It’s a strange tax, the Inheritance Tax. It raises, in relative terms, a vanishingly small amount of money – some £3bn of an aggregate tax take of almost £500bn. It is paid by a tiny number of people – some 16,000 per annum (3% of all estates). And yet it possesses a unique status as a kind of fiscal shibboleth, separating a ‘them’ and ‘us.’
Unique, unless of course we make the heroic assumption of a Labour victory in May, where it will be joined by a further shibboleth – someone out there will point out the plural, assuming also heroically, that a shibboleth is a notion such as can possess a plural – namely the Mansion Tax. That tax, too, will be paid by a tiny number of taxpayers. And as with the Inheritance Tax (remember Gordon Brown backing off a snap election when the Tories announced proposals to extend the nil rate band? It’s tempting to speculate on how different the political and economic landscape might now look had he held his nerve, fought and lost, leaving the Tories in control during the credit crunch. Tempting, but…) it’s a feature that dilutes not at all its potency.
I will allow myself this speculation though: one reason why they share this political potency might be that they are both wealth taxes. They get the newspaper barons up and out. For those, like me, who would like to see income taxes on productive strivers reduced in favour of wealth taxes on (in particular) economically fallow assets, it would be nice to think of the political success of the Mansion Tax – hugely popular with the electorate – as emboldening a future Labour Government or Opposition. Sadly, or so it seems to me, this Opposition has largely taken as its motto Matthew 5:5 – that the meek shall inherit the earth. But I’m yet young. I can wait.
You, on the other hand, might be less so. Where is he going, you might quite reasonably ask? I suppose it’s here: why is it that the Inheritance Tax – a tax paid by the donee on wealth she has not earned – is a political liability for Labour but the Mansion Tax a success? And the answer, I’d like to venture, is a matter of design. The Inheritance Tax is badly designed. It’s badly designed in technical terms. And it lacks popular legitimacy: it’ll only ever be a vote loser for Labour. The Mansion Tax, on the other hand, whatever its technical failings, is popular.
Poor technical design first. The cost of reliefs from Inheritance Tax is huge. The tax itself raises, as I have said, £3.1bn but the cost of the reliefs is more than seven times this at £22.4bn. Indeed, the real figure will be higher: the £22.4bn is the aggregate cost only of the 13 (of 88) reliefs from inheritance tax that HMRC publishes costs for.
True it is that much of that cost reflects a modelling decision. The joint nil rate band of £650,000 accounts for all but £4bn of the £22.4bn. And the level of the nil rate band reflects a political choice. The purpose and design of other reliefs is less clearly comprehensible.
Particularly difficult to understand is the privileged treatment given to agricultural property – holdings of farmland together with a ‘farmhouse’ on that land. The need to ensure food security might once have been advanced as a rationale for the relief. But if so, it is difficult to understand: the rationale is achieved by planning controls which limit the uses to which land can be put. However you tax the land, it cannot be used otherwise than to generate income through farming. Also ventured is the need to protect farms from being broken up on death: but I can understand neither why farmland should benefit from such privileged treatment nor how agricultural property relief achieves this goal.
As things stand, agricultural property relief is merely the latest and safest iteration of a kind of fiscal polo – the game played exclusively by the wealthy of ‘mitigating’ inheritance tax bills. Put your money into agricultural property and you can safely escape liability to inheritance tax. Indeed, with other mechanics for avoiding liability to the tax having slowly disappeared, farmland’s privileged status has seen its value – and indeed the cost of agricultural property relief – escalate sharply. The cost of agricultural property relief has tripled since 1999/00 whereas revenues from inheritance tax have remained broadly flat. This increase in the cost of the relief will partly reflect the increase in the values of farmland which have roughly quadrupled over that period (an increase itself likely to be a function of the slow loss of alternative inheritance tax avoidance mechanics). And it will also reflect the growing frequency of use of agricultural property as a token for avoiding inheritance tax – one that you buy old so that it sits, economically underproductive, in your estate for only a short period of time – and which changes hands frequently, forever being sold by younger to older hands.
I pause to note that, taxed as such, agricultural property does not derive its value from its capacity to generate income; this is likely to contribute to it being utilised less than optimally; and these effects are likely to be amplified by frequent changes of ownership. Anyway.
But what of popular legitimacy? The Tories, it has been widely speculated, plan to add to their raft of questionably funded tax cuts (in particular the increase in the income tax personal allowance to £12,500 and the raising of the point at which the 40p rate kicks in) by raising the Inheritance Tax joint nil rate band to a satisfyingly round £1m. Estates of a value below this figure will pay nothing, estates of a value above it may (because of the 36,000 estates valued at above the threshold, 20,000 did not have to pay inheritance tax because of the reliefs for which they qualified) pay 40% on values over it. This, they anticipate, and no doubt rightly, will be hugely popular.
