The Times | 28 August 2004

IMAGINE that you are the benevolent King of Anisia. You want to ensure that each Anisian child, regardless of background, grows up with a pot of savings. You have got £6,500 to split between two children — one rich, one poor. How much should each child get?

One response may not immediately occur to you: to give £6,000 (92 per cent) to the rich child, and £500 (8 per cent) to the poor one. What principle could possibly justify such a split? Not justice, equality or fairness, it would seem.

Now — surprise, surprise — this is almost precisely the Government’s position with the new Child Trust Fund (CTF), or “baby bond”. The CTF is a savings account created for every child born after September 2002. It starts with a means-tested deposit of £500 or £250 (an undisclosed further payment follows at the age of seven). The child’s family can, moreover, also save up to £1,200 per annum per child tax free. At 18, junior trousers the lot, plus interest. (Conspiracy theorists will enjoy the coincidence between the date of the first CTF cheques — April or May 2005 — and the bookies’ favourite date for the next general election.)

The CTF moves the focus of social provision one notch away from income and towards capital: away from government’s historic preoccupation with supplementing low incomes with benefit, towards a role in supporting individual wealth-creation. It aims to give children both some working capital, and a measure of early independence and control over their lives. Finally, it recognises that saving for “life-cycle needs” can be as important as saving for retirement. American research suggests that people will save more with a small amount of financial education. This too will feature in the British scheme. All well and good. So what is the problem?

Here’s what. The real value of the CTF lies not in the deposit but in the tax relief. Consider a higher-rate taxpayer with one child who receives the initial deposit of £250, and then saves £1,200 each year for 18 years. Assuming gross interest of 5 per cent per annum, this generates a lump sum of £34,000. Perfect to get little Rory through his first two years at university. But this £34,000 consists, roughly, of £21,500 of saver’s cash, £6,000 of initial deposit and tax relief, and £6,500 of interest. Now consider someone who does not or cannot save through the CTF. At best, this parent receives an initial deposit of £500, plus 18 years’ interest: roughly £1,200 for the child in total.

In other words, the Government — using my money and yours, remember — is giving the high-income parent £6,000 per child, twelve times more than the £500 it gives the low-income parent. Quite an achievement for a government committed to narrowing income differentials and increasing social inclusion. Imagine the feeling when the basic financial analysis class at St Snodgrass’s discovers that some pupils have 12 times less government funding in their CTF accounts than others.

Of course, taxpaying parents are saving their own money, which lower-income parents are not. So the difference in CTF funding at least rewards the desired behaviour. And the deposit means that everyone gets something, the impecunious more than the high-rollers. And maybe it is wrong just to look at the two ends of the spectrum. How many people will save nothing into the CTF?

Unfortunately, the answer is plenty. Half the households in the UK have £750 or less in the bank. Even if each household saved all its available “rainy day” cash reserves into a CTF for just one child, it would benefit from less than one year’s available tax-relief. There is also evidence that those on lower incomes do not understand tax very well; and that tax incentives tend to reallocate savings, not grow them.

So the CTF is unlikely to appeal either to many in the less well-off half of the population — the key target — or to increase the overall savings rate, now close to its historic lows. The CTF is a decent idea in principle, but poorly implemented. Our children deserve better.