Reforming ISAs would help savers and boost investment in UK firms

Last week this was backed up by the Chancellor, Rachel Reeves, using similar language. Reeves went further and suggested a need to “get the right balance” between incentivising cash holdings and owning assets that target a higher rate of return. This looks like a concerted ‘rolling of the pitch’ by ministers that are considering a change in the UK’s ISA policy. It is easy to be cynical - and opinion columns invariably get more clicks with a healthy dose of it - but the starting positions of both Reynolds and Reeves are intellectually sound. This doesn’t of course mean those positions will win out in what is a febrile public debate. Several UK newspapers have manned the barricades on behalf of their readers in staunch defence of the much-loved cash ISA.

So let’s review the evidence. Recent research by the investment manager, Schroders, suggests that in any given month both shares and cash deliver a return that has a 60% chance of keeping up with inflation - the minimum necessary to retain the value of your savings. However, the longer you hold those respective assets the more shares exceed the returns offerred by cash. Extend out to a one-year horizon and shares beat inflation 70% of the time; cash just 58% of the time. Longer term periods are even more compelling. Every rolling twenty-year period over the last century has seen the returns from shares exceed inflation. Cash, by contrast, has beaten inflation on just 65% of occasions. The message from history is clear, too much cash is bad for your wealth.

Now clearly saving by households is about more than just the returns they receive. Cash, despite its more modest historic performance, represents an easy-to-understand financial safety net. Physical cash in the form of notes and coins even more so, hence the deep-seated resistance to a cashless society. Despite a century of market data, it is also reasonable to be sceptical that the past is not a necessarily a good guide to the future. And of course, there will be plenty of Times readers raising an eyebrow at someone who works in the investment industry writing a column that supports the buying of shares.

But that healthy scepticism ignores a financial time bomb sitting under many UK households. In its most recent analysis of future pension incomes, the Department for Work and Pensions estimate that almost 40% of working age people - around 12 million Britons - are saving too little for a comfortable retirement. Targetting higher returns is one of the more efficient ways of addressing this shortfall when the options of increasing state pension provision, or increasing employer contributions to workplace pensions all appears blocked off.

The current Pensions Review has, rightly in my opinion, recognised with large increases in the National Living Wage, the imminent increase in employer National Insurance contributions, and the prospective introduction of the Employee Rights Act is a lot for UK employers to absorb in one go. Cracks are now appearing in the UK labour market. As a result there is a necessary focus on existing pensions and savings provision to deliver higher returns.

The ISA itself can trace its lineage back to Nigel Lawson’s 1986 Budget when he launched the Personal Equity Plan (PEP), and John Major’s 1990 Budget when he launched the Tax Exempt Special Savings Account (TESSA). In 1999 these merged to form the ISA. As global interest rates fell the political pressure to support the cash saving component became overwhelming. With a £20,000 cash savings allowance each year it is theoretically possible that a saver could put aside, after interest, more than a million pounds of cash savings during their working life. The upshot is that almost £300bn is now held in cash ISA accounts.

It is likely that Treasury ministers are currently looking at options to limit the cash component to around £5,000 a year, particularly at a time when higher real interest rates mean that the clamour to subsidise cash returns is rather less vocal. To a large extent that approach would be returning to the ISA to how it was conceived - a tax-effcient cash component and then, as Lawson noted in his 1986 Budget speech: “a radical new scheme to encourage direct investment in United Kingdom equities”.

And this is where any ISA reform may also take on a secondary objective. Lawson was unveilling these reforms in the teeth of reforms to UK captital markets – the 1986 Big Bang - and a program of retail share issues stemming from the privatised national utilities. The intellectual tenets of Lawson were to develop a vibrant shareholding democracy in the UK, and support the cost of capital for UK firms. Along the line these two aims have been heavily diluted as the proportion of savers who own stocks has halved over the last two decades to just 10%. Whilst the obligation that Lawson laid out for the tax relief to apply to UK equities has broadened to all shares on a recognised global exchange.

One of the objections that proponents of returning the stocks and shares component of the ISA to UK-listed shares is that the UK is a boring, low growth stock market. However there is very much a chicken-and-egg element to this conclusion. The high growing UK companies that investors want to get exposure to are either staying private, or listing overseas, because of depressed valuations and a lack of support from the UK domestic savings market. There is a strong argument that making tax relief for both pension funds – diluted by the 1997 aboltion of Dividend Tax Credits - and for retail investors by broadening ISA eleigibility to international shares - has acted to raise the cost of capital for UK companies. This has, in turn, discouraged high growth companies to raise money and scale their business in the UK, and directly contributed to the UK’s low growth and low productivity path.

ISA reform now being actively considered that supports saver returns and the cost of capital for UK firms may well be the first step off that depressing path.