Raising income tax for high earners is not the fix we need

The point of the Labour party is to help families like the one I grew up in. Labour needs to reduce child poverty if its existence is to have any purpose.

Growth alone will not be enough, so this moral mission must be funded, in part, by taxing richer people. Rachel Reeves says this will be “part of the story” of her budget at the end of November. But how, exactly, should the government tax people like Tim?

Raising income tax rates on reasonably high earners does not work very well. When tax rates are too high, people who don’t need the money stop working. They can decline overtime, move to a four-day week, or simply retire early. The Institute for Fiscal Studies (IFS) found that raising the higher rate of income tax in Scotland raised little or no revenue. Higher income tax rates on the most affluent would not raise a lot of money in the UK, and might reduce national income.

Instead, Labour needs to hit people like me in other ways. The IFS lists a “one-off” wealth tax as one option. But the best way is to cut the Isa allowance substantially. Being able to save £20,000 a year tax-free is a real boon for well-off people whose kids have left home and who have paid off the mortgage. This group are exactly the sort of people who have enough money to pay a bit more.

A reduced Isa allowance would not affect the amount people save – the Resolution Foundation showed that the Conservative party’s policy of raising the Isa allowance led to more money in Isas, but no rise in overall savings. It was simply a bung to richer, older people. There is no reason for Labour to perpetuate this. More generally, the recent rise in interest rates massively outweighs any reduction in the tax break.

An even better approach than a lower annual allowance would be a lifetime limit on the amount that can be put into an Isa. That is how Isa’s predecessor – the Tessa – worked. The maximum investment, adjusted for inflation, was £18,000. The IFS called for a lifetime maximum when Isas were first mooted, and they were right to do so.

There is a strong case for leaving the tax status of existing Isas as they are. People have invested with a reasonable expectation that they would remain tax-free. But the government could and should end the right to put more money into existing Isas. People should be given a choice of keeping their current Isa, or opening a new-style Isa. The latter could have a lifetime investment maximum of £30,000, with no annual limit.

Older, affluent folk like me would choose to keep their existing Isa, which would mean – de facto – no further tax-free savings of any sort. The country needs the money! By contrast, people with less than £30,000 would transfer their investments into the new Isa. Savings for taxpayers would start immediately and grow over time.

This should apply to both cash Isas and to stocks and shares Isas. The case for doing so is equally strong for both: the government needs the money, and neither tax break delivers much, if anything, in terms of changing behaviour. Of course, some people will be unhappy, but that will be true whichever taxes Reeves raises this autumn. People like me can bear tax rises better than most.

Tim Leunig is director of economics at the consultancy Public First

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