Don't Tax Savings!

Published in Investing on 25 April 2012

We need a radical reform of taxation.

Earlier this month, MPs on the Treasury Select Committee called on the government to examine the redistributional effects of quantitative easing. The money-printing programme has caused a massive shift of wealth from savers to borrowers.

Some estimates put the cost to borrowers since 2009 at £470bn, more than the £325bn injected into the economy by the Bank of England.

It's encouraging to see some consideration being given to the long-term impact of this unprecedented programme, which has given rise to the lowest interest rates the country has known.

Irony

But the irony is this. The present crisis was caused by uncontrolled, debt-fuelled consumption: all of us spending what we didn't have, encouraged by irresponsible politicians and bankers on both sides of the Atlantic. Gordon Brown's promise of 'no more boom and bust' was a call to arms comparable to Lord Cardigan's charge at Balaclava.

The real solution to the crisis is austerity: a decade or so of scrimping and paring expenditure so we can pay back our debts. Quantitative easing (QE) may be a necessary sticking plaster to keep the economy going, but it's certainly not the solution.

But shouldn't policy makers give some thought to the structural issues that lay behind the crisis? Should they, perhaps, learn a lesson from the savings culture of China while taking its money to bail out their own debt-ridden economies?

Radical

One way governments can influence behaviour is through the tax system. So here's my proposal:

  • Remove tax on savings (i.e. interest income).
  • Remove (or cap) the tax break on business borrowing.

If that sounds radical, it's meant to be. But five years ago, the idea that the Bank of England should resort to printing money would have been unthinkable. The economy has been so royally trashed that incremental thinking won't be enough. But that also creates the conditions in which radical changes can be effected.

Allowing savers to keep interest gross would:

  • Immediately help those who rely on savings income and who have suffered worst from QE, especially pensioners and the elderly. That's the issue the Treasury Select Committee wants the government to address.
  • Encourage a culture of saving, something this country lost in the decades from 1970 to 1990. In the war of the generations, those who claim the baby boomers have put housing out of the reach of younger people forget that, before the 1970s, it was necessary to build up a record of saving with a building society before you could ask to borrow. That culture of having to save to spend has been lost.
  • Bring onshore money that the rich currently save in offshore tax havens, and channel more money into the productive economy rather than tax avoidance schemes.
  • Put more stable retail deposits onto the high-street banks' balance sheets.

Banks

That last point is crucial. Symptomatic of the high-octane debt dependence that created the financial crisis was the greater reliance of banks on cheaper but more volatile wholesale funding, epitomised by the disastrous Northern Rock.

The whole panoply of complex savings products could be simplified. With a little encouragement from the regulator, more of peoples' savings could go onto banks' balance sheets as retail deposits. Banks know all about the inertia of retail depositors.

That would enable commercial banks to rediscover their traditional role of maturity transformation, and so lend more to the productive economy, more cheaply and more safely.

Borrowing

More, better bank lending would be vital to implement my second proposal, to remove (or cap) the tax shield on business borrowing to pay for the first measure.

Arguably, it is a distortion that debt finance is tax deductible for businesses. It shows most clearly in the highly leveraged private equity deals that have enriched deal makers since the 1980s, stripped countless companies of their cash flows and, ultimately, pushed many into administration with tragic loss of jobs.

Of course, private equity ownership has in many cases injected financial and commercial discipline into companies and so benefited the economy. But the use of high leverage is entirely ascribable to the tax deductibility of debt, and fundamentally has no economic benefit other that the transfer of wealth from taxpayers and the target company to the new owners.

More generally, there is no doubt that the tax benefit is a strong incentive for corporate treasurers to borrow. It would be better for companies to determine their optimal capital structure without tax distortions.

Behaviour would evolve to match the circumstances. Without the tax shield it might, for example, become more common for a company to finance investment with convertible debt, paying a relatively high interest cost at first but being rewarded with fresh equity if the investment produced share price growth. Existing shareholders would bear such dilution if the share price rose.

Certainly, it's a good time to implement such a change. With companies' balance sheets stuffed with cash, the short-term impact would be muted.

SMEs

Except, perhaps, for small-to-medium enterprises (SMEs). It would obviously be wrong to suddenly bump up their borrowing costs. They have enough problems as it is, and don't have the resilience of larger companies. So maybe the tax shield should be capped rather than removed altogether.

