Savings

Capital for everyone

The challenge

Savings are the third foundation of the mass middle class. Even more than full employment or home ownership, the accumulation of liquid assets by ordinary working people is the surest proof of a property-owning democracy.

Savings provide individuals and families with the dignity of choice. Having enough money to put aside not only demonstrates a capacity to afford more than the essentials, it allows people to take charge of their lives – by providing for the future, hedging against threats and preparing for opportunities.

Despite the full employment and welfare provision of the era, post-war Britain was characterised by an ever-strengthening savings culture. In the immediate aftermath of war, the household savings ratio stood at around zero – meaning the average family saved nothing from their disposable income.

But with each subsequent decade the ratio edged upwards – peaking at twelve per cent by the early 1980s.[62]

There was a dip at the end of that decade, but the ratio quickly recovered, standing at around ten per cent for most of the 1990s.[63]

This was also the era of privatisation, in which the great public share offers gave millions of Britons a chance to own a direct stake in blue chip companies. The percentage of households owning shares directly more than doubled.[64] The Conservative vision of a genuinely popular capitalism never seemed so close to being achieved.

The decade of debt

But, again, it was with the new Millennium that things went wrong. In the first decade of the 21st century our savings culture turned into a debt culture.

The household savings ratio collapsed, hitting a meagre two per cent by the eve of the financial crisis.65 Gross household savings (the absolute amount saved) halved between 2000 and 2007.[66]

At the same time, there was a huge increase in the level of household borrowing – from around 110 per cent of average disposable income to almost 170 per cent – exceeding anything seen in the other G7 economies.[67] Most household borrowing is mortgage debt, which not only expanded as a consequence (and cause) of house price inflation, but also because of mortgage equity withdrawal. This period was further marked by the rapid expansion of unsecured consumer credit.[68]

In response to the ensuing financial crisis, households borrowed less, increased the rate at which they paid off their debts and, if they were able, put more money aside. As a result there was a sharp recovery in the savings ratio – though to a level well below that of the early and mid 1990s.[69]

Long-term consequences

The scramble to shore-up our personal finances has so far only repaid a small proportion of Britain’s accumulated household liabilities. With indications that the savings ratio is now heading downwards again[70] – the massive overhang of personal debt is likely to remain in place for years to come, with enduring negative consequences for the economy.

The destruction of our savings culture has had other consequences too. Share ownership by individuals fell away over the previous decade – as has indirect ownership through pension funds and insurance companies.[71] Furthermore, there’s strong evidence that ownership of non-housing assets has become increasingly concentrated in the hands of the richest individuals. In 1976, the poorest fifty per cent of the population owned twelve per cent of the country’s non-housing wealth.

Ten years later this was virtually unchanged. However, by 2002, this proportion had diminished to just two per cent of the total. Over the same period, the proportion owned by the richest one per cent rose from 29 to 35 per cent.[72]

Our response

If wealth inequality is the problem, then some people think that a wealth tax is the answer. There is support for this approach on the right as well as the left, because taxing wealth is supposedly a lesser discouragement to entrepreneurship than taxing income.

However, the real problem is not that the wealthy have too much capital, but that the rest of us don’t have enough.[73] Pulling down the rich won’t recapitalise the poor. In fact, wealth taxes won’t pull down the rich anyway, because they have the means to keep their assets safe from the tax man.
In practice, the most likely targets of a wealth tax are the homes and savings of ordinary working people who don’t have the option of shuffling their wealth between different countries and asset classes. The confiscatory approach to wealth inequality not only wouldn’t work, it would create a further disincentive for saving, when the urgent need is for new incentives.
Of course, half the battle is to build the homes (chapter 1) and create the jobs (chapter 2) that would leave ordinary working people with enough money at the end of the month to be able to save. However, they also have to be willing to save – and that will require a complete turnaround in the direction of government policy, which currently favours debt.

An end to financial repression

The first and most fundamental step is to end financial repression. This is the name given to policies that are designed to suppress interest rates and encourage inflation.[74]

The excuse for such policies is that they are needed to give governments, businesses and households time to recover from the banking crisis and to repay their debts. However, the banking crisis was itself caused by the ‘cheap money’/‘easy credit’ policies of previous governments, both in Britain and elsewhere, that encouraged excessive borrowing and discouraged saving.[75]

Government now needs to send a strong signal that the age of cheap money, financial repression and quantitative easing is over. If it doesn’t, the risk is that individuals and businesses will get complacent again, stop repaying their old debts and start running up new ones – thereby creating the conditions for a new financial crisis.