A confession. Like Margaret Thatcher I am not a fan of shrinking the tax base. It might be politically expedient – everyone’s favourite tax is one that someone else has to pay – but it represents bad policy, rendering the yield ever more volatile and susceptible to economic and political shocks. I believe we should all pay something: an amount both reasonable and according to our means.
And the big problem with the current design of Inheritance Tax is that it fails on both scores. Why should those with estates less than the predicted £1m pay nothing? And why should those with estates above suffer a reduction in wealth of a number as high as 40%?
I’m not aware of any polling on the issue but I would hazard that the reason why changes to IHT are such a potent political weapon for the Tories is that the rate is so widely perceived to be too high. A 40% wealth tax on death is a tax set at a level as to lack legitimacy – and so to generate fiscal rebellion in the form of avoidance mechanisms. Gandhi’s Salt March is our fiscal polo.
Cut the confiscatory rate from 40% to 20%, lower the joint threshold to £500,000 (or lower) and fund the difference by abolishing agricultural property relief. And take a long hard look at the 87 other reliefs. There’s a truly radical reform. One which will reduce avoidance, be as close to tax neutral as matters, and be hugely popular.
[NB: for those interested, the distributional impacts of such changes would create a big loser of estates at £500,000 (which would see an increase in tax of £30,000). This increase would reduce until the estate hit £725,000 (at which point the changes would be tax neutral). Above this, and leaving aside the effects of abolishing APR and any other reliefs likely to fall hardest on the largest and hence best advised estates, it would generate winners.]
I think popular legitimacy is much more to do with branding than technical details. I am struck by the research that shows how many people who are very unlikely to be affected by the inheritance tax are opposed to it, just in case.
Inheritance tax v death tax. Mansion tax v homes tax. Bedroom tax v spare room subsidy. In each case the first term has stuck better, and this has determined the attitude amongst people who know the name but not the detail.
We all have bedrooms, and we all hope for an inheritance, but only the rich have mansions.
I view Inheritance tax as a bit of a joke – the only people who pay it are those who have not planned properly to avoid it. Prime example of those who do plan properly are Ed and David Miliband…
While I view the underlying rationale – to limit the extent to which wealth is inherited rather than earned – as laudable, the plain fact of the matter is that IHT simply does not work to do that. And as with all transaction/event driven taxes, it can have significant negative consequences. I would be happy to scrap IHT in exchange for a proper wealth tax – starting with residential property.
I’m not sure that’s quite as true now as it once was. But your underlying point i entirely agree with. Reducing the rate is a poor start for broader reform…
I appreciate that my dislike of inheritance tax will surprise no one but I am old enough to remember its similar, immediate predecessor, capital transfer tax being introduced. Even Denis Healey (a determined new tax introducer as has ever been Chancellor) recognised that agricultural property relief was essential if the UK’s successful farming sector was to survive; the amenity value placed on agricultural land takes it to a value – and, potential IHT liability – which could simply not be met out of the relatively modest returns from farming. Healey was not so foresighted with regard to business property; the relief was not included in the original CTT legislation enacted but it rapidly became evident that owner-manager businesses would be crippled by paying CTT on business/share values calculated by applying the deemed P/E ratio to the ongoing profits upon the owner’s death. In essence, it cannot be justified pursuing a tax principle (and a misguided one in my view) which bets the future of the UK’s owner-managed businesses to collect a few hundred million of tax in the short term at the expense of some billions in the medium/longer term.
An economic return on agricultural property certainly can’t be earned when the price is driven up by its token value as a means of passing wealth between generations free of IHT. Without that token value, the price would fall, making it much more likely that an economic return could be earned.
But even leaving that point aside, if I buy gilts, they’re not going to earn me enough to meet the IHT burden on my holding when I die – and they don’t benefit from an exemption from IHT – so why should farmland?
I accept that the IHT exemption is part of the reason that agricultural land prices are high but there is also the amenity value to the present generation of owners. I cannot see that the parallel with gilts is responsive to my substantive point i.e. no business is threatened if one needs to sell, say, 40% of a holding of gilts – or, more generally, listed company shares- to finance IHT after (unpredictable) death. Do we want to see our successful farming sector being converted into economically unsucessful and long term subsidy dependent holdings such as our nearby country neighbour? In my view, just not a price worth paying.
I’m sure you’re not saying that “amenity value to owners” is a reason for a fiscal subsidy. Are you? And it is the tax relief that causes farming to lack economic viability – the fruit isn’t worth the price of the (expensive) tree. And as I point out, the effect of the tax relief is that “agricultural property does not derive its value from its capacity to generate income; this is likely to contribute to it being utilised less than optimally; and these effects are likely to be amplified by frequent changes of ownership.”
