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“Nothing in this world can be said to be certain, except death and taxes,” wrote Benjamin Franklin in 1789. Certain surely, and bundle the two together as inheritance tax (IHT) and you have one of the most unpopular taxes of the lot. The idea of abolishing IHT has quite suddenly become a hot political issue, and we will see how the Government handles it. On the one hand, it raises relatively little money; on the other, is it right for the Tories to be seen to be cutting a tax paid by the relatively well-off?
But what about the economics – and how do other countries cope? The arguments for abolition, or at least radical change, go like this.
Digging into the figures
For fiscal numbers, the best place to start is the Institute for Fiscal Studies (IFS), which on Wednesday has conveniently produced a report on reforming IHT. It acknowledges its unpopularity, with a recent YouGov poll showing that just 20 per cent of Britons deem it “fair”. Revenues are small, some £7bn, though this is projected to grow. To put that £7bn into context, this financial year the Office for Budget Responsibility expects income tax and national insurance to bring in £440bn and total tax revenue will be around £950bn.
The IFS suggests various ways in which it could be reformed, mostly closing loopholes, such as relief for agricultural land and some businesses, and money in pension pots. This would raise a bit more revenue, and arguably would be fairer, but the numbers would be quite small. Besides, such changes might make the tax even more unpopular. And as the IFS points out, if you are worried about the inequalities in the distribution of wealth, changing IHT would not have much effect. By the time most people inherit from their parents, they are in their late fifties and early sixties and are already well-off. As they put it:
“While a reformed inheritance tax could do more to promote intergenerational mobility, big wealth inequalities by parental background already exist before inheritances are received.”
Alternative options
So what else might be done? A radical plan has been put forward by the Resolution Foundation for replacing IHT with a lifetime receipts tax. The idea would be that you are allowed to receive tax-free a certain amount of money in the form of gifts or inheritance, but the more you were given the more the rate would go up. So, if you were given more than £500,000 in total, you would pay 30 per cent on every additional £1 you were given.
It is a neat theoretical idea, but there are two problems with it. It might be just as unpopular as IHT, maybe more so. Do you really want to keep a lifetime tally of the money you are given? And only one other country in the world has tried it, Ireland. It is called a capital acquisition tax and it is complicated by the fact that many Irish families have children living abroad. By contrast, much of the rest of the English-speaking world has either done away with inheritance taxation, or as in the US, fixed it at such a high level that it affects very few people.
The OECD does a neat tally of inheritance tax, estate tax and gift taxation around the world. The difference, by the way, between inheritance tax and estate duty is that the former is paid by the people who inherit the money whereas the latter comes straight out of the estate before it is paid over. In practice, they come to much the same thing.
A world without IHT
The list of countries without inheritance or estate taxes is a long one. It includes Australia, Canada, and New Zealand. As it happens, Australia, the US and Canada are the top three destinations for Britons to emigrate to, with New Zealand number six. (Ireland is fifth, reflecting the numbers of Irish people who have made their careers in Britain retiring at home.) So at least some of the wealthy older British people with offspring in Australia or Canada who move there may be choosing to do so to avoid IHT.
In Europe, too, several countries have no inheritance tax or estate duty, including Norway and Sweden – two relatively egalitarian societies -, Austria, Czechia, Slovakia, Estonia and Latvia. In Switzerland, there is no inheritance tax at a federal level, though most cantons impose it. In Portugal, there is no tax if money is passed to spouses, children and grandchildren.
Tax revenue boost
So, were the UK to abolish IHT it would not be an outlier in either the English-speaking world or in Europe. It is quite plausible, though impossible to quantify, that a number of people who have decided to leave the UK for tax reasons might decide not to do so, thereby boosting other tax revenues. So the overall cost to the exchequer may well be smaller than that headline £7bn.
With that in mind, in purely economic terms, ending IHT would seem to make sense. It would end all sorts of distortions, such as people buying agricultural land simply to escape the tax, and it would have only a marginal impact on increasing wealth inequalities. But in political terms, it does not have a good look.
Capital gains tax
There is, however, one way of making the change more palatable, and one that would seem fair to most people. It would be to impose capital gains tax on all their assets when someone dies. At the moment they are not charged at all – you pay IHT instead. True, capital gains tax is generally charged at 20 per cent rather than IHT at 40 per cent. The IFS calculates that levying capital gains tax at the point of death would raise £1.5bn. But maybe more elderly people would take capital gains earlier, so that might bring forward tax revenue. Canada charges capital gains tax on most of a person’s assets on their death, so this is a tested policy.
There are no easy answers. But one thing has not changed in centuries. Taxation should be levied in as socially acceptable a manner as possible. More than a century before Benjamin Franklin wrote about death and taxes, Jean-Baptiste Colbert, finance minister to 17th century French King Louis XIV, famously observed: “The art of taxation consist in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”
IHT does not pass the Colbert test.
Need to know
There are many frustrating things about inheritance taxation, but the one I find most irritating is that the very rich pay hardly any such tax, whereas the moderately wealthy have to go through complex planning to cut their liability. The very rich also have the opportunity to locate more or less wherever they want to, whereas successful professionals are pretty much tied to the societies where they have built up their careers.
Looking around the developed world, the picture emerges that some countries are good at the feathers/hissing test, whereas others are not.
Global examples
The UK seems pretty much middle of the pack, in that there is general consent for most taxes, and not that much evasion by international standards. But we have reached a taxation limit and the electorate will push back against additional taxation levels. Indeed it is already doing so. As far as absolute levels of taxation relative to GDP, the UK is a bit below the European average, but higher than Australia, Canada and of course the US. So when Britons leave they tend to go to lower-taxed places, but I would guess that is more for reasons of culture and language.
Actually, looking around the world, the thing that strikes me most is the similarities of taxation systems rather than the differences. One outlier is the US because it does not have VAT. So there are state and local sales taxes but no national one. Also since health insurance costs are so high, in effect Americans pay pretty much the same amount out of their income for social reasons as do people in other advanced nations.
Revamping the tax system
So the question for the UK is not so much about the levels of taxation but whether there are detailed changes that can be made to the tax system to make the somewhat higher tax take, the highest since the 1970s, more acceptable. As is probably clear from the above, my own preference would be to abolish IHT but charge capital gains tax on assets held at the moment of death. My guess, and it is only a guess, is that there would be very little loss of revenue overall. Some people who were considering emigrating would choose to remain. There would be some inward movement of Britons who had made their careers overseas and would return to the UK rather than retire somewhere else. It is just possible, too, that some people who have decided to retire early on the grounds that it makes no sense to pile up more assets if 40 per cent will go to the taxman, will decide to stay working. We certainly have to figure out how to get early retirees back into the labour-force somehow. But whatever we do, it has to be made to appear fair – and indeed be fair.
If you want to dig deeper, the thing I would urge you to look at is the OECD report mentioned above and linked here. It is a really thorough piece of work, and importantly, a non-political one. The thing I find most interesting in it is that there is a general trend towards abolishing inheritance tax over the past 30 years – Australia, Canada and so on. So were the UK to move it would be fitting in with a wider pattern. My guess is that whatever the Tories do now, we will abolish the tax in the next 10 years.