Therefore, we propose:

  • That a cautious, but lasting, transition back to normal monetary conditions should be made an explicit part of the duties of the Bank of England and its Governor.
  • Legislation to put the instruments of financial repression – especially quantitative easing – beyond use: this will not, of course, stop a future government from repealing such legislation, but they would have to justify their actions in doing so.
  • A balanced budget rule and other tough fiscal measures must be enacted in support of these monetary objectives (see chapter 4) – to limit the political incentives for a return to a cheap money policy.
  • While the cheap money policies of the previous decade were the ultimate responsibility of the politicians who pursued them, the financial sector played its part by facilitating the flow of easy credit: the current British Government has gone a long way to reforming a deeply dysfunctional financial regulatory framework; progress must now be closely monitored and additional necessary reforms enacted not in response to the next financial crisis, but in time to prevent it.
  • Given the crisis it inherited, quantitative easing may have been the least worst option for the current government: however, a public inquiry should now take place to establish the facts about who gained and who lost as a result of these emergency measures[76] – and to investigate the workability of a windfall tax on the major corporate gainers.

A fair deal for ordinary savers

According to some economists – such as Thomas Piketty – the rich will eventually end up owning everything because the long-term rate of return on capital (which benefits people who already have wealth) is greater than the long-term rate of economic growth (which gives people who don’t have wealth the chance to earn some).[77]

This may come as news to most ordinary savers, who can only dream of getting that sort of return on their money. Evening-up rates of return on capital would go a long way to reducing wealth inequalities – most people would have the incentive to save more and their nest eggs would grow faster.

Therefore, we propose:

  • To rebalance the burden of taxation away from ordinary savers and towards the wealthy – paying special attention to investment income from economically non-productive assets like land and property.
  • The fight against aggressive tax avoidance must be stepped up: the principles-based approach to the enforcement of the law, as now used in the regulation of financial institutions to stop the exploitation of loopholes, should also be applied to taxation so that aggressive tax avoidance schemes can be prosecuted and punished as tax evasion.
  • Enhanced tax revenues from the investments of the wealthy should be used to provide tax incentives for ordinary savers – in particular, those who haven’t benefited as much as others from recent pension reforms and the expansion of ISAs: a new Young Savers Tax Credit would be a good way of focusing incentives on the young and low paid.
  • Government bodies should be under a legal duty to ensure fair and open access for ordinary savers to the best state-provided investment opportunities – including bond issues and privatisation share offers.
  • A fiduciary responsibility should be placed on pension funds, banks and similar institutions to actively manage their shareholdings in major companies so that executive pay increases do not come at the expense of ordinary savers.
  • The current Government has undertaken important measures to give people more control over their savings and pensions – and to promote a greater choice of financial service providers: again, this an area in which progress must be closely monitored, and further reforms enacted as required, because fair and vigorous competition is the ultimate guarantee of a fair deal for savers.

A new settlement on tax relief

Though government taxes many forms of saving, other forms – especially pensions – attract tax relief. In total this is more than £25 billion per year in upfront reliefs alone.[78]

The problem is that it disproportionately benefits the wealthiest savers (both because they have more money to save and because higher rate income tax payers get a correspondingly higher rate of tax relief). It is estimated that just 25 per cent of all pension tax relief goes to basic rate taxpayers.[79]

A fairer allocation of this vast amount of money could provide ordinary working people with a powerful new incentive to save.

Therefore, we propose:

  • A new settlement on tax relief – the foundations of which would be secured by cross-party agreement.
  • The key objective would be to reconfigure the system so that the highest rates of relief would be on savings made from ordinary working incomes.
  • The settlement would encompass tax relief on pension contributions, but also tax relief on other forms of saving – such as ISAs.
  • There are a number of mechanisms that could be used to achieve these objectives, but the preference should be on minimising the bureaucratic hurdles for ordinary savers.
  • The best place to promote the uptake of tax incentives for saving is at the point where people pay tax – therefore, as a nudge measure, government should allow taxpayers to save through their Self Assessment tax returns, i.e. by ticking a box an additional amount would be automatically collected for payment into a nominated pension scheme or savings account.

Action to rebuild a savings culture among young people

By the time a student leaves school they will have seen hundreds, if not thousands, of adverts encouraging people to borrow.[80] They will have walked along high streets full of shops pushing pay day loans and other sub-prime forms of credit. And, thanks to the student loans system, they are told that getting heavily into debt is the key to all future advancement. To cap it all, millions of young people emerge from twelve or fourteen years of state-funded education with an inadequate understanding of personal finance.[81], [82]

This is no way to build a savings culture.

Starting this year, financial education will be part of the National Curriculum for the first time. This is a welcome and long overdue step forward – but it is vital that it leads to verifiable improvements in financial literacy and changing attitudes to debt and savings.

Furthermore, financial education in schools should only be the start. Ongoing interaction between the individual and the state must reinforce the savings culture.