Of course not! I am saying that the economic return from farming cannot support a substantial, unpredictable IHT tax levy on its value. I have no connection to the sector personally but consider that, relative to our EU competitors, it is both efficient and well structured. It is often easy to calculate the cost of a tax relief but assessing its value is much harder. My guess that an incoming Labour government would recognise that there are many more important tax issues with much lower economic risks and would leave APR alone as did the previous Blair/Brown government.
Why do you regard agricultural property as privileged, but not other business property?
To answer your most important question – since we are speaking English rather than Hebrew, the plural of shibboleth is shibboleths. And on Matthew 5:5, several commentators have said “powerless” is a better translation than “meek”, which is interesting in the context of the party that is not currently in power…
make some substantive observations before you start trying to unravel the argument and then I’ll answer your question…
I’m not trying to unravel the argument, I’m just wondering why it focuses on APR rather than including BPR as well, given that in my experience BPR is the more common relief.
I find it hard to comment on IHT generally, as I think it’s a very poor tax that I don’t see the point of – personally I’d rather do away with it altogether. The root problem is that it’s trying to tax transfers of wealth, but there are so many ways of doing so that it flounders, misses out a lot that it should catch, and ends up a bit arbitrary.
I prefer on principle to tax the creation of wealth – regarding capital growth as analogous to income (which is why I’d also like CGT to be at IT rates, with indexation, but that’s another issue) – as that’s something that people want to do anyway. As it is, IHT just makes people jump through hoops and achieves no great revenue or policy purpose.
Tinkering with the current IHT system doesn’t address that root problem.
My preference (though I haven’t thought it through extensively) would be to replace IHT with CGT on death – that is, use death to make sure that all income and gains over your lifetime have been captured. s165 holdover relief would then serve the purpose of APR/BPR; with PPR to protect the family home, arguably you’ve got everything sheltered that ought to be sheltered so taxing the rest would seem fair enough. Cash in the bank has of course been taxed when acquired.
OK: there’s a more radical reform than yours which (as it taxes only gains on non-domestic land and non-business assets) should be more popular than IHT, and by using IT rates would be more progressive. Not sure how much it’d raise, though.
I think APR (£306m) costs more than BPR (£260m) which is one of the reasons I focused on it. I also think APR has more powerfully negative effects on the economic uses of farmland than BPR has on the economic uses of business: that was another reason. But I did have (amongst others) BPR in mind when I said we should take a hard look at other reliefs.
As to taxing the creation of wealth v taxing the fact of wealth, and your other points, I guess I’d have two observations. The first is that if you tax wealth creation you have to figure out what to do with pre-existing wealth. That’s quite a big legacy issue. The second is that – I entirely agree – we could (and perhaps should) take a more radical look at the structure of CGT/IHT/wealth taxes/PPRR etc. But that wasn’t what I was trying to do here.
Interesting point re BPR. I’m nowhere near the farming sector and haven’t advised there for 15 years, but I do come across BPR issues.
In particular, the way in which BPR absolutely fails to achieve the objectives that it purports to uphold. Does it foster a generation of entrepreneurs? No – these people are not people thinking of starting off in business. What it does encourage is
a) people to pass their business to their family, who are not best suited to run it – leading it to be driven into the ground – for no other purpose than securing tax relief, or, worse still,
b) make the owner continue holding and managing the business way past their sensible retirement date, because dying with cash is bad but dying with a business is good.
FWIW, part of the problem with inheritance tax is property prices. “Ordinary” families are now living in the world of “death duties” from Chekov or Upstairs/Downstairs period drama. That world is one where the kids don’t have a home of their own, but when the parents die, the taxes mean the family home has to be sold… Like it or not, people have an emotional attachment to the family home, esp. when it’s the only one the family has.
Fixing the housing market issues in the UK would see inheritance tax take on a lot less salience.
As per Metatone above, part of the problem is high property values. But the biggest annoyance with inheritance tax is that you have to think about it all the time, even when nobody is dying. Take the typical example of a parent who wants to gift their child some money to get on the housing ladder. If the parent dies within seven years, 40% of that money gets clawed back in IHT. So while you’re thinking about helping your kids, you’re also worrying about potential IHT liabilities (even though those kids are still getting another £325,000 which should more than cover it). It causes far more worry than a tax should.
Politically, VAT is the best tax: few people even realise they’re paying it.
I’d agree only if by “politically” you mean the Jean-Baptiste Colbert sense. Consumption taxes can fall disproportionately on the poor – but then that’s a debate for another day.