments of all colours have encouraged families to save for the medium term as well as for pensions. They have done this through a range of tax-efficient savings vehicles. The Tories started the ball rolling with Peps in 1986 and Tessas in 1991.
In 1999, New Labour introduced Isas. One of the aims of Isas was to encourage more people to save. The Government hoped that simplifying tax-efficient saving, extending the range of assets available and lowering the maximum investment limits (and later the age limits) would make Isas attractive to younger and less well-off people.
In 1997, Tony Blair outlined the aims of Isas: “For the first time, (lower and middle-income families) have got a tax-free account into which they can put their savings. It is about extending opportunity to save, not curtailing it. There is a choice. We can either spend the same amount of money on tax relief, giving these new six million people the chance to save, or we can carry on with the existing system.”
But have these aims been achieved? Forthcoming IPPR research compares the take-up of Isas in 2000/01 with that of their predecessors. Overall levels of tax-free account holding are higher with Isas than Peps and Tessas. However, more important is the question of whether poorer and younger households have been induced to save.
In short, they have not. Isas are no better at reaching lower-income savers than Peps and Tessas. Among the key group earning between £10,000 and £15,600, Isa holdings are only 1 per cent higher than was the case for Peps and Tessas. The income profile of savers is virtually identical to that of previous savings vehicles.
We see a similar story with age. Account holdings, in both 1997/98 and 2000/01, are lowest among the young and tail off again among older people.
A positive note is that Isas have brought a small increase in tax-free saving by young people between 16-34. At first glance, this appears welcome, yet dig a little deeper and most of these younger people are in high-income households.
In short, Isas have not achieved their aim. Tax relief still does not benefit the poor and there has been no substantial increase in tax-free account holding among a wider spread of the population.
If we are serious about ensuring that more younger and lower-income people accumulate financial assets, we must understand why Isas have only limited appeal. One reason is simply that many might not have the money to save. Yet there is a near universal desire among all income groups to save. There are other barriers.
One of these is financial exclusion. Many people are disengaged from mainstream banks, often managing their finances without even a current account, let alone any form of saving. Many save informally in jam jars or with friends and relatives but feel barred from mainstream savings opportunities. Measures need to be taken to reduce such exclusion.
Even if financial exclusion were reduced, Isas are likely to remain exclusive. The central problem is tax relief. The group who benefit most are higher-rate taxpayers. Basic-rate taxpayers benefit to some extent but those paying no tax do not benefit at all. What is more, tax relief is not cheap, amounting to £420m for Isas in 2000/01. It is questionable whether this money is spent in the most effective way.
Policymakers need to explore more effective incentives. We need to move beyond tax relief. The principle of matching saving has already been established by the savings gateway, where low-income savers will see their deposits matched pound for pound by the Government. Such a transparent incentive but at a less generous ratio could offer an option for reform of Isas.
Indeed, the Conservatives recently broached this subject. Shadow Work and Pensions Secretary David Willetts has recognised that incentives to save cannot be directed solely through the tax system. The Conservatives' proposal for a lifetime savings account uses matching rather than tax relief. For every pound that an individual deposits in the account, the Government also makes a contribution. Because all people receive the incentive, regardless of their income, the policy could provide real encouragement for moderate and low-income earners to save.
Would it not be refreshing if the Government noted the value in Willetts' idea and explored a similar policy that provided genuine incentives for more people to save?
Will Paxton is research fellow at the IPPR