But removing the tax deductibility of borrowing should put pressure on banks to reduce the cost of their loans. They have the headroom to do so. The latest Bank of England credit conditions survey reveals that SME loan rates have barely moved since 2008, during which time the bank base rate has dropped from 2% to 0.5%.

The bigger issue is availability of credit, which the boost to bank balance sheets from retail deposits should help.

Am I crazy? Feel free to tell me in the box below!

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Comments

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CunningCliff 25 Apr 2012 , 12:18pm

Savings and investments above a certain level MUST be taxed, so as to avoid handing unearned, dynastic wealth to a few powerful individuals.

Down with les rentiers; vive la revolution! ;0)

Cliff

Wuffle 25 Apr 2012 , 12:23pm

Too complicated a problem to analyse in a brief reply, but....

China's saving culture is not a valid comparison as they have no welfare state as we would know it.

The tax wrappers available, if managed well, give a tax free income comparable to the national average wage.

The tax break for businesses worked fine whilst proper (non-financial) businesses utilised it.

Many older savers benefited in a similar way to private equity through gearing on property purchases in the good years. And am I correct that we had mortgage tax relief a few years ago? Too young to remember.

That'll do.

Wuffle.

Wuffle 25 Apr 2012 , 12:38pm

Indeed Cliff,

It's already possible to earn more from investments without paying tax than I earn working all week up North.
Even under the current system I don't seem to be gaining on the Rothschilds. Can I get a guillotine from IKEA?

Wuffle.

mackeson29 25 Apr 2012 , 12:54pm

'Savings and investments above a certain level MUST be taxed, so as to avoid handing unearned, dynastic wealth to a few powerful individuals.'

Dear, oh Dear Cliff. You have come down in my estimation......time to put that hammer & sickle down.

'unearned' is a can of worms - someone, somewhere earned it. If someone chooses to pass those earnings down their family line, it is not for any of us (through the state) to decide we should be entitled to a slice of it.

If it is to be seen to be an unfair advantage, then we should surely also be looking at all ways parents help their children. Private schooling, surely gives an unfair advantage, which then leads onto a better job (which in the zero-sum game you think we are in) means that person gets the better paid job rather than someone without that hand up.......

Oh & where do we put the 'limit' for taxation to start ? Just above your level of wealth, perhaps ?

tux222 25 Apr 2012 , 1:48pm

I have to agree with Cliff that savings above a certain level should be taxed. I'd suggest maybe making savings income exempt from basic-rate tax, but subject to higher-rate tax (i.e. someone paying 40% income tax would pay 20% on their savings). Or,

More complex, but fairer, relate the tax on savings to CPI or RPI increases for the year. Interest that no more than maintains the real purchasing value of savings should be tax-free even for the wealthy. This complexity could be handled by the bank. The end-of-year tax-statement would state the amount of tax-exempt income, and the amount (universally zero at present?) on which income tax was due. Basic-rate tax would be deducted at source as at present.

Or even combine both of these ideas. What I can't accept is multi-millionaires bank accounts growing larger *in real terms* every year without paying any tax on the income. Especially if they are still charging 28% CGT on savings more intelligently invested by people of much more modest means.

kiffberet 25 Apr 2012 , 2:06pm

Sounds radicle but im not convinced it would what you're saying.

The reason most people aren't saving isn't because returns are taxed, but more likely they either don't have any money to save or would rather p1ss it up the wall. The ISA allowance of £5k is a lot more than most people can dream of saving each year!

Saving would have to be hammered into people, or even enforced somehow, before it's likely to start happening en mass.

Granted, not taxing any savings would encourage bundles of offshore money to return to these shores, but would its effect offset the revenue lost to HMRC?

tux222 25 Apr 2012 , 5:00pm

"The ISA allowance of £5k is a lot more than most people can dream of saving each year"

Each year, yes. In one particular year, no. Windfalls happen. Inheritances. Voluntary severance packages. Successful novels. One-off music hits. Lottery tickets.

