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THE REAL PROBLEM with inheritance tax is that we're not paying enough of it. For all its faults in practice, it is in principle a perfect tax. Provided you have sufficient protection for business assets, and for dependent family members (of which more later), the tax liability comes at a point where those who did have the money no longer need it, and those who are about to get the money have managed quite well so far without it. Except in a very few cases, there is no problem with liquidating assets in order to get the funds to pay the tax. On Jean-Baptiste Colbert's well-known inverse scale of goose feathers plucked per hiss, it should score very highly.
Why, then, is there such pressure on the Chancellor to abolish inheritance tax completely? Why are there tabloid newspaper campaigns — supported by the sainted Richard and Judy no less — attacking it? Why, indeed, are so many of you reading this article thinking that the editor of Taxation has finally and irretrievably lost his marbles?
One in three?
The hissing has got so loud mostly because people who never thought they would come within its net now believe that they will. Research carried out by Lombard Street and Grant Thornton last November was reported as saying that by 2009 up to 3.6 million people 'will be liable to pay IHT on their estate when they die' ('This is Money', Associated Newspapers, 5 November 2005). Going one better, research from Scottish Widows was recently reported as showing that one in three households — 8.2 million — 'are now liable to have to pay inheritance tax on their estate when they die' (ibid, 3 February 2006). IHT is of course charged on individuals, not households, and the Lombard Street/Grant Thornton figures seem to be based on the most appropriate data set, so it is interesting to look at what they actually predict and why.
Their key assumptions are about growth rates. Once the already announced increase to £300,000 in the IHT threshold has worked through, they expect future increases to be based on inflation, which they assume will average the Bank of England target, 2%. On the other hand, they assume that asset price inflation will remain at its long-term average over 20 years of 7.5% nominal. It can be argued that this is not comparing like with like, and it would be interesting to see the figures reworked simply using the long-term average real rate of asset inflation. It is also arguable that house price inflation has been running at a rate which is unsustainable in the long term.
Leaving those doubts aide, the figure of 3.6 million is their estimate of the total number of people in 2009 who, if they all dropped down dead during the year, would fall within the charge to IHT. The number of estates which they estimate would ACTUALLY be charged to IHT in 2009, on the same assumptions, is 37,000 out of a total of 653,000 deaths. So far from being one in three estates paying tax, it will be more like one in eighteen. They are estimated, in total, to pay £5.2 billion in IHT.
It is true that those figures are significantly up on the corresponding ones for 2002, the last reliable year available when the research was carried out. The number of taxpayers has increased by just over 50% from 24,000, and the tax take has more than doubled from £2.4 billion.
The tax take increases proportionately more than the number of taxpayers mostly because it is assumed that those who would already have been in charge to IHT will find a higher percentage of their estate liable to tax — in short, that there is no change in behaviour caused by the increase in the number of estates and the percentage of the assets within them that are liable to tax. This is an assumption which the authors say is 'distinctly unsatisfactory' although they consider it to be of little importance to their conclusions.
Tax take
The subject of the tax take is the one where commentators seem most prone to make mutually contradictory comments without any sense that this might indicate a logical flaw. On the one hand, they suggest that paying IHT will become commonplace even for modest estates. 'Modest' is almost always the word used, either of the estates or of the homes that take those estates into charge, and anyone looking for a doctoral thesis topic in semiotics could usefully investigate what else, apart from relative financial status, such words signify when used by the middle-brow tabloid newspapers.
On the other hand, it is often claimed that the amount raised by the tax is so small that it could be abolished without any great financial consequence. Even the Lombard Street/Grant Thornton research includes a sideways swipe that IHT currently raises 'no more than the amount mistakenly overpaid in working family tax credits'.
In fact the current projection for IHT paid in 2005-06 is £3.3 billion, some £0.5 billion more than the amount to be raised by CGT. Tax is the ultimate zero-sum game; the reduction in, or abolition of, one tax must inevitably lead either to an increase in another or a reduction in public spending (assuming a fixed level of borrowing). By coincidence, £3.3 billion is about the yield of one percentage point on the basic rate of income tax. So the cost of allowing the beneficiaries of the top 5% (currently) of estates to inherit them completely tax free, just as the other 95% already do, is that everyone liable to income tax pays a basic rate of 23%, not 22%. Put that way, does the argument sound so compelling?
As the tax take increases, so the argument changes to being about the relative merits of increased spending or of tax cuts in other areas. By 2009, if the research is correct, a Chancellor who is doing his job properly could choose between cutting £2 billion from income taxes (which would pay for a significant increase in allowances over inflation) or to spend it on schools, hospitals, roads, etc. Alternatively he can use it to take a further 1% of estates out of tax altogether and reduce the charge on the remaining 5% that would remain liable. Does the last sound like the best use he can make of the money?
Reasons to be fearful (Part 1)
The Daily Express is currently running a campaign to have IHT abolished. It asks readers to sign a coupon, to be passed on to Gordon Brown, which says 'I believe that there is no justification for the unfair inheritance tax and demand that it should be abolished immediately'. So what grounds does it give for it being 'unfair'?
In an article on 17 February this year, it quoted Richard Madeley (who is also a Daily Express columnist), speaking on the eponymous Channel 4 'Richard & Judy' programme. He gave two reasons for abolishing IHT. The first was what happened if both parents died before their children were adult.
