Clause 4 will introduce a personal savings allowance that means basic rate taxpayers can receive up to £1,000 of interest or other savings income without any tax being due. Higher rate taxpayers can receive up to £500. Because the vast majority of taxpayers will have no tax to pay on any of their savings income, clause 39 will remove the requirement for banks and building societies to deduct tax from the account interest they pay.
As the Committee will be aware, over recent years low interest rates have helped households and businesses through difficult economic times by keeping mortgage payments down, but at the same time, low rates have made it difficult for people’s savings to grow. Economists, including Nobel prize-winning economist James Meade and Sir James Mirrlees, have long pointed out that ordinary savings are over-taxed compared with other types of investment. The Government believe that in such circumstances it is right to reward and support savers by cutting the tax they pay on their savings. In addition, customer research has shown that individuals do not understand how their savings are taxed. As a result, many low-income savers were paying too much tax by not registering bank accounts for gross interest, even though they were eligible to do so. Simplification of the system is therefore long overdue.
The changes will benefit 18 million savers. From this year, 95% of taxpayers will no longer need to pay tax on their savings. With the personal allowance, dividends tax allowance and 0% starting rate for savings, it is now possible for a taxpayer to receive up to £22,000 of income without paying any tax at all, and that is on top of any income from ISAs. As well as providing a tax cut for millions of savers, the change also simplifies the rules. The vast majority of savers will have no tax deducted from their savings income and will have no tax to pay or reclaim. Most will therefore have no need to contact HMRC about their savings. Crucially, the change removes the possibility that lower-income savers will pay too much on their account interest.
For the minority who do still have tax to pay, most will declare their savings income by completing a tax return, as they currently do. In other cases, where a taxpayer does not complete a return, HMRC will collect tax through pay-as-you-earn, where possible. That will involve changing tax codes based on the information that customers or banks and building societies provide about account interest received or paid.
Clause 4 will introduce a new nil rate of tax for savings income within an individual’s savings allowance. Each individual will have an annual savings allowance of £1,000, unless they have any higher rate income for the year, in which case their allowance will be £500, or any additional rate income, in which case their allowance will be nil. The allowance can be used for any of the individual’s savings income. It also includes income from alternative finance arrangements, income equivalent to interest, purchased life annuity payments and gains from certain contracts for life insurance.
Clause 39 will remove the requirement for banks and building societies to deduct tax from the account interest they pay. The clause will add bonds offered by National Savings and Investments, including its highly successful 65-plus guaranteed growth bonds, to the list of products that pay interest without tax being deducted.
The changes made by those clauses will provide the most significant reform to the taxation of savings for a generation. That will reward and support millions of savers by reducing the tax they pay and provide a long-overdue simplification of tax rules that have been poorly understood in the past. I therefore hope that the clauses will have the support of both sides of the Committee.
I thank the Minister for that lucid explanation. I fear that this measure may not be the simplification that he prays in aid. Taken in reverse order, clause 39 is, in a welcome sense, rough and ready, with a £1,000 allowance or nil rate for basic rate taxpayers—call it what one will, but that is important for the accountants and I concede that I do not entirely understand the difference. For a higher rate taxpayer, that figure drops from £1,000 to £500. My understanding from a press release issued in February by the Low Incomes Tax Reform Group, to which I am indebted, is that the drop is a cliff edge, so someone who moves into the higher rate tax band finds their allowance suddenly drops from £1,000 to £500 on the tax at source proposals under clause 39.
If there is a cliff edge, I urge the Government to look at that again, though I appreciate that that is difficult when going for the rough and ready simplification that we broadly support. However, taking these sorts of measures together, it is not clear that there will be the simplification that the Opposition and the Government would wish for. There is often a balancing act when various measures interact, and we will come on to that.
On simplification, the Low Incomes Tax Reform Group fears—I understand this fear—that a number of taxpayers will find it difficult to disaggregate, work out and understand the interconnection between the tax-free savings allowance, the starting rate for savings and the tax-free £5,000 dividend allowance, which is all to do with what we used to call unearned income. That is a problem.
