Everyone hates inheritance tax. But what are the best arguments against it?

Nothing boils the blood of Britons like inheritance tax, often dubbed the “most hated tax”. The paradox is that only four per cent of ‘estates’ are actually affected.

Historically analysts have assumed that Brits misunderstood and thought they would be taxed themselves – hence the hatred. However, new polling today showed that this isn’t true. Even when voters have the tax threshold explained to them, they remain opposed (with the notable exception of Liberal Democrats). 

But what are the best arguments for cutting or indeed abolishing it?

1. It’s a ‘tax on the dead’

True – poor dead people. Britain is actually an outlier in taxing the deceased. Most countries tax the recipients of the money – which you’ve got to admit makes much more sense. 

This alternative could potentially allow for the introduction of a progressive tax, meaning that those passing on more would pay more. 

Out of OECD countries only Denmark and the US also tax the estates of deceased donors rather than the recipients.

If you think about it, it is a little bizarre. If you are concerned about inequality, it doesn’t matter how much wealth the deceased accumulates. They’re dead. What matters is how much each recipient gains – and what their personal circumstances are. 

A recipient-based inheritance tax would be much more sensible than an estate tax on the total wealth transferred by donors.  

2. It’s anti-aspirational

This one is politics dependent – taxes often constitute a balance between raising revenues without disincentivising work. If you suddenly faced income tax of 80 per cent you might find yourself less willing to finish that report by Friday. But with inheritance tax, would a higher rate for those passing on more funds really prevent people from working hard in their lifetime? It depends.

“While people may not currently have assets sufficiently valued to attract the tax, they may hope to one day have such an estate, perhaps through improvements to their home, or working that bit longer to set their families up when they pass on,” says Elliot Keck of the Taxpayers’ Alliance.

But that logic won’t motivate everyone. Perhaps it’s more likely that families with inherited wealth don’t want to lose it.

“Britain should not be a country where wealth depends primarily on getting lucky with house price rises, or being born into the right family,” Adam Corlett of the Resolution Foundation said. 

So it’s equally possible to argue the other side – a level playing field for all could be seen as more meritocratic and motivating. Plus, if you’ve inherited a load of cash, you might indulge in artsy ventures or self-pleasure, doing nothing for Britain’s pathetic productivity rates.

3. It’s easy to avoid – so is it pointless?

This is ostensibly a bit defeatist – if something’s broken, fix it.  

In avoidance schemes, arguably the rich benefit as they have more liquid assets to pass on during their lifetimes which are less likely to be taxed. As Elliot Keck of the Taxpayers’ Alliance says: “The truly super wealthy, with long-term tax planning, can exploit the numerous barmy carve-outs to drive their liabilities right down. It’s the middle class that are really hit in the end.”

Adam Corlett of the Resolution Foundation agreed Inheritance tax could be improved. It should not be optional for the richest, as can currently happen through special reliefs and lifetime giving. 

For smaller estates a marginal rate of 20 per cent rather than 40 per cent would improve perceptions of the tax. But overall – and particularly for the wealthiest estates – inheritance taxes should be going up not down.

Does this in fact constitute a redirection of funds to the pockets of tax advisers and away from the Treasury? 

In 2018 Philip Hammond commissioned a report from the Office of Tax Simplification which suggested a load of measures. Nothing has been done yet.

4. It’s not a progressive tax, it’s a flat rate. Is this unfair?

It is unusual to have a flat rate, which at the moment is 40 per cent. Dan Neidle of the Tax Policy Associates suggests cutting or capping the over-generous reliefs from inheritance tax and using the revenue to cut the rate overall.

As he put it: “The high (by international standards) 40 per cent rate drives avoidance. A low rate and wide base is the standard boring tax policy response to most problems – and it’s the right one here.” 

By comparison in the US this year “the federal estate tax ranges from rates of 18 to 40 per cent and generally only applies to assets over $12.92m”. In Denmark it’s closer to 15-25 per cent.

Then again, in Belgium the rate is progressive and ends at 80 per cent for the highest earners.

However, Corlett suggested “for smaller estates a marginal rate of 20 per cent rather than 40 per cent would improve perceptions of the tax”.

5. There are some weird exemptions like farmland which now seem old fashioned 

Currently farmland can count as an exemption. This is having the unintended effect of pushing up the price of farmland, as rich people buy it in droves as a form of asset, pushing farmers out of their homes. Derelict or unused land doesn’t count. But whack a tractor and some buildings on top and anyone may be able to trick the taxman – the relief can be up to 100 per cent on farms, farmhouses and other agricultural assets.

Anyone can make gifts of £3,000 or more without paying inheritance tax provided you don’t die in the next seven years. So if you’ve given your child a large cheque then kick the bucket five years later, that money will be taxed retrospectively. 

The seven years before you die legislation also risks appearing arbitrary, as it it is a little. 

Families are given huge perks which could seem outdated in a world where people marry less, cohabit more and shun having kids. Grandparents’ gifts of up to £2,500 are also exempt. 

Also, if you’re married or in a civil partnership, you will not be taxed at all on your partner’s estate. But if you’re cohabiting siblings (yes this exists in a non-creepy way) or friends, you will be.

6. If you’re richer you can pay more to make use of exemptions such as the one where if you invest in stocks that are riskier then you don’t need to pay IHT – seems like mixed incentives in one policy

There are some incentives that are “perverse” (if you’re the Guardian) or cool if you’re a British startup looking for cash. Buying shares on the Alternative Investment Market are free from inheritance tax after two years.

Whilst the reasoning is sound, it does muddy the waters of the tax so it would be useful to separate these.

7. Inheritance tax threshold has not risen with inflation 

This is a persuasive argument. Inheritance tax has not risen in threshold since 2015 when George Osborne upped it to £500,000. Yet property prices have risen 51 per cent since then meaning more and more people aer qualifying. As such, revenues from the tax have risen from £3.8bn in 2015 to £7bn this year.

The Office for Budget Responsibility said: “Residential property makes up the largest share of most estates and average house prices have risen by more than 70 per cent between 2009 and 2022. The rise also reflects significant fiscal drag as the IHT threshold has remained at £325,000 since 2009”.

As Keck points out: “Sure, you need to have a home worth over £1m in order to be liable for the tax in many cases, but in London this is an increasingly unremarkable price for housing.” That is an oversight on the part of regulators.

The number of families paying inheritance tax has increased by 25 per cent over the last year apparently. 

‘It’s not a rich person’s tax any more,’ says Helen Morrissey, head of retirement analysis at wealth platform Hargreaves Lansdown.

Broken system

Britain’s inheritance tax system is clearly imperfect. The flat rate is unjust, the threshold is a relic and the loopholes must be tightened.

Whilst inheritance tax doesn’t affect the majority of Brits, it affects more than the four per cent often touted. As Keck says: “a YouGov poll in July suggested that 31 per cent thought the tax would have to be paid on their assets when they died. This disparity is explained partly by the fact that four per cent of estates encompasses far more than four per cent of the population. Many people are impacted by the death of an individual.” 

Scrapping it would be wrong – morally but also fiscally. The Institute for Fiscal Studies found that scrapping the tax would cost £15bn per year. 

Both Keck and Corlett agree inheritance tax is over complicated and could do with reform. It seems like any solution would improve the system from its current archaic and absurdist reality. 

If the Chancellor doesn’t include any reform in his Autumn Statement tomorrow, and if you have the money – why not go out spend it (preferably in the Square Mile) and get our exhausted economy going?