Perhaps unsurprisingly with a general election at most just over a year away and political party conference season having recently ended, tax policy has once again been hitting the headlines.
In particular, there have been calls for either the reform or scrapping of inheritance tax both within and outside of the Conservative party, with one leading government minister describing it as "punitive and unfair" in the lead up to the Conservative party conference.
It is worth remembering that the threshold to pay IHT is high. Indeed, just 3.73 per cent of deaths were subject to an IHT charge for the tax year 2020 to 2021. Nonetheless, there is certainly space for a debate on the fairness of people being taxed on their assets and income throughout their life and then again after they die.
Arguing for IHT to be scrapped altogether is not necessarily a controversial position, with a recent Ipsos survey showing that IHT is considered the most unfair of all taxes.
What the ongoing debates seemingly fail to recognise, however, is that now is not the right time for such significant reform.
If IHT were to be scrapped, or even just cut, money would have to be found elsewhere to plug the holes.There is agreement across the political spectrum that Britain’s public finances are in a poor state, with UK government gross debt the equivalent of 100.5 per cent of gross domestic product, according to the most recent figures from the Office for National Statistics.
That suggests, as reflected by the global financial response to last year's "mini"-Budget, that the UK is not in a position to embark on unfunded tax cuts.
IHT has been a growing source of revenue to the Treasury, with receipts now worth more than £8bn a year and the Institute for Fiscal Studies predicting that scrapping it would cost £15bn a year by 2032.
As a result, if IHT were to be scrapped, or even just cut, money would have to be found elsewhere to plug the holes – and the government currently has limited options to accomplish this.
A ceiling on income tax
It should be noted that it is not yet clear what plans the government may have in relation to cutting IHT, but a further increase to income tax surely is not a realistic option.
The reason, in short, is that the UK is already very heavily taxed on income. The Office for Budget Responsibility expects income tax to raise £268bn over the next tax year, which equates to 10.4 per cent of the national income and £9,400 per household.
There is little scope for further increases to income tax, particularly as the government has, in effect, already increased it by freezing the threshold, rather than allowing it to increase in line with inflation.
As a result, the proportion of taxpayers paying the higher band of income tax has increased from 12.2 per cent at the start of the 2020 tax year to 15.6 per cent over the past four years, a rise of over 28 per cent. Further income tax hikes could run the risk of negatively impacting economic growth, such as by reducing consumer spending.
Capital gains tax – rewards or risks?
If increasing income tax does not provide a feasible route to replacing IHT receipts, what other steps could the government take?
One possible approach would be to bring the CGT rate in line with the income tax rate, as recommended by the Office of Tax Simplification in 2020.
The government chose not to take action on this recommendation, however, and the OTS has subsequently been closed, which could suggest that its recommended approach to taxation was not ‘in vogue’ as far as this government is concerned.
An alternative approach the government could consider with regard to CGT is to adjust the rates on specific asset classes. Given that this policy is already partially in place, with gains on residential property already taxed at a higher rate than other gains, there may be more support for expanding it across more assets.
However, it would not be without risk. Specifically, a higher rate of CGT on more assets could simply stop many people from selling assets on.
The chancellor has also been fairly unequivocal in stating that there is no room for tax cuts, despite calls for the contrary.When the tax bill on selling an asset is around 20 per cent to 25 per cent of a resulting gain, people are generally happy to live with that. But it would be optimistic to assume that doubling that tax bill would have no impact on people’s willingness to sell their assets.
After all, rates drive people’s behaviour. Abolishing IHT and raising CGT rates may well prove to be an instructive example of this, particularly because the asset-owning taxpayer unsurprisingly tends to skew older.
The 55 to 64-years-old age group consistently has the highest number of capital gains taxpayers. It is not altogether difficult to imagine that, rather than selling an asset and paying a hefty tax bill, such taxpayers would decide to keep hold of an asset and leave it in their will, tax free.
Where next?
It should be noted that despite prominent Conservatives and others calling for IHT to be scrapped, there has been no commitment to do so thus far from the Treasury. The most recently reported plans were to reduce the IHT rate in March 2024 and then abolish it at an unspecified future date, when they can afford to.
However, this is hardly an ironclad commitment. The chancellor has also been fairly unequivocal in stating that there is no room for tax cuts, despite calls for the contrary.
In many ways, this uncertainty reaches to the heart of the issue. There is no clear path to cutting or abolishing IHT and, it would appear, not even agreement within the government as to whether or not it is feasible.
What is more clear, however, is that abolishing IHT would bring significant upheaval to the UK’s tax system – upheaval that may well prove to be more trouble than it’s worth, whichever side of the debate you come down on.
Katharine Arthur is a partner and head of private client at Haysmacintyre
