Going further and abolishing it entirely would have some obvious attractions. But equality of opportunity concerns might point in a different direction, towards the replacement of IHT with a tax on lifetime receipts. At the very least, IHT is in need of reform.
IHT at death is charged at a rate of 40 per cent on estates’ value in excess of a threshold, while transfers made up to seven years before death are taxed at reduced rates and transfers made seven years or more before death are not normally taxed.
Bequests to a spouse or civil partner are exempt from IHT and, as a result of Alistair Darling’s October 2007 change, any unused allowance can be transferred to a surviving spouse. The threshold is currently set at £325,000, which means that married couples can collectively bequeath £650,000 tax-free.
The recent IFS-led Mirrlees Review of the UK tax system noted that IHT is “a somewhat half-hearted tax, with many loopholes and opportunities for avoidance through careful organisation of affairs. This leads to charges of unfairness and makes a principled defence of inheritance tax difficult”.
Agricultural land and certain business assets are exempt, for example, creating obvious avoidance opportunities; and of course the simplest way to avoid IHT is to pass on assets above the threshold more than seven years before death.
Exploiting such opportunities is easier for the very wealthy than for the merely quite wealthy whose main bequeathable asset is often their home, so IHT is not very effective at achieving wealth redistribution.
Scaling back reliefs and extending the reach of the tax to gifts made more than seven years before death would be an improvement. If desired, the extra revenue generated could be used to reduce the rate or increase the threshold.
An alternative direction of reform would be to abolish the tax completely. IHT is not a big tax. HMRC estimates that in 2013/14 it was levied on less than one in 20 estates and raised only £3.4bn – less than 0.6 per cent of all tax revenue, or around 0.2 per cent of national income.
As shown in the chart below, these figures have fallen sharply since 2007/08 – a result of the 2007 reform combined with the financial crisis and associated falls in asset prices.
IHT revenues are forecast to rise sharply in the coming years, due partly to growth in the price of houses and other assets, but also to the government’s decision to freeze the threshold at £325,000 through to 2017/18.
By 2017/18 the threshold will have been frozen in cash terms for eight years – a reduction of 22 per cent or £70,700 relative to inflation. Such a large real-terms cut stands in stark contrast to Mr Cameron’s aspiration to increase the threshold, stated both in the 2010 Conservative Party manifesto (which proposed increasing the threshold to £1m) and again last March.
David Cameron’s ambitions aside, on current government policy IHT revenue is forecast by the Office for Budget Responsibility to rise to £5.8bn in 2018/19. That is not a trivial amount of revenue to give up, but it remains less than 0.8 per cent of total tax revenue and given the unpopularity of IHT, politicians might find it more attractive to raise the money elsewhere.
More than half the gains from abolishing IHT would go to households in London and the South East. According to Nationwide figures for Q1 2014, the average house price in London is now £362,699 – well above the threshold.
Abolitionists ask why individuals should be encouraged to spend their money before they die rather than providing for their children. To the extent that bequests are financed from earnings that have already been taxed, abolishing IHT would remove a source of double taxation. And it would certainly simplify the tax system.
There is, however, also a case for moving in a different direction. Taxing transfers of wealth to the next generation can arguably be justified on grounds of equality of opportunity.
Individuals do not control whether or not they are born to wealthy parents, so it might be seen as unfair that some are able to inherit more than others. This argument points to taxing what each recipient gets, rather than what each donor passes on.
It is also hard to see in principle why gifts made during someone’s lifetime should be treated differently from bequests at death. If concern for equality of opportunity justifies taxing transfers to the next generation, a more logical approach than the current one – albeit with practical challenges of its own – would therefore be to tax individuals at progressive rates on the total amount of gifts and inheritances that they receive over their lifetime.
The real choice, however, should be between abolishing the tax entirely or, alternatively, replacing it with a tax on lifetime receipts.
Abolishing IHT would simplify the tax system and remove an incentive for people to spend their money rather than leaving it to help secure their children’s futures.
Replacing IHT with a tax on lifetime receipts would reduce the extent to which people’s life chances depended on their family background. The choice between those two visions is where the real philosophical battleground lies.
Stuart Adam is a senior research economist and Carl Emmerson is deputy director at the Institute for Fiscal Studies
KEY POINTS
* IHT at death is charged at 40 per cent on estates over £325,000 – the average London house price is now £362,699
* One option is to abolish the tax completely
* Another option is to replace it with a tax on lifetime receipts