Therefore, we propose:

  • To allocate funding and raise sponsorship money to endow every school with the seed capital for an investment portfolio – with pupils studying its progress and contributing to investment decisions as part of their financial education.
  • National and local prizes would be awarded for the best-performing school funds.
  • Dividends would be paid out to every pupil – under two conditions: firstly, the passing of a financial literacy test and secondly, that the money is paid into a personal saving account to be opened as part of the test.
  • The syllabus would include debt education lessons to enable pupils to evaluate the claims of lenders for themselves.
  • Nudge measures should be applied to the tax and benefits system – so that a small percentage of all benefit and tax credit payments would be automatically paid into a savings account as a default option, which the recipient would have to deliberately opt-out of if they wanted it to stop.
  • The student loans system would be abolished (see chapter 2).

Create a UK Sovereign Wealth Fund with shares for all

In countries like Norway people don’t just save as individuals and families, but also as a nation. The Norwegian Government Pension Fund Global[83] is effectively a savings account for the whole population. While, in most other countries, ‘windfall’ revenues – such as those from Norway’s North Sea oil fields – would be spent by the government of the day, the Norwegians put the money into long-term investments.

Not only does this contribute to Norway’s future prosperity, it also strengthens confidence in the country’s finances and provides a powerful example for individuals to follow. Britain may not enjoy the same endowment of natural resources per head of population, but there is scope to use windfall revenues in the same way.

Therefore, we propose:

  • The creation of a UK Sovereign Wealth Fund into which all new public windfall revenues[84] – for instance, the tax revenues from offshore gas and oil extraction – would be paid.
  • Independent trustees would be appointed to manage the fund on the Norwegian model.
  • The fund would be mutually owned by all British citizens thus safeguarding its assets from predatory governments.
  • The ownership structure would guarantee that all dividends are paid out on a per capita basis, though with the option of doing so for particular age groups – for instance the fund could be used to endow school investment portfolios (see above).
  • Any dividend scheme would need to be approved by a two-thirds majority in Parliament.

References

  1. ONS data / Chris Dillow, Stumbling and Mumbling, ‘What savings culture?’, 25 June 2010
  2. ONS data / Thomas Crossley and Cormac O’Dea, Institute for Fiscal Studies, ‘The wealth and saving of UK families on the eve of the crisis’, July 2010, page 5, table 1.1
  3. James Banks and Sarah Tanner, Institute for Fiscal Studies, ‘Household saving in the UK’, October 1999, page 42
  4. Thomas Crossley and Cormac O’Dea, Institute for Fiscal Studies, ‘The wealth and saving of UK families on the eve of the crisis’, July 2010 page 5, figure 1.1
  5. ONS data / Economics Help, ‘Savings ratio UK’, 1 January 2014
  6. Credit Suisse, ‘Global wealth report 2012’, October 2012, page 23, figure 1
  7. Centre for Social Justice, ‘Maxed out: Serious personal debt in Britain’, November 2013, page 34
  8. ONS data / Trading Economics, United Kingdom Households Saving Ratio 1955-2014
  9. Ibid.
  10. Office for National Statistics, ‘Ownership of UK quoted shares’, 2012, 25 September 2013, page 3, table 1
  11. Office for National Statistics, ‘Social Trends 32’, 2002, page 102, table 5.24 and ‘Social Trends 35’, 2005, page 80, table 5.25
  12. For instance, see Max Wind-Cowie, Demos, ‘Recapitalising the poor: Why property is not theft’, July 2009
  13. For instance, see Carmen Reinhart, ‘The return of financial repression’, Banque de France, Financial Stability Re- view, April 2012
  14. For instance, see Raghuram Rajan, ‘The true lessons of the recession’, Foreign Affairs, May/June 2012
  15. See Thomas Pascoe, The Telegraph, blog, ’The gap between rich and poor will continue to grow until we give up on QE’, 5 March 2013
  16. Thomas Piketty, ‘Capital in the 21st century’ (Harvard University Press, 2014)
  17. Michael Johnson, Centre for Policy Studies, ‘Retirement saving incentives: The end of tax relief and a new begin- ning’, April 2014, page 4, table 1
  18. Michael Johnson, Centre for Policy Studies, ‘Retirement saving incentives: The end of tax relief and a new begin- ning’, April 2014, page 6, table 5
  19. StepChange Debt Charity / The Children’s Society, ‘The debt trap: Exposing the impact of problem debt on children’, May 2014, page 16
  20. YouGov, ‘Britain’s financial literacy’, 7 June 2012
  21. Personal Finance Education Group, press release, ‘Young people entering adult life with “dangerous gaps” in finan- cial knowledge’, 3 June 2013
  22. Norwegian Ministry of Finance, ‘The Management of the Government Pension Fund in 2013’, 2014
  23. With the exception of government revenues from onshore shale gas extraction in the north of England which we would earmark for the Northern Infrastructure Fund (see chapter 2)