The Big Sleep

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The Big Sleep

Following the recent Fair Dues report on IHT, RICHARD CURTIS considers death and taxes.

IT SEEMS STRANGE to me that human beings, as the one species that can apparently comprehend the inevitability of our own death, spend so little time planning for it and, what is more, actually spend most of our time ignoring the certainty of it. I suppose that the alternative is too awful to contemplate. Perhaps it was best summed up by Woody Allen:

So, other than the rather hackneyed 'death and taxes', what has this all got to do with tax? Well, the tax most closely associated with death — inheritance tax — has been making quite a few waves recently. It has always seemed to me that there are two basic approaches to inheritance tax:

Now, this may sound like heresy but, after some reflection, I have started to subscribe to the view that they are both equally valid. You might think that 'this is it' and once you are dead, that's the end of it all; alternatively, you might believe that you go to heaven, paradise or are beamed up by aliens. If you do believe in an afterlife, it has always seemed to me that the last thing one would want to spend eternity doing, was worrying about one's earthly inheritance tax liability. Neglecting your tax affairs in this way may not rate highly among the sins of omission and commission, but there is not much that you personally can do about it when you are gone.

The latest research

So what has made me wax philosophical? Well, sad to say, it was not studying religious texts or gazing on the beauty of nature; rather it was the thoughts of the Institute for Public Policy Research on the question of inheritance tax. Its document, Fair Dues, proposed that a radical rethink was needed with regards to this tax. The suggestion prompted a large amount of comment in both the national press and tax and accountancy publications and also on the Internet. What I find particularly amusing is the amount of bile and vitriol this subject generates and my amazement is further increased when I reflect on the fact that this is the one tax that the individual will generally not pay personally. (Perhaps we can avoid discussion of discretionary trusts, etc. for the moment.)

For a sample of such comments from the tax practice itself, AccountingWeb provides an interesting and illuminating cross section, which even its editor John Stokdyk describes as a 'mixture of philosophy, technical acumen and outright invective'.

Mark Lee provided a typical example of the reaction that this subject seems to cause. His first comment, by reference to the IPPR press release which was released a day before the full document to which it referred, stated that he 'was astonished at the spin contained in what is supposed to be an independent think tank's press release'. He followed this up shortly thereafter in a second entry by asking 'where is the equity in levying IHT on the prudent savings of a homeowner who has avoided becoming a burden on the state through careful planning? He/she has paid taxes on all income generated (and saved), but then pays another 40% on the savings that remain when he/she dies. The aggregate tax on such accumulated income is regressive'.

However, a day later he returns:

What I am trying to illustrate here is that the mere mention of inheritance tax can cause an initial reaction that may not be borne out by more considered reasoning.

The Fair Dues Report

So what was the report actually proposing? Well, it starts by noting that 'at a time when there is growing evidence that wealth inequality contributes to unequal life chances, and the richest 2% own almost one-third of all the wealth in Britain, inheritance tax is under attack from both left and right. There are excellent reasons to defend it: inheritance tax is a crucial counter-weight to the accumulation of wealth, and as a tax is relatively undistorting. But to secure its long-term future we must reform it, creating a more progressive structure that causes fewer difficulties for those who pay'.

Defend and reform

This, the title of the first section of the report, notes attacks on 'death duties' both in the UK and abroad, but believes that 'there are powerful egalitarian arguments for taxing inheritance'. In addition to accepting that abolition would mean that the lost revenue would need to be raised elsewhere, the report argues that the distortionary impact of IHT is less than income tax and VAT, increases in which can penalise work or spending (and thus earning) respectively. The report suggests that any distortionary effect of IHT will depend upon whether bequests are 'accidental' or 'intended'. Capital savings may be accumulated for use in old age, especially as life expectancy increases and the costs (e.g. of care) are uncertain. After death, the remaining capital available for distribution is 'accidental'. Intended bequests are where money is saved specifically to be gifted.