ISAs also need reforming. Perhaps cash ISAs should have a cap rather than an annual subscription limit. Why should someone who can find £5k every year for 20 years get savings tax relief denied to someone who inherits £100k once in his lifetime? (But that's less radical than abolishing basic rate tax on all cash savings, majking cash ISAs pretty much obsolete).

jadeplant 25 Apr 2012 , 10:40pm

"The real solution to the crisis is austerity: a decade or so of scrimping and paring expenditure so we can pay back our debts."

Depending on what you mean, probably not. Rather a lot of people are pointing out that austerity programmes strangle economies, and that what's needed is state investment to increase economic activity. For instance, browse in www.neweconomics.org/blog

newtona2 25 Apr 2012 , 10:57pm

I already pay 40% tax (including NI) on all that I work 60 hours a week to earn and have spent 30 years developing the experience and the skills to warrant.

Why should I then pay 40% tax on the savings I make for the old age I know the government won't help me in?

Why indeed should someone more rich than me, who probably worked even harder and is even smarter than me (even if that smarts is in their feet, their fists, or their families) pay it too, on material savings that do in fact monetize the banking system for all the lamos who can't be bothered to save, or even work?

So, say I earn £100,000 in a year, and as I'm living below my means want to save 50% of my after tax earnings. So I take home about £60k, and save £30k of that. I can put £5640 in an isa and have to put the rest into risk shares, or into the banking system. I earn 3% on that, less 40% - on money I have already paid 40% tax on.

This is simply not fair, and not right. And it does make people not bother, certainly when rates are low. 3% is poor. But 1.8% is woeful.

At the very least ISA limits should be massively more - £20k at least.

spinquark 26 Apr 2012 , 1:19am

Some of these comments seem to suggest that a high salary and wealth are somehow directly and proportionally attributable to "working hard". I have to say that many people work very much harder for poor pay and almost no opportunity to accumulate any wealth than the high paid and wealthy.

Some kind of lifetime personal allowance which can be held without further tax seems infinitely fairer - Say £300k. The person saving £10k per annum for 30 years and their neighbour building a business they then sell in one particular year for £300k gain are then on an equal footing.

EdSwippet 26 Apr 2012 , 9:30am

Tax on savings income only to the extent that it exceeds inflation. That would finally put a brake on govt's confiscation of wealth through inflation.

Also, watch for flying pigs.

GrahamMiller0 26 Apr 2012 , 12:20pm

I have always argued that only the proportion of interest that exceeds inflation should be taxed. Ditto dividends.

somedangfool 26 Apr 2012 , 12:46pm

Cliff - hmmm - isn't that followed by D'Arcy?

I was under the impression that putting a De in front of your name meant that you were either a nob or had aspirations to become one. A bit like Mohamed Fayed's Al, or Runstedt's von.

So whence this anti-elitist stuff? Or are you a class traitor?

Frantico 26 Apr 2012 , 1:03pm

Excellent article. Brave steps must be taken by the Government. But to start,
I suggest that tax on savings should be applied on amounts over £18,000 and the tax shield should be capped rather than removed.

theoldone1 26 Apr 2012 , 1:32pm

Good article and makes a number of very valid points. The problem is that the tax system has become so convoluted and distorted that the only people who benefit are lawyers, accountants and the rich people who can pay them to develop ever more complex schemes to avoid paying tax.

We actually have three tax systems i.e. standard tax, NI (a tax by any other name) and VAT and this gives greater opporuntity for fraud and tax avoidance etc.

As a radical suggestion I suggest a flat tax system such as we imposed in Hong Kong. The strange consequence of such a system is that with less opportunites to avoid tax it becomes much fairer and simpler to operate. The current system is a complete mess and frankly I think it has grown to the size and complexity that it can never be fair.



TRhere 26 Apr 2012 , 1:47pm

Cliff,

I'm not sure taxing savings prevents the creation of unearnered dynastic wealth...

Today's rentiers build buy-to-let portfolios - and get tax deduction on their borrowings!

Tony R

Madjay 26 Apr 2012 , 2:23pm

This is a fundamentally flawed and deeply misguided article.

Let's get a minor criticism out of the way first. We don't tax savings. We tax interest and capital gains, which is unearned income paid in proportion to how wealthy you are. The title of this article is completely wrong, and this confusion is why people like newtona2 wrongly argue that this is double taxation.

But this is a minor point. This article completely misses the point that saving and investment are two sides of the same coin. They are supply and demand for capital, and the interest rate is the price which brings them into balance.

