Introduce inheritance tax bands to make system fairer, think tank says

The government should introduce a banded inheritance tax system to make the levy more progressive, a leading think tank said today.

Demos urged the government to make inheritance tax fairer by introducing different bands. This would replace the current 40 per cent flat rate, which applies on any estate worth more than £325,000.

The think tank suggested that there should be a 30 per cent rate on estates worth less than £1m and a 45 per cent tax rate for estates worth more than £2m. The 40 per cent rate should be retained for estates worth between £1-2m.

Demos said these changes would support the government’s objective of lowering the tax burden on working people while also making the system “more progressive”.

The loss in revenue from cutting the rate for inheritance under £1m would be “partly offset” by increasing the rate on estates valued at over £2m, the think tank said.

Alongside introducing bands, Demos recommended that the capital gains ‘uplift’ on inherited assets should be scrapped. The ‘uplift’ effectively means that any capital gains on assets held up to death are wiped out. Scrapping the relief would raise £1.6bn, Demos said.

Abolishing the capital gains ‘uplift’ would “remove the distortive incentive that currently exists for people to hold onto assets until they die – which may be inefficient and undesirable,” it said.

The Demos report also called for the tax-free allowance to be reduced for the top one per cent of estates and for a £500,000 cap on business relief. Altogether these reforms could raise £2.6bn.

Inheritance tax is one of the many levies that officials in the Treasury are reportedly set to reform to help put the public finances on the surer ground.

A recent report from the Institute of Fiscal Studies (IFS) suggested that the government would have to raise taxes by £25bn in the Budget to avoid austerity. This figure includes the tax commitments already made in Labour’s manifesto.