In the first case, it can be argued that there is no excess burden or substitution effect, so arguments could be made for a high level of tax. In the second case, a high level of tax could have a welfare cost. The report notes that intended bequests, for example, tend to take account of the recipient's income, whereas the division of an estate often does not.

This section of the report also notes that inheritance and wealth are very unequally distributed — and in fact seem to be becoming more so under a Labour Government. IHT can make a small, but important counter-balance. Similarly, whilst there was a large degree of hostility to the tax, attitudes were complex and 'often contradictory' and a consistent theme was that IHT 'is "optional" for the super-rich, so is mainly paid by those on moderate incomes'.

The report suggests that the tax should therefore be more progressive, have a reduced welfare cost and increase revenue.

Options for reform

An interesting option considered in the second section of the report is the replacement of IHT with a capital receipts tax (e.g. as in Eire), which would be levied at progressive rates on lifetime gifts and legacies received. The subject is considered at some length, but is ultimately rejected.

Progressive 'banding' was seen as possible and desirable and various 'banding' options are considered, with the report considering that a lower band — set at 22% on the first £25,000 of the estate over and above the current (maintained) nil rate of £263,000 — would be attractive. There would then be the present 40% rate, with a possible 50% top rate where the estate exceeds £500,000. The suggested advantages of this would be that 20% of taxpaying estates would only pay at the lower rate, 'addressing complaints that inheritance tax penalises the moderately wealthy, who are unable to use complex tax avoidance techniques'. (The report notes that the wealthy are, of course, also able to avoid IHT by simply giving away assets during their lifetimes, which the less wealthy cannot afford to do, especially when it is locked up in real property.) Using the same 22% rate as for income tax might also mean that people saw inheritances as windfall 'income'. The report calculates that 87% of estates would be better off under this system, while the other 13% would have a higher tax bill. Total revenue received would increase by £147 million (compared to the total projected receipts of £2.5 billion for 2003-04).

The report considers the removal of exemptions and closing of loopholes; it also wonders whether the capital gains tax exemption on death should be removed. So that this would not be retroactive, it proposes that only gains accruing after such a policy change should be taxed. The effect of the tax on homes is noted as being 'emotionally significant', but the report notes that the spousal exemption will be extended when the Civil Partnership Bill comes into force and that IHT on 'illiquid' assets can be paid over ten years or when the asset is sold. The report believes that the exemption could be extended to unmarried partners and long-term dependants (e.g. severely disabled adult offspring). Extending it to the next generation is not seen as realistic. As the report puts it: 'most children would, to put it bluntly, take too long to die'.

Earmarking

The final section of the report notes that support for IHT could be increased if it was earmarked for a specific purpose. However, whilst there are problems with such hypothecation, the report argues that there is a strong case for informal earmarking of additional tax revenue, perhaps linked to child trust funds or the elderly.

Recent discussions

Following on from the comments on the initial reception of the report, a new peak of excitement seems to have been scaled with the recent Conservative Party conference. Oliver Letwin considers IHT to be one of those taxes that is 'manifestly unfair' but, as he has promised not to make any promises about taxation, whether we will see it in the party manifesto is another matter. However, The Times also reports Brooks Newmark — Tory candidate for Braintree, Essex — as wanting 'a clear commitment to hard-working families: we will abolish this unfair and immoral tax'. And the same report states that Mr Letwin sees 'people on modest incomes … struggling to pay inheritance tax'. All emotive stuff, but is this really the case; do people really struggle to pay IHT; surely in most cases they are dead?

