Why we need to radically reform inheritance tax

I upset rather a lot of you with last week’s article. Some of you wrote in support of my ideas on how we should tax inheritance. Many did not. You say that you have read my column for years, that you are long-term fans and that you usually agree with me, but that on this issue, you must fundamentally disagree.

Given that almost nothing upsets me more than upsetting you, I am going to return to the subject this week and run through your objections one by one.

My argument was that we look at inheritance the wrong way round. Instead of thinking of it as a tax on the capital wealth of the dead who no longer have an interest in the matter (as one doctor pointed out to me, no one in his “fridge room” has ever mentioned taxes), we should think of it as a tax on unearned income accruing to the living.

Unearned inheritances would be taxed in the same way as earned income. All loopholes would be closed, with any gifts given during the donor’s lifetime also falling into the income tax net (no more trusts, no more IHT-free business assets, no more seven-year rule or free gifting out of excess income).

This would be simple – it would be collected via self-assessment as it is in Ireland – and, as with all simplifications that closed loopholes, it would also raise significant amounts of money that might even allow an overall reduction in income tax rates (which is what I consider to be the final goal here).

On to the first major objection. It is that inheritance tax is a double tax – and so is this new levy – let’s call it a ‘gift tax’ or GT. I have a few answers to this.

The first is that money is constantly circulating and being taxed at every turn. VAT is a double tax. Un-indexed capital gain is a double tax. Almost the only thing that isn’t is IHT on the untaxed capital gains made on primary properties in the UK by the dead.

The second is that if you look at an inheritance as an income to the recipient, it isn’t a double tax on any one individual. The recipient hasn’t paid tax on the money yet – the income tax on it is, from his perspective, the taxman’s first bite of the cherry.

Look at it like that and you can instantly see that the double taxation argument is nonsense. If this still isn’t convincing, note that income doesn’t have to be taxed. Anyone receiving a lump sum at their marginal rate might pop it into their pension over a period of years and claim that tax back – making their inheritance effectively tax-free after all. A GT could instantly arrange things such that inheritance becomes pensions. Clever, isn’t it?

Next up is the argument from farms and small businesses. These can effectively be passed down through families inheritance tax-free – which is why farmland has outperformed Mayfair property over the past decade. Take away that loophole and charge the recipients income tax, say the owners of farms and firms, and they will all collapse.


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Maybe, maybe not. There is much worry in the UK about short-termism – how owners of small companies tend to sell up rather than build their businesses. So how about making income tax deferrable on inherited business assets? You would become liable for it not when you receive the business, but when you sell it, something that gives a clear incentive not to dispose of a business.

Next is the idea that people who have cared for their parents somehow deserve their inheritance and we shouldn’t mess with that. This seems to be a circular argument in that if you are caring only to be rewarded by an inheritance, surely that inheritance is deferred earned income and should be taxed as such? I think that’s all we need to say there.

Many of you also objected to GT by suggesting that it looks at the problem in the UK from the wrong perspective: it is property prices that are too high, not IHTs that are too low. If inheriting a house in the south wasn’t quite such a stunningly life changing event, would we all care quite so much about this?

I entirely agree that we have a problem with property prices (see many past articles). But I’m not sure it has anything to do with my basic premise, so I’m afraid I’m dismissing that one too.

The final point made by many of you is that I shouldn’t be thinking about how the state can raise more tax revenue, but about how we can force it to slash spending.

I am of course deeply concerned about this issue (see more past articles), but I can’t see a situation in which the electorate will genuinely tolerate a fall in spending to below 40% of GDP given our ageing population and pressure on the NHS and pensions systems. Unless that changes, the tax must be raised and in the simplest way possible.

That pretty much covers your objections. But there is one more vital argument I want to make for radical reform of the inheritance tax regime. It is about the quality of life of our over-55s. I rarely meet a person in that age bracket who knows what I do who doesn’t ask me about it.

They think of endless complicated schemes and get scammed by people who can think of more. They give away money they can’t really afford to give away to take advantage of the seven-year rule; they move out of houses they really wanted to stay in; and they worry about fairness – should they leave more to their bankrupt dimwit of a son than their hardworking successful daughter?

Changing everything around so that any tax payable is nothing to do with their actions and everything to do with the incomes of their children would make these problems disappear. It would in that sense be a very kind policy. There aren’t enough of those about.

• This article was first published in the Financial Times.

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13 Responses

  1. 14/04/2014, Sceptical wrote

    OK Merryn – agreed a much simpler tax system is desirable. Also agreed a state that spends 40% or less of GDP is not only desirable but ultimately inevitable if not only deficit elimination but also debt reduction is to be accomplished. That said, your simpler tax system also has to be FAIR and I do not agree that your proposed solution meets that test.

    I get that you do – but then you are clearly more than a little fixated!

    More to the point where’s the survey you referred to in the footnote to your editor’s letter in the most recent Moneyweek?

    Given that there are clearly quite a lot of conflicting opinions it would be helpful if those declaring them would also declare their interest i.e. is IHT an issue for them either as donor or recipient. It is easy to be in favour of something if it doesn’t affect you! I’ll set the ball rolling – I could buy several new Ferrarris with the amount my kids will pay in IHT if I fall off my perch tonight.

