Britain’s public finances are in a “parlous state”, according to the Institute for Fiscal Studies. More than a decade of public spending cuts has ripped the welfare safety net and left the NHS and other public services more stretched than ever, while it is costing increasingly more to service the country’s high and rising debt burden. Yet speculation increased last week that the chancellor, Jeremy Hunt, may be considering the abolition of inheritance tax in his spring budget in March. This would be a pre-election giveaway for some of the country’s wealthiest families that the UK can ill afford.
There is a conundrum at the heart of inheritance tax that makes it an appealing prospect to some Conservatives ahead of an election. It is paid by a relatively small number of people; currently, only the wealthiest 5% at death.
Yet it is unpopular; voters see it as the least fair tax in the UK. While scrapping it would leave a £7bn hole in the budget today, rising to an estimated £15bn a year by the early 2030s, it accounts for a far smaller slice of exchequer revenue than income tax or VAT. So the calculation by some on the right is that scrapping it could be an eye-catching but relatively cheap way to win votes.
But the reality is that abolishing inheritance tax would deliver huge gains to the rich. Analysis by the IFS shows that almost half of the tax giveaway would go to people in the top 1% of the wealth distribution league, a group that has amassed average wealth of £2.1m each by the time they die, and that they would receive an average tax cut of £1m each. This windfall for the wealthy would need to be paid for by others, either by increasing the tax burden on the less affluent, or through further cuts to already underfunded public services and to tax credits and benefits.
Inheritance tax is unpopular because many perceive it to be a form of “double taxation”. But people pay more than one tax in relation to money they earn all the time; on their income, and then on the things they spend it on, for example.
Inheritance should be taxed because it is damaging to social mobility in a society where wealth is already unevenly spread, partly because of a dysfunctional housing market that has delivered huge gains to people lucky enough to buy in the right place at the right time; gains that have come directly at the expense of a younger generation now facing stratospheric housing costs.
Wealth begets wealth when it comes to inheritance: people whose parents are in the bottom fifth of the wealth distribution inherit just £2,000 on average despite themselves only having wealth of less than £200,000. People whose parents are in the top fifth of the wealth distribution table stand to add more than £370,000 of pre-tax inheritance to their own average worth of over £800,000. The average inheritance today goes to someone in their 50s; for today’s generation of young people, the average age of inheritance will rise to 61.
If anything, inheritance tax makes too marginal a difference: it reduces the average inheritance for those whose parents are in the top fifth of the wealth distribution by less than £40,000. There is plenty of scope for it to go up more by tightening the exemptions that mean the very wealthiest end up paying proportionately less – estates of more than £10m have an average tax rate of 17%, compared with an average tax rate of 24% for estates of between £2m and £3m. Ending business and agricultural reliefs and exemptions for pension wealth would significantly raise inheritance tax revenues, mostly by making it a harder tax for the very wealthiest to avoid.
But one of the biggest loopholes of all is the fact that people can gift their wealth to their children while they are still living, so long as they do so seven years or more before their death, completely tax free. This also benefits the richest, whose wealth is less likely to be tied up in their home. It also makes no sense, as intergenerational transfers are taxed only towards the end of someone’s life or after their death.
So a more comprehensive reform would be to replace inheritance tax with a tax on lifetime receipt of gifts, as suggested by the Resolution Foundation. Under its proposals, everyone would get a lifetime allowance of £125,000 of inheritance and gifts they can receive tax free, but beyond that they would pay a basic rate of 20% tax and a top rate of 30% on gifts above £500,000 received over a lifetime – lower than the current 40% headline rate of inheritance tax. It estimates this would raise almost double the amount of inheritance tax.
Passing on wealth to children and grandchildren is something that many people want to do; working hard to give their children a better life is a strong motivator for many parents. However, high levels of existing wealth inequality, coupled with a housing market that has delivered huge windfall gains to one generation at the expense of another, means that inheritance will have an increasingly distortionary effect on social mobility.
It is right to ask those who are lucky enough to receive significant wealth transfers from their parents to contribute towards counteracting some of those effects through the tax system. Abolishing inheritance tax would only make Britain an unfairer place to live.