Tax and Fiscal Policy

Why Tory plans to reform Inheritance Tax will make a bad system even worse

Whenever we approach a General Election or Budget, the competition for the daftest tax policy idea is always intense. The current front-runner is probably the proposal to largely exempt houses from Inheritance Tax.

Some Conservatives are currently pushing plans to increase the amount of an estate which will be exempt from Inheritance Tax by the value of a family’s primary residence up to £350,000. This will save many families up to £140,000.

Tax rates should be low and flat. Tax exemptions lead to discrimination and distort economic behaviour. If this tax change goes through, two families with identical total assets could find themselves paying vastly different amounts of Inheritance Tax if one of the families invested in shares and the other invested in their home. Such discrimination against business investment is wholly unjustified. It adds to the already heavy tax discrimination in favour of owner-occupation.

The proposal will encourage investment in housing rather than in other forms of investment. Given the fixed supply of housing due to planning constraints, the result will be higher house prices. It will also encourage older people to remain in larger properties rather than downsizing, moving into more appropriate sheltered accommodation, or moving back in with their family. The incentives will not be trivial. A 90-year-old woman, for example, living in a four bedroomed house in Leicester might pay an extra £100,000 in Inheritance Tax by choosing to move into sheltered accommodation, or an extra £140,000 by choosing to be cared for in her son’s or daughter’s house.

Ideally, we should follow Australia, Sweden and many other countries and abolish inheritance tax entirely. People should not pay tax on assets accumulated from income on which they have already paid tax. And the inheritance of assets can give people a chance to invest in establishing a business. However, pending abolition, the worst features of the tax could be avoided by radical reform.

Many countries that have retained an inheritance tax instead tax recipients on their lifetime gifts received rather than taxing people on their assets when they die. Indeed, it is more logical to tax the beneficiary of a gift rather than the donor.

Our Budget submission proposed that each individual should be granted a £500,000 lifetime gifts and inheritance allowance (indexed to wage rises). When this allowance is exhausted, any further gifts received would be taxed at a flat rate of 20 per cent. Small gifts of a few thousand pounds would not count towards the lifetime allowance, and gifts would not count towards the allowance if they did not take an individual above the personal income tax allowance that year. Transfers between husband and wife, of course, would be entirely exempt.

The broad principle would be that those receiving substantial gifts would pay tax at a much lower rate. Further, estates split between many beneficiaries would incur less tax, as the recipients would be receiving less money.

Such a reform would make Inheritance Tax less bureaucratic and avoidance much less worthwhile.

This article first appeared in City AM.

Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

2 thoughts on “Why Tory plans to reform Inheritance Tax will make a bad system even worse”

  1. Posted 18/03/2015 at 16:43 | Permalink

    “The proposal will encourage investment in housing rather than in other forms of investment. Given the fixed supply of housing due to planning constraints, the result will be higher house prices.”

    Which is exactly the intention. Keep the house builders busy at all cost and the allied trades will contribute to lower unemployment.

    That is, of course, until the price of housing is so high that landlords are unable to find creditworthy tenants in sufficient numbers to ensure their debts are serviced.

    But, never mind that will be after the election. As John Maynard said, “in the long run………..”

  2. Posted 19/03/2015 at 08:57 | Permalink

    Philip – You are perfectly correct and your proposal is very sensible. What I can’t understand is why no politician proposes it – I can’t see why it wouldn’t be universally accepted (in principle, at least, although they may differ on the tax threshold and rate). Indeed, it is hardly ever pointed out that we don’t have inheritance tax in this country (even though we have a tax called ‘Inheritance Tax’) as there is no tax on what someone inherits, only a tax on the assets someone leaves when they die.

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