    Maybe we wouldn’t start from here if IHT didn’t exist but it does and so does the problem of spendthrift politicians and a greedy State. Nor is it, as you seem to think, simply a matter of house price inflation in the South East (or presumably Edinburgh). I live in the South east but my house is less than 25% of my net worth.

    Finally, we can debate it as much as we like but any fundamental change is going to come from the politicians. Do I expect one – definitely not!

  2. 14/04/2014, ZOOM wrote

    If your proposals were implemented, I would emigrate, and become non domiciled, and take all my money with me.

  3. 14/04/2014, Guido wrote

    Merryn, I am afraid you’re being suckered into the parlour game of how people should be taxed as a general idea. It’s a distraction from the really pressing question, which is how to cut taxes and starve our bloated government into submission.

  4. 14/04/2014, CityFarmer wrote

    What I would like to see is a simple 20% tax.

    20% VAT ( we already have that ),
    20% flat rate income tax ( no allowance ),
    20% CGT ( no allowance )
    20% business tax ( we already have that ),
    20% IHT ( no allowance )
    20% CGT ( no allowance )

    No allowances, no wangles, no fodder for armies of accountants to play with, no tit bits at every budget for specific voter interest groups of the party of the day, just a simple rate that everyone can understand and just isn’t worth the effort of bothering to avoid paying.

    • 16/04/2014, mr clyde wrote

      This would be great if the only purpose of taxation is to raise public revenue, but, whether you like it or not, tax also needs to provide negative feedback within any economy to keep it stable. I.e. re-distribution. Therefore a flat tax system should be modified by an allowance at the bottom and a ‘super’ tax at the top. I would suggest iro £12k and 40% respectively applied to both IT and CGT with the CGT allowance being cummulative. Otherwise an excellent suggestion.

  5. 14/04/2014, J P Hamilton wrote

    The proposal you make Merryn may be a more equitable way of distributing IHT however, is it that simple?. You say all loopholes would be closed, some maybe, though I expect people would find a way around compliance, no doubt the wealthy would. To suggest it could reduce income tax, may be used by the government of the day, to make it more acceptable but, I believe they would then put the loss on somewhere else to make-up this additional tax revenue.

    I would assume when an inheritance is received more money will be spent on goods and services which will generate tax receipts. The £325000 tax allowance on the deceased estate seems about right (yes it would have tax implications for my own family) any increase to be linked to the RPI and adjusted accordingly.

    Your quip regarding firms and farms maybe, maybe not that could go bust and why should a family carer be exempt comes across as the mechanical calculations of a numbers cruncher. I could think of a good reason, the recipient(s) not owning the property, they have lived and worked in or cared for a family member in, suddenly find themselves having to sell up and move out to pay the tax.

    I can think of several things to disagree with you on this subject, as I believe your argument is somewhat unbalanced.

  6. 15/04/2014, robin wrote

    Great point! Completely agree.

    Just to add another aspect to the debate:

    Modern capitalism/free market has a fundamental flaw in that it rewards those that are already wealthy. This leads to a gravitational effect of money being attracted to those who already have money.

    If we don’t have some equitable redistribution of wealth in the system somewhere, the consumers won’t have anything and won’t be able to spend. The entire market reduces in size as a result.

    Our taxation system is all focused on taxing positive changes in wealth (i.e. income). Why should this be the case? You live in this society, you benefit from the investment in infrastructure/ services its people provide.

    On the other hand taking people’s wealth away decreases incentives to achieve.

    High IHT seems a very sensible alternative. In fact I’d argue we should have more IHT and less general tax.

    • 15/04/2014, Sceptical wrote

      @robin

      And what is your exposure to IHT – do you/will you have a liability? In other words are you a maker or a taker?

      • 15/04/2014, robin wrote

        Maker/taker are very loaded terms. They suggest good/bad. How about we rephrase?

        Entitled/oppressed sound better? To answer your question I would nor benefit but my kids might.

        This is a diversion in any case. You haven’t addressed my points. Any of them. Instead your question regarding me is supposed to invalidate my argument since I have a selfish motive?

  7. 15/04/2014, inigo5j wrote

    All sounds perfectly reasonable. but while you are simplifying things why is the capital gain on a first home not taxable? As long as we are talking about a real after inflation capital gain of course.

  8. 16/04/2014, mr clyde wrote

    Robin is absolutely right! At the risk of sounding like a neo-marxist, it is an irrefutable fact that the only way to acquire wealth is to make a ‘profit’ i.e. ‘overcharge’ for the goods or services that are provided. The acquisition of wealth is also (in engineering speak) a positive feedback system, i.e. ‘money makes money’,and therefore ultimately entirely unstable. There will always be a symbiosis between producers and consumers and therefore re-distributive mechanisms are absolutely necessary, the only issue is to find a concensus on how and how much. The concept of ‘makers and takers’ is completely invalid.

    • 16/04/2014, mr clyde wrote

      …or even a consensus.

  9. 23/04/2014, Cicero wrote

    Odd

    I posted a comment, but it now does not appear.

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