'What people don't realise is kids could be turned out of their house to pay the inheritance tax if both parents are killed — in a car accident, for example.'
This is far from being a convincing argument. First, if the parents have left wills they will almost certainly have survivorship clauses in, which may allow both nil rate bands to be used. To be fair, there probably is also a valid argument for allowing a special relief to the estates of parents who die leaving their children as orphans under the age of 18. However (and this is the second reason why the argument is not persuasive), the number of occasions when this happens is very small, and does not justify a call to abolish the tax rather than slightly amending it. Finally, and most importantly, if any parent has been so financially careless as to leave the children without significant life insurance protection in addition, they are going to be out of the house anyway in order to raise funds for their living expenses.
The second argument Madeley makes is one that is repeated elsewhere in the article.
'This is money which has been used to buy the house, in many cases it has been taxed at 40% and you also have to pay stamp duty and then you get hit beyond the grave.'
It is, of course, not unusual to have to suffer tax on payments out of income that has already been taxed. Taxed income is used to buy goods and services on which VAT and duties are then charged. But more importantly, as the article itself acknowledges, the main reason more people are falling into charge is that the value of their main residence is increasing. This gain otherwise escapes tax entirely — not taxed as a gain on the only or main residence during lifetime, and given a tax-free uplift on death. When making comparisons with other jurisdictions, particularly with those which have abolished death duties, it is important to bear in mind the particularly generous treatment already afforded by the UK tax system to main residences.
Reasons to be fearful (Part 2)
So is there any other evidence that IHT is unfair? Is it, for example, at a historically high level compared to other taxes?
The Lombard Street/Grant Thornton research says that IHT revenues have averaged 1.5% of total Inland Revenue receipts over the past ten years and have never exceeded 1.7%. The predicted figures for 2005-06 have it at the top end of that range, just over 1.7%. However, on a longer term historical view, this is a low percentage. 1987-88 is the first year in which no estate duty was collected. Capital transfer tax (as IHT was then called) collected £1.4 billion in that year, out of total Inland Revenue taxes of £64 billion — nearly 2.2%. Go back nearly twenty years earlier, to 1968-69, and estate duty collected £382 million out of £6.5 billion — 5.9%. Go back nearly a century and estate duty raised £18 million out of a total of £96 million in Inland Revenue taxes; nearly 19% of the total. It is the burden of income tax which has increased disproportionately — not death duties.
What about the abolition of death duties by other countries? Surely if a 'tax and spend' country like Sweden can abolish its inheritance tax, we can? However, Sweden has still retained its wealth tax, an annual charge of 1.5% on the excess of estates (including real estate) over 1.5 million kroner — just under £110,000. It also charges gains on main residences as income, at 30%. When it had inheritance tax, it did not exempt gains on business assets, which led to the forced break-up of thriving businesses, and contributed to the pressure for its abolition.
What about the most common argument of all — that those with real wealth are able to avoid the tax, whereas those with modest (that word again) estates are the ones who pay? As has already been explained, the tax only affects 5% of estates anyway. However, the burden of tax paid is instructive.
First, the repeated comment that estates over £275,000 (at present) are taxed at 40% leads some readers to believe that once you are over the limit your whole estate suffers a 40% charge. In fact, the work carried out by Lombard Street/Grant Thornton calculates that for 2002-03 the total value of the above-threshold estates which paid the £2.4 billion in inheritance tax was £35 billion — an average rate of less than 7%.
Second, the estates that have the best claim to be 'modest' in 2002-03, those of less than £500,000, paid about £620 million in inheritance tax. There were just over 19,300 of them, so the average bill was about £32,000. Estates between £0.5 million and £1 million paid £791 million in inheritance tax. However, the 1,000 or so estates of over £1 million paid just over a billion pounds of tax. So over two-fifths of the benefit from abolishing IHT would go to the beneficiaries of just a thousand estates each year — more than a million pounds per estate. IHT is a tax that is paid predominantly by those with butlers and Bentleys, not by Darby and Joan in Rose Cottage, Borsetshire.
Reasons to be cheerful (Part 3)
So let's turn this whole argument on its head. There are sound economic reasons for rewarding entrepreneurship and hard work, and reducing taxes on income and gains. There are particularly good arguments for decreasing the burden of tax on those who are caught in the 70% plus marginal rates of tax credits. So rather than be concerned that IHT is going back up as a percentage of tax collected, why not make it a cornerstone of policy? Aim for, say, up to 5% of direct taxes to come from IHT, on the grounds that it takes tax at a time when people can best afford it, and where it will have least impact on the economy and productivity. Reduce the nil rate band to, say, £100,000 and put in a 20% band for the first £200,000 charged to tax, then use the extra revenue to provide tax cuts where tax really is acting as a disincentive to work and production. Bearing in mind that estates left to spouses, and those comprised mostly of business or agricultural property, pay no IHT, this change would probably bring a further 60,000 or so estates into charge. That would mean that about 15% of estates paid some IHT, still leaving the genuinely 'modest' estate to be passed down to the next generation tax free.
Will it happen? Of course it won't. It would be political suicide to propose it. But the more I look at it, the less I understand why.
