It has been said that the purpose of the Daily Mail is to keep the Conservative middle classes in a state of continual outrage. Certainly, that appears to be the purpose of one of their regular campaigns, which has resurfaced recently: their campaign against Inheritance Tax. The campaign is backed by the Conservative Growth Group, led by Liz Truss.
Inheritance tax is a strange tax. Although there is a good case to be made for it as a progressive, socially desirable, tax, it is badly framed, and it provokes great political resistance among many people who will never have to pay it.
A painless tax?
The principle is simple. When people die, most of the wealth which they have accumulated goes to the beneficiaries they name in their will, but a proportion is taken by the state.
For the government, it should be one of the most painless ways of raising money, because it is paid by people who are already dead. All other taxes are paid by living people from money they think of as “theirs”. The only people who lose from inheritance tax are those who had hoped to inherit it, who usually did little to earn it.
It can also be argued that it is some compensation for the services which the state has provided, and which made the acquisition of the wealth possible to acquire in the first place.
Inheritance drives inequality
The economic effect of inheritance is important. The economist Thomas Piketty has shown that inheritance is the main driver of inequality in developed countries. He points out that wealth inequality, which fell during the mid twentieth century, has now risen to levels comparable with their historic peak in 1914. While average wages in the UK have only risen slowly over recent decades, and have not risen at all since 2008, the returns on investments have risen dramatically.
For example, someone aged 50 who inherits a house worth the UK average price (just below £300,000), sells it and invests the proceeds in the FTSE 100, could reasonably expect to see the value of that sum reach £2 million by the time they retire. That would be much more than the total average wage for that period.
An ageing population is strengthening the effect. A generation ago, most people were dying in their 70s, leaving their estates to “children” who were in mid-career. That is the stage of life when expenses peak, and the money was spent on mortgages and teenage children. But life expectancy has risen, and most people are dying in their 80s. So, the “children” are now themselves approaching retirement, with diminishing financial responsibilities. That’s how wealth continues to grow and concentrate.
How inheritance tax works
Like most of our tax system, inheritance tax is not simple, though the outline is clear. When someone dies, they can leave up to £325,000 without any tax liability, and anything they leave to spouse/partner or a charity is excluded from the calculation. With the additional “main residence allowance” a couple can leave as much as £1 million tax-free.
Tax is charged at 40% on the balance above that threshold. To avoid people escaping tax by giving away their money at the last minute, tax may also be liable on gifts made within the previous 7 years.
Almost nobody pays
Although there is a good case to be made for inheritance tax, in its present form it has real weaknesses.
In practice, hardly anyone pays the tax. Although the rate of inheritance tax rate in the UK is higher than in most countries, fewer than 4% of deaths result in any payment. The number is small because most estates fall below the tax threshold, and because of a series of exemptions, for agricultural and business property, foreign holdings of non-doms, and trusts. As a result, estates worth £1-9 million pay an effective tax rate around 20%, but those worth £10 million pay half that.
In total the tax collected (nearly £5 billion) amounts to less than half a percent of all government revenue. Despite avoidance schemes, 82% of the tax was paid by the 3.8% of estates which were valued at over £1 million.
Why not tax more?
Despite opinion polling showing that most people say they would like higher taxes to pay for better public services, in practice raising taxes is unpopular. This is especially true among people on the political right, who believe in low taxes in principle, and who are more likely to vote than their children and grandchildren.
The issue is emotive. Inheritance happens at a time of personal stress. Most people aspire to leave their children better off than themselves. Some people will argue that it amounts to “double taxation”, where the money has already been taxed when it was earned.
The least unpopular tax
Nevertheless, there are vocal campaigns to reduce current levels of wealth inequality, and to tax the rich more. Making more, and better, use of inheritance tax could achieve both. Closing the loopholes could increase the tax take, and simply freezing the thresholds would (slowly) bring more estates into scope. More radically, the thresholds could be lowered and some of the allowances reduced or removed.
But the issue is an explosive one for the right-wing media. The Daily Mail regularly returns to it, despite the fact that the vast majority of their readers will never have to pay it. Perhaps its appeal is simply to keep readers’ attention by jabbing at their outrage. Perhaps it is a defence of the personal interests of owners and key supporters.
Whatever the reason, surely the time has come for government to grasp this nettle.