One more good reason to completely rethink inheritance tax

While I was standing around in the rain waiting to be interviewed for 5 Live earlier in the week, I got talking to an academic from the University of Stirling.

He specialises, among other things, in the knotty problem of youth unemployment. We talked about the root causes in Scotland, and I wondered to what extent lousy education is to blame. He wasn’t sure about lousy, but conceded that the lack of an efficient apprenticeship or trainee system that put people on the road to careers without a full university education was partly to blame.

We should, he said, be more like Germany, where the apprenticeship system is designed to feed skilled young people into Germany’s phenomenally successful, small and mid-sized family companies – the Mittelstand.

This gets them into work and keeps them in work – and good work at that. So much so that Germany, far from grappling with the labour surplus so exercising the minds of the rest of Europe, is facing a shortage. It, says the FT, “already very close to full employment.”

There is not much to argue with in this. But I wonder if assuming that apprenticeships are an obvious answer is to look at things the right way around. Surely it is not just the apprenticeship system that we need to be recreating at home, but the Mittelstand as well. Without them, the education system is pointless.

So let’s think about why the Mittelstand exist. Is it because the Germans are harder-working than us? More long-term thinkers than us? Or perhaps more family-minded than us?

The myth would have you think so, but there is actually a rather more prosaic reason that at least partially explains the existence of these long-term family companies. It is inheritance tax (IHT).

In the UK, we get 100% IHT relief on business assets (details here) Pass a business you have built up to your kids, and they get it tax-free to do whatever they like with it. They can keep it and self-manage it (all too often a mistake); they can run it down; or they can sell it and pocket the cash.

Either way, no tax is payable, something that makes our IHT rules for family companies the most generous in the world. Not so in Germany.

You can read the details of their system here. The key point is that IHT relief is highly conditional. You can get full relief only if the business is continued for a minimum of seven years, and if over that period your direct wage costs amount to at least the same on average as they did in the seven years before you inherited it*.

See the incentive here? It is to keep the business, rather than to sell it or to merge it, and to make sure it expands a little along the way (productivity gains would mean the wage bill would fall unless you also grew the business), something that in turn encourages getting in professional management rather than letting sometimes useless elder sons have free rein to destroy firms their parents or grandparents have built up.

There is no such incentive in the UK. Yet another reason why our IHT regime has absolutely got to change. See my previous article on the matter here.

* This might be why the Mittelstand account for 70% of Germany’s employment but only 50% of its GDP.