The Conservatives have abandoned their manifesto commitment to raise the Inheritance Tax threshold as part of the coalition deal with the Liberal Democrats. This his highly regrettable.
Inheritance Tax is clearly unjust in the sense that it represents triple taxation. Tax is paid on the initial income, then on savings and then again after death, creating significant economic distortions. One result is the small army of tax advisers employed to minimise exposure to death duties; another is that resources are allocated in order to avoid tax rather to achieve the highest returns. Perhaps most importantly, the tax reduces incentives to save rather than consume, thus lowering investment and hampering the production of wealth.
Inheritance Tax raises about £3.5 billion per annum for the Treasury – a tiny proportion of the overall tax take. The Conservative plans to raise the threshold would therefore have cost relatively little. Indeed, given its impact on investment and allocative efficiency, it is probable that inheritance tax actually reduces overall tax revenues in the long term.
The Liberal Democrats’ alternative policy of raising personal allowances to benefit the low paid is worthwhile in order to improve work incentives by reducing the horrendous marginal withdrawal rates produced by benefits and tax credits. Nevertheless, given the fiscal crisis, the measure will have to be funded by tax rises elsewhere. If, as the reversal on inheritance tax suggests, this means higher taxes for the relatively wealthy, it may represent a transfer from those with low time preferences (entrepreneurs and savers) to those with high time preferences (low-income spenders). Accordingly, the economic benefits of this realignment of the tax system are far from clear.
The impact of Inheritance Tax is explained in Euthanasia for Death Duties by Barry Bracewell-Milnes.