What does this show?
This chart illustrates how the Institute for Fiscal Studies, an independent think-tank, forecasts the benefits of a new personal savings allowance will be distributed.
According to the IFS analysis, it will be higher earners who stand to gain most from the relief — announced in last week’s Budget— when it comes into effect in 2016.
What is this savings allowance?
Under the policy, “basic” rate taxpayers — who pay tax on savings income (where not held in a tax-free individual savings account) at 20 per cent — will not pay tax on their first £1,000 in annual earnings from their savings.
“Higher” rate taxpayers, for whom a 40 per cent rate on savings income is payable, will get a tax-free allowance of £500. Like basic rate payers, they can therefore earn up to £200 more in net savings income each year.
Chancellor George Osborne claimed that the changes would take 95 per cent of savers or some 17m people out of savings tax altogether.
But the reforms are regressive?
Yes, but with one caveat. “Additional” rate taxpayers— the 1 per cent of taxpayers who earn more than £150,000 a year — will not qualify for the relief at all.
Nonetheless, although all taxpayers could benefit by up to £200, it is generally well-off households who will benefit more, according to the IFS.
Analysis by income deciles reveals that the top 10 per cent of earners are expected to be better off by an average of £132 a year, all other things being equal.
In contrast, those in the fifth income decile — just above average — are set to gain by £25 a year, while those with the lowest 10 per cent of incomes will earn only 19 pence more, the IFS says.
Why is this?
There are a few factors at play. The first — and most obvious — is that higher earners generally have much larger savings on which they can derive income.
According to the latest official figures from the ONS, roughly one-third of households have no savings. A further third have total savings of less than £8,000.
In the low interest rate environment, where cash savings often barely return 1 per cent a year, even relatively large deposits will deliver small amounts.
In this climate, which the IFS assumes for these estimates, those with lower incomes — and typically smaller savings — inevitably stand to gain very little from a tax-free allowance for their minimal savings income.
What if interest rates rise?
If rates rise, and cash savings start to command higher rates of return, savings income will increase across all income bands and the tax-free annual allowance will become more relevant.
While the policy would deliver more equitable gains in these circumstances, its cost to the Exchequer would of course be greater than currently predicted. The government estimated the price tag — combined with a new flexibility to withdraw and replace Isa savings without eroding annual limits — at £1bn in 2016-17, declining to £565m the year after.
What about retired savers?
One group who stands to gain little from the new allowance is retired savers. But that’s because they received a boost in last year’s Budget.
From April, individuals will be able to receive up to £15,600 a year — the personal income tax allowance plus an extended “zero” rate on savings income of £5,000 — from their savings and state pension, before paying any income tax.
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