The great inheritance-tax giveaway

David Cameron's proposal to reduce inheritance tax on many properties is controversial.But does the way we tax inherited wealth need an overhaul anyway? Simon Wilson reports.

What have the Tories proposed?

The allowance will be tapered away on estates of more than £2m, with the effect that couples leaving more than £2.35m won't benefit. The cost of the changes would be about £1bn a year, to be met by withdrawing pension relief on very high earners.

Is this a popular idea?

What's more, the dramatic rise in property prices in London (where an average house is around the £500,000 mark) and the South means that more estates are being dragged above the current zero-rate threshold.

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The number of estates paying IHT remains small and is projected to rise from about 6% now to about 10% by 2019 (under current rules, according to government figures). Nevertheless, there's a growing unease that it is the better-off middle-classes who are paying the tax, rather than the truly rich, who can pay to avoid it via a variety of schemes.

Who's opposed to the Tory plan?

Just like the capital-gains tax exemption on primary homes, it instead encourages Britons to buy and keep hold of the biggest and most expensive houses they can. This situation worsens all kinds of related problems, from high house prices to generational inequality, to labour-market rigidities.

But isn't IHT fundamentally unjust?

This is not necessarily an argument that slots into conventional political perspectives. Plenty of "right-wing" economic liberals, who generally argue in favour of a smaller state and smaller overall tax take, are (for the reasons outlined above) in favour of abolishing inheritance tax on estates but replacing it with a simple "gift tax" on recipients ie, an income tax on inheritances and pre-death gifts.

What do other countries do?

Fifteen of the OECD countries have no inheritance tax, including New Zealand, Norway and Sweden. The United States has the same 40% rate, but the zero-rated threshold is $5,430,000. Germany has a broadly similar system to us.

However, unlike the UK, which allows businesses (and farmland) to be passed on free of IHT, Germany imposes strict conditions on family businesses aimed at encouraging the next generation to continue growing the business. Another interesting model is Canada, where inheritances other than a principal residence are taxed as capital gains.