ISAs - a savings scheme too far?

News Analysis: Individual Savings Accounts are meant to create millions of new savers, but it's all falling apart

WHEN LABOUR first set out its policy on personal saving two years ago, there was supposed to be a simple problem and a simple solution. Half the population have less than pounds 500 in savings. More people should save, especially those on lower incomes. The reason they did not was a combination of fear of being ripped off and an aversion to locking away their money.

Labour's answer was Individual Savings Accounts (ISAs), a new all-in- one version of previous tax-exempt savings schemes such as PEPs and Tessas. With a bit of nip and tuck with tax rules, Labour planned to double the number of savers to 12 million. Rip-off fears would be allayed by introducing "benchmarked savings" carrying a government endorsement. Savings vehicles would be made cheaper by distributing them through mass-market outlets. And the lock-in would be abolished.

Sixteen months after the election, many are asking if the policy is disintegrating. In the spring the Government was forced to back down after opposition to a plan to cap the total amount savable in ISAs, PEPs and Tessas at pounds 50,000. But the concession failed to stop the entire strategy being called into question. Was this really designed to encourage saving, or was it driven by the Inland Revenue's desire to cut tax relief?

The Government's plan to endorse the right type of ISAs, published in May as a Treasury consultation paper, was also panned as impractical and even dangerous. In childishly large capital letters the paper proclaimed its objective - "Making Saving Easy". The big idea was the "CAT-mark", a Treasury stamp of approval awarded to savings products on the basis of cost, access and terms.

Richard Branson was happy. The only share investment the Government would approve was a fund tracking the FTSE 100 - just the kind he had long promoted through Virgin Direct, his financial services venture. But managers of active funds fumed, pointing out that trackers were the most volatile kind of investment.

The Treasury was attacked for opening up the possibility of a "mis-buying scandal". Helena Wiesner, deputy chairman of the PIA and a consumer representative, said that the Treasury would be blamed if people lost money after buying trackers with Treasury approval.

Then things really began to fall apart. The Government had said it wanted life insurance to be available within a CAT-marked ISA. Standard Life, initially an ISA fan, said it would not do it: only pounds 1,000 of life assurance could be saved each year, charges would have to be tiny, and life insurers could barely make money. Other insurers agreed.

A change of personnel at the Treasury made matters worse. Initially launched by Geoffrey Robinson, the paymaster-general, the ISA plan was taken over by Helen Liddell, Economic Secretary to the Treasury.

The Government is now rumoured to be ready to ditch its plan to CAT-mark stocks and shares and restrict its endorsement to cash. But no-one really knows what is happening. The savings industry was led to expect hard Treasury proposals on CAT-marks by the end of July, but a reshuffle left a new minister, Patricia Hewitt, in charge at the Treasury. Since then, the Government has said nothing about the consultation.

Autif, the trade body for unit trust providers, says its members would find it nearly impossible to change computers by April, when the grand launch of ISAs is due. The cost is estimated at a minimum of pounds 185m. "All it's going to do is cost the industry a hell of a lot of money which inevitably will get passed on to the consumer," says Anne McMehan, Autif spokeswoman.

Worse, the heads of "supermarket banks" have become critical. Sainsbury's, Tesco, Marks & Spencer and others were supposed to offer ISAs in their stores. Sainsbury's and Tesco were considered a crucial distribution channel for the cash version of the ISA.

Stuart Sinclair, the chief executive at Tesco Personal Finance, has dubbed ISAs "a real camel" - a hotchpotch animal created by a committee. The government assumption was, he said, that Tesco would offer ISAs "for love". How could ISAs be sold without incurring the usual sales and advice costs?

Richard Chadwick, the deputy chief executive of Sainsbury's Bank, said the Government was being optimistic about the new savers it would attract. "A lot of people don't save because they haven't got the money," he said. Even Marks & Spencer, which has said it will offer an ISA next April, is worried about delays.

The Treasury can take some comfort in the fact that some sort of ISA will appear next April. But will it achieve the objective of boosting saving? The National Consumer Council, which represents precisely the low-income groups targeted, thinks not.

Low-income savers will be attracted in one respect - unlike Tessas, ISAs will not require savers to lock their money up for years. But what inducement do savers have to use ISAs at all? Ruth Evans, a director of NCC, says: "Neither tax-free ISAs nor CAT standards will do much to boost the level of savings. Tax relief is pretty meaningless to the 28 per cent of working adults who are too poor to pay tax. Anyone saving on a small scale will gain virtually nothing from the relief."

Labour's original grudge against PEPs and Tessas was that tax relief was an upward redistribution of wealth - a subsidy from all taxpayers to those who can afford to save.

But Howard Flight, Conservative MP and head of fund managers Guinness Flight, claims this effect will become worse. ISAs discourage the poor from investing in shares. The tax relief means nothing to non-taxpayers. Basic-rate taxpayers get a credit of only 10 per cent, which disappears after 2004. Because of the way the tax benefits work, only taxpayers paying the top rate of 40 per cent will really benefit.

"The less well off you are the less you will benefit. The whole pretence that this was being done as something of benefit to low-income groups is a complete facade," says Mr Flight.