I have also seen the argument, from both tax professionals and others, that inheritance tax is inequitable because it is a tax on money that has already suffered tax. But is this not true in many cases? Friends of mine, not tax experts I hasten to add, regularly ask me why they should pay tax on bank interest; after all they have already paid tax on the money that went into the account. And a similar argument could no doubt apply to spending on petrol, cigarettes, alcohol, etc. As shown in many queries to our 'Readers' Forum', getting the distinction clear between capital and income can sometimes be problematic; but if a gift is received from a relative, what difference — in real, monetary, terms — is there between that and other income? We seem to have accepted that a capital gain should be charged to tax at the same rates as income, so why not lifetime gifts? After all, tax is generally charged on transactions and why should these transactions escape tax, when someone earning less than £100 per week will be liable to tax?

A radical rethink

Some time ago, I read an article by John Whiting entitled 'The Death of IHT' (Tax Adviser, October 2001, p40) and the Fair Dues report, and its suggestion that 'a radical rethink' is required of inheritance tax, reminded me of this. At the time of John's article suggesting the abolition of IHT, I was considering an article proposing that inheritance tax should be levied at 100%. Bear with me for a moment, does this not have a certain philosophical attraction? 'We brought nothing into this world and it is certain we can carry nothing out.' Perhaps we can skip by the case of the late actor Robert Morley who, I recall, insisted that he should be buried with his credit cards. Apparently having been told that 'you can't take it with you', he determined that he was 'going to have a damned good try'!

And as Irwin Stelzer said in The Times (6 October 2004):

No doubt statements like this will promote debate and the details of any replacement of, or amendment to, IHT will need working out. Having recently re-read John's article, rather than seeking abolition he was instead seeking a new approach, and I think that he is right, but this must be divorced from the emotional language that the subject seems bound to inspire.

For example, one fact that has recently caused dispute between Conservative and Labour parties on this subject is the fact that there are now 86 towns in the country where the average house price exceeds £263,000, whereas there was only one (Gerrards Cross, apparently) when Labour came into power in 1997. Apparently, 'even former council houses are being drawn into the net'.

I am not sure whether this is more indicative of a national obsession with house prices, than of relevance to IHT. Surely these are simply signs of potentially increasing national wealth, rather than arguments that the principal private residence should be exempt from IHT as well as CGT; although (heresy again, I suppose) I have never quite seen why we should expect to make a huge and largely effortless tax-free gain from these assets when other investments (and — if only from the level of 'Readers' Forum' enquiries — it certainly seems that private houses are as much this as a form of shelter) are subject to tax. I can see the argument for relief when selling and repurchasing, but why should this be the case where the owner is 'downsizing' and, even more, why should this be the case when the beneficial gain is from someone else's estate? Are these not simply 'windfall' gains and would a tax charge (as there is in some other countries) even help to calm increasing prices and also limit the seemingly ever-increasing levels of debt that are secured against the rising values of these 'investments'?

A policy review

When considering reform in any future review, perhaps we should also not lose sight of the fact that very few estates actually pay IHT and the Fair Dues document includes a Revenue estimate that only 6% of the value bequeathed each year is taken in tax. Some sources indicate that a wider based 'tithe', perhaps at a lower rate, might be more acceptable. In addition, a recent survey by the Leeds & Holbeck Building Society may also indicate that there is a certain amount of 'media hype' surrounding this subject. The survey found that more than 60% of people over 50 had not sought advice about IHT planning.

As Fair Dues states, 'the increasingly unequal distribution of wealth, amongst other reasons, suggests a higher tax rate could be desirable'. The report also notes the question of whether a more equal society is a happier one. By coincidence a recent report seems to suggest that it might be. Apparently, the problem is that as we gain more wealth, instead of comparing ourselves with our peers before that increase, we instead make the comparison with our new, more wealthy neighbours. Keeping up with the Joneses does not guarantee happiness. But it remains to be seen how many people would accept that the corollary — paying more tax — will make them happier instead.

No doubt the arguments and discussions over this, one of the most emotive of taxes, will continue, especially in the light of the approaching election. But, one final point — and naturally, in view of my preceding comments — if anyone out there knows how Robert Morley got on, I would be extremely interested in hearing from you!

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