The Chancellor is in a fiscal pickle. In her Budget last year she said that she would not come back for another tranche of tax rises. Three things will force her to do exactly that. First, the government’s failure to kick-start growth. Sure, tariffs and the like don’t help, but putting up employers’ national insurance was bound to hit employment in the short run, and the big rise in the youth minimum wage was a gamble too far. Second, Labour backbenchers refused to back welfare reforms, and the PM was either too spineless to back his economic team, or thought his government would collapse if he tried to force them to do so.
Third, interest rates on government borrowing are rising around the world, and especially here in the UK. Combined with inflation rising from 2.2% to 3.8% in the last year means that the UK had to pay 30% more interest on the national debt this August than last.
The government needs to save all the money it can. I think I can save £1bn in debt interest costs.
Premium Bonds are popular. They pay 3.6% interest, allocated as prizes ranging from £25 to £1m each month. Obviously on average you will earn 3.6%, although since a few people get a much higher return, most people get a bit less.
Historically, the interest rate on premium bonds has been just under 70% of the Bank of England’s base rate. In January 2000, for example, base rates were 5.75%, and the premium bond rate was 4%. In October 2004 the two rates were 4.75% and 3.2%, while in June 2008 they were 5% and 3.4%.
That all changed after the great financial crisis. With base rates as low as 0.1%, it just wasn’t possible to maintain the traditional ratio and still have a decent range of prizes. The Premium Bond rate never fell below 1.15%.
Interest rates have risen since then, and premium bond rates have risen as well, to rates considerably above the conventional ratio.
I have two policy proposals…
First, we should restore the traditional ratio of premium bond interest to bank base rates, meaning a premium bond interest rate of 2.8%, rather than 3.6%.
Since £132bn is currently invested in premium bonds, this will save the government £1.056bn. As I say, every little helps.
The best ISAs now pay around 4.3%, so people choosing 3.6% either enjoy the dreams of £1m, or have already used up their ISA allowance. We don’t have data on the incomes of premium bond holders, but about £100bn of Premium Bonds are held by people with at least £25,000 invested. I suspect many of these people have used up their ISA allowance.
My second suggestion is therefore to scrap the maximum investment, currently £50,000. If people want to lend money to the government for 2.8%, well, that is cheaper than the 3.8% government is paying on 2 year gilts, and the 4.8% it is paying on 10 year gilts. I think a lot of people would do this - 2.8% tax free is equivalent to 4.7% if you are a higher rate taxpayer, and 5.1% if you pay tax at 45%. For some people this would remain a very good offer.
Lower rates, but no limit: a new deal for premium bonds that is a winner for taxpayers.
My issue with premium bonds is that they are an unnecessary tax perk for higher rate taxpayers, but make little sense for basic rate taxpayers who find the isa allowance sufficient for cash savings. They should come with a competitive prize rate but the prizes received should be treated as income. Secondly, the state should be encouraging people to invest, not to park large sums in long-term cash savings. Holding up to £50,000 (or £100,000 for a couple) in Premium Bonds is excessive in most circumstances—especially for higher-rate taxpayers, who typically have a greater capacity for risk and loss.
Maximum investment is 50k - I suspect you're right that such holders have maxed out their ISA allowances (over more than one year...)