/rant mode
I know I have already covered this subject but the whole thing is so annoying I am going to talk about it again. Before you read on, let me clarify this is a TAASUKNA post. TAASUKNA is an ancient word which roughly translates to “talking authoritatively about stuff you know nothing about”.
I did GCSE Economics, I am a Business Graduate and a Finance Post Grad. That is to say I have studied Economics but it’s never been my main focus. A little knowledge can be dangerous, so I am quite happy to be corrected on my economic principles by people who actually know about this stuff.
Let’s discuss reducing the Cash ISA allowance from an Economics Perspective. It’s a pretty simple concept, reducing the net return on cash will make the relative return of equity more attractive. On a macro scale this will mean that a non-zero proportion of people will move their Cash ISAs to Stocks and Shares ISAs.
More investment in Shares is considered to be a desirable outcome. A sentiment shared by investment managers, who I am sure are not in any way swayed by the AMC they would receive. Banks & Building Societies seem to disagree, and I’m sure it has nothing to do with the cash outflows they would receive. Nice to know everyone is so thoughtfully looking out for the little guy.
Elasticity
Elasticity in economics means responsiveness, it usually refers to how much demand and supply respond to price. Price here is the interest rate or investment return. Demand and supply are a little mixed up in this scenario but it doesn’t really matter, it relates to the willingness for investors to provide capital.
I would suggest the responsiveness of savers is likely to be relatively low (inelastic), while they may shop around for better interest rates, they won’t necessarily look to the stock market. We know this because we have had a decade of low interest rates. People who were happy with 100% of 1% are not going to be concerned by only getting 80% of 4%.
There’s also the friction caused by the extra complication of whatever the new rules end up being. I did a video about the clown show which was the British ISA, ultimately it was a crap idea which was rightly shelved, but these proposals risk bringing the worst elements of that into the normal ISAs. I don’t think, trying to manipulate uninformed people to make specific asset investments will work on a mass scale.
Beta
As financial planners we think of Beta as responsiveness (similar but different to elasticity). Something with a beta of 2 has twice the responsiveness of the benchmark, while something with 0.5 has half. I used to believe this was just sentiment, the market knows that something is more or less responsive than the index, so prices it accordingly in a sort of self-fulfilling prophecy. However, in Corporate Finance beta relates to a company’s debt ratio, something I found confusing until I realised these were not different beta’s at all.
Debt is a key component of a company’s value. If your debt ratio is 1% and your share value halves, your debt ratio is now 2%, not likely to make a significant difference to your business. Imagine your debt is 40% and share price halves, debt is now 80% a significant financial stress and likely to put pressure on your share price. The level of debt there is therefore a significant contributor to a company’s responsiveness to market movements. OK but what’s this got do to with ISA’s?
Beta and ISA
I mentioned in my last ISA rant how I didn’t see how directing money into Stocks and Shares ISAs would do much for the economy since the money would mainly go into existing shares, so doesn’t help the businesses themselves. If anything, it just pushes share prices up higher without any improvement to the fundamentals.
However, higher share prices means lower debt ratios, which means easier borrowing, in a kind of monetary policy. This could allow for more research and development or capital expenditure which could plausibly boost the economy. Great!
There’s at least one problem, the money which provides this share price increase is being taken from Cash ISAs in banks and building societies. Therefore reducing the level of deposits held by these institutions available to lend, this means more demand and reduced supply driving up borrowing costs for businesses somewhat mitigating the benefit. There will of course be winners and losers when it all shakes out and who can know what that will look like.
Is there another motivation?
If my amateur hour economic assessment is even a slightly better take than the mono dimensional comments I am seeing in the press, then the Treasury must be aware of these issues. They do have actual economists working for them, so I am sure they have figured it out. You might therefore, be forgiven for thinking it’s a straight up cash grab. I don’t believe many more people will move cash to shares due to this policy, they will just pay the tax on their deposits. Interest rates being what they are, this could be a non-trivial amount of money.
As I mentioned in my last ISA post I think ISAs should be scrapped altogether, the main reason to save (or invest) should be to build up savings, not to avoid tax. This doesn’t mean I don’t approve of good tax planning vehicles. The likes of Pensions and Capital Allowances are great, they defer tax while allowing for that money to work for you in the meantime a much better philosophy and one which should be embraced more.
/rant mode off