If interest rates are low, it is because there is too much saving going on in relation to the opportunities there are for investment, not because governments are trying to 'rip off' savers. The problem is there is too much saving going on right now, and the last thing we need to do is to give rich savers preferential tax treatment.

But, you might say, saving is virtuous and it is excessive borrowing that got us into this mess in the first place! Its true that no one should be encouraged to spend beyond their means. The problem is that hoarding by the super-wealthy creates excessive credit (remember, two sides of the same coin) and the last thing we need to do is pamper and encourage this hoarding to continue - instead we need to penalise saving to excess, and the tax system is a good way to do this.

EdSwippet 26 Apr 2012 , 2:42pm

@madjay: ...rich savers..."

Which I presume you define as anyone who has saved more than you have.

Random13 27 Apr 2012 , 4:24pm

I agree with feelings that the tax system is over complicated and some simplification would do wonders for stopping tax avoidance and ensuring people understand the system.
ISA's are pretty complex and discriminate against un-sophisticated investors.
Far simpler to allow a tax free amount of interest/dividends/capital gains per year (1-2k for the interest) - regardless of where the money is saved. This will also stop banks making it difficult to move isa's offering low values etc. It will also stop people building up massive pots of untaxed income (I include share isa's here as well - it beggers belief that there is a system in place that millionaires are free from paying tax due to the earning their income in an isa)
It also means saving will be more rewarding for people with short term savings.

mittler100 27 Apr 2012 , 5:19pm

my savings income has nosedived so low i no longer even pay tax

As a pensioner who was frugal throughout life as a matter of course the parlous state of my finances now will put me in the poor house but CO does not care what happens to pensioners struggling to exist on savings income just as he fails to recognise many do not get full state pension

All savings income should be tax free while your income remains below the 40% band

just as age allowance should not be clawed back unless you are in 40% tax bracket

AlysonThomson 28 Apr 2012 , 2:40pm

I'm with you! Let's give your ideas a go. They can't make any more of a mess of the Country's finances than has already been made of them.

watching1 28 Apr 2012 , 7:17pm

how is it fare on hard-working families, who are paying 40% in Tax and NI, struggling to maintain a family of 2 children in London , paying 1000 house rent and other costs, where as people not working at all for years-- aren't happy with housing allowance of even 21000 per annum. They are much better of than that working poor chap.

This cant go for long, this practice is unsustainable, you wont be able to borrow money for long to continue this practice, where people get punished for their hard work.

BleudeMaine 29 Apr 2012 , 4:21pm

So sensible, it will never be implemented in our Semi-Socialist State, which now spends 50% of GNP. Still, the USSR got to 75%.

Savings and capital are by definition unspent labour earnings. Labour may be too little , or too highly paid ( Tony Blair, Rooney, Jery Paxman and John Snow). But there is no such thing as 'unearned income'. You have already paid tax when you worked, now up to 62% + employer's NI of 13%, and you will pay again when you spend, up to 400% if you happen to buy tobacco or fuel.

One darling of the Left, John Maynard Keynes, described inflation as the ultimate stealth tax. The frugal and careful are stepwise expropriated; our Sterling of 1946 is only worth about 5 pence now, that of 1901 just one penny.

And what does HMG do? Of course, it taxes inflation. Most of the interest/ investment return is just an attempt to compensate for inflation. Only the non-inflationary part should be taxed.

The taxable reward of every investment should be no higher than the real interest that HMG pays on its borrowing: the long-term average is about 1-2%. Tax that at any top-income rate you find compatible with not killing off the economy. Remember, it's as low as 15% in many countries which escaped socialist poverty and tyranny.

So what happens now? Indeed, too few save. Too many spend. We have a chronic import surplus and domestic underinvestment. That has to be filled: by periodically crashing the currency, making it even cheaper for more frugal and saving foreigners to buy up more of GB PLC. You can see it now in how our infrastructure, utilities as well as London homes are sold and owned.

It takes a long,long time, to go from the most prosperous nation on earth 120 years ago to one of the also-runs. But you get there eventually. Argentina is a great example of what ruinous, financially and morally, socialism eventually does to your country.

That's the price an overconsuming and undersaving country pays, unless it mends its way.

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