The cliff edge is a problem, though it may be one we have to accept for simplification. However, in terms of the interaction, I start to get quite questioning when the Minister helpfully gives us an example—he will correct me if I have got it wrong—where, in a certain confluence of circumstances, someone could have an income of £22,000 plus ISA income on top and be paying no income tax at all. In particular, later in the Bill—I cannot remember the clause but the Minister will—we will get on to heritable ISAs, which allow surviving spouses to take over ISAs and therefore have the benefit of the tax advantage of the deceased’s ISAs.
We would all like those at the lower end of the income scale to get a better deal on income tax. That is what progressive tax is about. We might interpret how progressive it should be, as we did in clause 1, and so on, but as an overall concept, I think there is broad support for the progressive nature of income tax in our society as a measure of those with the broadest shoulders and so on. However, we have that example of someone who could have an income well above £22,000: because ISAs have been around for so long, there are people with £1 million in ISAs and all the income on that is tax free. That is quite legitimate and not immoral at all as any of us would see it; they just built it up year on year, using the ISA allowance for however many years ISAs have existed, which is perhaps 25 years. Because of the interaction of various measures, people can now have quite a substantial income and pay no income tax at all on it. I get a little bit uneasy about that, but overall we support clause 4 and clause 39.
This is a very important move by the Government, and we broadly welcome it for two main reasons. First, as the Minister has already rightly indicated from comments by people such as Professor Mirrlees and others, ordinary savings have been overtaxed for many years. Ordinary savings are increasingly important for a lot of people who have lived their working lives on modest incomes. For example, there was a demonstration yesterday by Women Against State Pension Inequality—the so-called WASPI women, many of whom have very modest savings. The measure is of some assistance, albeit small, to many of the people who are in the most vulnerable of circumstances. That must be welcomed.
Secondly, there is always the dilemma of simplification. When moving towards something that is relatively sophisticated, trying to simplify it normally introduces some hazards, so I am particularly interested in the Minister’s response to the questions posed by Labour Front Benchers in that regard. On the whole, we think the right thing is being done, so we will support it.
I am grateful to both hon. Gentlemen for the points raised on these measures, and I am grateful to the hon. Member for Kirkcaldy and Cowdenbeath for his strong support. He is absolutely right on the concerns of the overtaxing of ordinary savings. The hon. Member for Wolverhampton South West essentially raised two concerns—one about cliff edges and one about circumstances that could involve a substantial amount of income on which no tax is paid. My first point is that both circumstances are likely to be pretty unusual.
First, the allowance has been set at a level at which 95% of savers will not have tax to pay on their savings income, so the question of a cliff edge simply does not apply for the majority of savers. Had we not designed it in such a way, and had there been a differential treatment in terms of the size of allowance for higher rate taxpayers versus basic rate taxpayers, I suspect the Committee would criticise us for the fact that the largest beneficiaries, in terms of the cash benefit, would be higher rate taxpayers and not basic rate taxpayers.
The design of the personal savings allowance means that no one can gain by more than £200 a year, regardless of their circumstances, which is an important means to ensuring that there is no disproportionate benefit to higher rate taxpayers. That is why there is a difference. Our concern is that trying to address the cliff-edge problem would add a degree of complexity to the tax system that would be unfortunate and disproportionate, given the nature of the issue that has been identified.
Secondly, I certainly do not deny that someone could have £22,000 of tax-free income with a combination of all the various policies in this area. That is absolutely true if we take into account the tax-free personal allowance, the starting rate for savings, the personal savings allowance and the dividend allowance. However, in reality that is an uncommon set of circumstances that we believe will be extremely rare. Again, it is not apparent to me how we could try to address that problem without adding considerable further complexity—for example, a system in which, if someone made use of one allowance, they could not use another allowance—and we would be rightly open to criticism for adding that unnecessary complexity to the system.
We are trying to end the distortive effects that we have had up to now, to come back to the comments of Professor Mirrlees and others on the effect of the existing taxation system on savings. That is why we have taken these decisions. I hope that that helps the Committee and that, notwithstanding the perfectly fair points made by the hon. Member for Wolverhampton South West, it will support these clauses.