Inheritance Tax: right or wrong?

Nothing, as Benjamin Franklin said, is certain except death and taxes. For those in the UK fortunate enough to have an estate worth more than £325,000, the two go hand-in-hand. Known variously as ‘inheritance tax’, ‘estate taxes’, or ‘the death tax’, taking the assets of the dead and siphoning off some quantity for the state has its roots as far back as 1694 in the UK. Nevertheless, surveys consistently find that the British public don’t like it, despite it being a favoured tax among economists and despite very few Brits ever needing to pay it. Only around 4% of estates are affected by this tax, with the rest coming in under the threshold for Inheritance Tax.

Everybody is going to die, so a death tax is impossible to dodge

So firstly, why do economists like inheritance taxes? Economists often look to minimise how ‘distortive’ a tax is. That is, how much it changes people’s behaviour in a negative way. In general, taxing something discourages it – taxing cigarettes means people will buy less, for example. So, the theory goes that if you tax income, people will work less. If you tax investments, people will invest less. Therefore, the ideal tax is something none of us can see coming (so we can’t modify our behaviour due to it) and none of us can avoid. On this front, Inheritance Tax seems perfect. Everybody is going to die, so a death tax is impossible to dodge.

On a moral level, inheritance taxes are also attractive. Even the most ardent of capitalists will argue that our economic system should incentivise hard work. Inheritance, obviously, makes a mockery of that. Limiting the flow of wealth from one generation to another would be highly desirable. Children don’t earn their parents, and inheritance helps to further stack the deck in favour of those who come from a wealthy background. Of course, most socioeconomic inequality is entrenched long before a parent or grandparent dies, with middle class children getting a better education, living in safer areas, and having access to contacts and disposable income, but inheritance is the cherry on the anti-meritocratic cake.

The tax take from inheritance tax is negligible – making up just 0.7% of the total UK tax revenue

At 40%, the Inheritance Tax rate in the UK is fairly steep. However, since it’s only payable on inheritance above £325,000, most estates don’t qualify. Amongst those whose estates would qualify, Inheritance Tax is also fairly easy to avoid. Firstly, gifts given more than seven years before death don’t count as part of the estate. As a result, through large gifts in middle age, or trust funds and shell companies, many of the wealthiest in our society avoid paying tax on their inheritance almost entirely. The tax taken from Inheritance Tax is negligible – making up just 0.7% of the total UK tax revenue. Sure, these exemptions could be tightened up and avoidance could be made more difficult, but that would just put more money into the hands of expensive accountants. Taxation on all gifts to one’s children is impractical (not to mention politically infeasible) and, without that, Inheritance Tax is ultimately avoidable.

As I mentioned earlier, Inheritance Tax is overwhelmingly unpopular. Despite most people not needing to pay it, people feel that it is unfair. In part, that’s because this is so-called ‘double tax’. People pay Income Tax or Capital Gains Tax when they earn in the first place and then Inheritance Tax when passing the money on to their children. The ease with which the super-rich dodge Inheritance Tax just adds to this – it’s a tax on the middle class, with exemptions for smaller estates and easy tax-dodges for larger ones. It also exacerbates the generational wealth divide, leaving older generations with their wealth untaxed, but preventing them from passing it to younger people.

The government would be better replacing inheritance tax with another tax on people’s estates

Taxes are rarely popular in the UK. Whenever politicians look to raise revenue, they face significant opposition. Inheritance Tax being so unpopular relative to its revenue-raising capacity makes it a poor use of political capital. Despite the theoretical allure of inheritance taxes, they don’t work well and they hardly raise any money. The government would be better replacing them with another tax on people’s estates, for example an annual Land Value Tax.

Overall, Inheritance Tax is a nice idea for a tax. It was designed with the best of intentions – aiding social mobility and lowering distortion, whilst raising revenue. However, when policy doesn’t work, ideology must be discarded. It’s too easy to avoid the Inheritance Tax and, frankly, it causes too much angst for the bereaved to be worth the meagre revenue it raises. It’s high time the UK Government scrapped Inheritance Tax and replaced it with a more innovative, less avoidable, tax.