Here we go again. David Cameron is back on the airwaves talking about inheritance tax, saying it should only be paid by really rich people and not the striving middle classes who have worked hard all their lives. He’s got past form here, having muttered about raising the nil-rate band to £1m earlier this year.
Inheritance tax is a remarkable political weapon. That mythical £1m level was first floated back in 2007, when it was enough to force Gordon Brown to rethink plans for a snap election. But IHT is also a badly structured tax about which a huge amount of nonsense is talked. Here are the five biggest myths:
It’s become a tax on the middle class. In 2011/12, the latest year for which detailed figures are available, 248,981 estates did not pay IHT and 15,976 estates did. That’s 6 per cent of the total, and far fewer than the 34,060 estates that paid it in 2006/07, before the nil-rate band became transferable between spouses.
Figures from the Office for Budget Responsibility show that IHT accounted for just 0.6 per cent of tax revenue in 2012/13, and predict that it will account for 0.8 per cent by 2018/19. If you want to get angry about fiscal drag on the squeezed middle, get angry about the five million people now paying higher-rate income tax (on money they actually work for).
It’s ineffective because the rich can avoid it. It’s ineffective because anyone can avoid it. Of course the very well-off buy assets that qualify for business property relief, or establish trusts, or set up offshore bonds to cover the bills. But a simpler way is to give your money away while you’re still alive. You get to avoid tax and see the cash put to good use. You might even have a say in how it is used. This is what people in many other countries do. It’s only the British that have this fascination with becoming millionaire corpses.
It’s double taxation. I would argue that in most cases, it’s not. Capital gains on main residences, which I suspect account for a big chunk of IHT receipts, are not taxed anywhere else in the system. But even if it is, so what? If you want to get angry about double taxation, what about VAT (paid disproportionately by the less well-off, of course)? What about the taxation of interest on savings? These affect far more people but seem pretty well tolerated by comparison.
It penalises work and saving. Yes it does, but not in the way you might imagine. Someone earning £50,000 a year for 10 years would pay £96,270 in income tax, assuming current tax rates remained constant. Someone inheriting a £500,000 estate would pay £70,000 in inheritance tax. Under certain circumstances, they would pay nothing at all. Why bother to work?
As an aside, those who built fortunes through genuine entrepreneurial endeavours are often deeply circumspect about handing it all to their heirs. Many of those featured in our My First Million columns regard inherited wealth as corrosive and dangerous, and plan to give most of their money to charity rather than their children.
You should be able to pass a family home on to your children. Those were Mr Cameron’s exact words this week. I wonder what the reaction would have been if he’d said this instead: “Those people living in London and the southeast of England should be able to use all of the substantial value fortunately accrued by owning a house in a prosperous part of the country to give their kids a huge leg-up in life. Those living everywhere else, whose houses aren’t worth as much, can just lump it and their kids can struggle”. IHT is the ultimate postcode lottery.
It’s also disingenuous to rail against the supposed injustice of inheritance tax while simultaneously constructing a system of social care that, despite insistences to the contrary, effectively depends on the release of housing wealth to finance it. I suspect that far more “ordinary middle class” people will end up selling their houses to pay for care than will ever pay inheritance tax.
So if IHT is a widely misunderstood tax that’s easy to avoid, doesn’t bring in very much money and whose application causes enormous stress for bereaved families, why don’t we just get rid of it altogether? Funnily enough, that is what the Institute for Fiscal Studies, the Office for Tax Simplification and various think-tanks and academics have already recommended. The question is what would replace it.
The usual answer is that bequeathed assets should be taxed according to the circumstances of the recipients. That’s simpler to administer and fairer in the sense that those with modest incomes would theoretically derive more benefit from bequests than those who are already higher earners.
But the reality of the UK’s system is such that under that arrangement, far more people would end up paying 40 per cent tax on inherited assets than do now. That probably makes it a political non-starter.
It also wouldn’t address the issue of how to tax accidental profits on property made by specific generations, even allowing for the fact that higher earners are more likely to live in those areas of the country where property values are high. Inheritance tax is really all about property. We can only really fix it by figuring out how best to tax real estate in a fair and sustainable way. And that’s a topic for another time.
Jonathan Eley is editor of FTMoney. email@example.com.
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