Time To Scrap IHT?

Inheritance tax (IHT) has faced significant criticism and a growing chorus of calls for its abolition. Recent polls indicate that nearly 60% of the British population disagrees with IHT, a sentiment echoed by a group of 55 conservative MPs, including Nadim Zahawi*, who are urging Rishi Sunak to scrap this perceived "morally wrong" tax.

[you may recall Zahawi's recent "moral objections" to paying Capital Gains Tax, resulting in HMRC imposing a £1.1 million fine alongside the £3.7m tax due.]

The primary argument for scrapping IHT is its classification as a "double tax." Critics argue that it imposes a tax on assets that have already been subjected to taxation at least once before.

Should Inheritance Tax be Abolished?

The answer is no.

Scrapping IHT would have adverse consequences such as reducing government revenue, exacerbating inequality by benefiting the wealthy disproportionately, and potentially discouraging saving.

However, when it comes to the question of whether IHT will be scrapped, I suspect the answer may be yes.

There's a strong possibility that it could happen, mainly due to its potential popularity among voters, especially those residing in key Conservative swing seats.

Given the urgency faced by the government and their need for a significant political boost, scrapping IHT could be their Hail Mary move.

While relief on mortgages was ruled out by Jeremy Hunt, the government has already abolished the pension Lifetime Allowance, indicating a willingness to make substantial and controversial changes.

Targeting middle England baby-boomers and their Generation X beneficiaries, who are particularly aggrieved by IHT, would be a strategic move for the Conservatives.

Considering the low risk and relatively low cost associated with scrapping IHT (as we will see below), it becomes a "nothing to lose" option for the government.

As the next budget approaches, which will be just before the general election, the possibility of IHT's abolition becomes increasingly plausible.

The Paradox of Inheritance Tax

The paradox surrounding IHT lies in the fact that only a small fraction of individuals are likely to pay it, and even if they do, it represents a negligible portion of their overall lifetime tax burden.

Merely 4% of estates paid IHT in the 2019/20 tax year, a figure will have increased due to the Nil Rate Band freeze, but still pales in comparison to the 58% who oppose it.

4% is significantly less than people think, as evidenced by a recent poll conducted by Money Saving Expert, Martin Lewis on how often IHT is paid.

Over 43,500 respondents shared their views, with the majority (nearly two-thirds) believing that at least 10% of deaths lead to an inheritance tax bill. A significant portion (18%) thought it affected over half of all deaths, and another 19% estimated the percentage to be between 26% and 50%. Only 27% accurately guessed that the tax was paid in less than 10% of deaths.

In terms of revenue generated, IHT is relatively minor for the Treasury.

In the tax year ending April 2023, it contributed a modest £7 billion.

While this may sound substantial, it doesn't even rank among the top 10 taxes. For perspective, the total tax revenue for the UK in the same year amounted to a staggering £1,017 billion, with Income Tax alone accounting for £249 billion.

When considering the full breakdown of taxes [IHT is included in capital taxes* alongside Capital Gains Tax (£18 billion) and Stamp Duty (£15 billion)], it becomes evident that its financial impact is relatively small.

Source: House of Commons Library, Tax Statistics: An Overview - June 2023

* capital taxes also encompass other levies such as ATED, PRT, and CCL.

A Matter of Equity

Perhaps the core issue at hand is one of equity.

Royal Exemption

An interesting case arises with regard to the exemption of the Queen's estate from Inheritance Tax (IHT) through a special agreement established in 1993.

This agreement, known as the "Sovereign to Sovereign" deal, ensured that the Queen's assets were free from IHT upon her passing.

The primary objective of this arrangement is apparently to safeguard the financial autonomy of the monarchy and relieve the Queen's heirs from the burden of a substantial tax bill…poor Charles!

Considering the substantial value of the Crown Estate (just part of the Queen's overall estate), estimated to be around £15 billion, the exemption amounts to a staggering £6 billion tax break.

Disparities in Geographical Impact

A significant portion of IHT is attributable to property, and property prices have risen at a faster pace in southern England compared to other regions of the country.

This situation creates a sort of postcode lottery where property owners in specific areas have experienced considerable and some would say, arbitrary gains.

Should such property owners, who have already greatly benefited, further advantages that reduce their tax liability.

This presents a contrasting perspective to the double tax argument, as the combination of property value appreciation and elimination of IHT would constitute a dual wealth benefit.

Proposed Reforms for a Fairer IHT System

Several suggestions can be put forward to enhance the fairness of IHT.

1. Raising the Exemption Threshold

To address the impact of inflation, it is crucial to increase the current nil rate band, which has remained unchanged for several years.

By re-linking it to inflation, the value of the threshold can be preserved over time.

For instance, in 2009, the nil rate band was £325,000, which, due to inflation, would be equivalent to £428,000 in 2023.

Adjusting the threshold immediately to the £400k+ level and ensuring future adjustments keep pace with inflation would rectify the eroding value and prevent more individuals from falling into the IHT bracket.

2. Introduction of Individual Lifetime Allowance on Inheritances

Taking inspiration from Ireland's Capital Acquisitions Tax (CAT) threshold, implementing an individual lifetime allowance on received inheritances could contribute to a fairer system.

CAT is a tax on gifts and inheritances received by individuals, and its threshold establishes the maximum value of tax-free gifts or inheritances one can receive during their lifetime.

Tailoring the thresholds based on the relationship between the recipient and the donor can help distribute assets more broadly, fostering a more equitable redistribution of wealth.

3. Exploring a Wealth Tax Alternative

A wealth tax presents an alternative approach to addressing accumulated wealth, differing from IHT's focus on asset transfer upon death.

A wealth tax aims to levy an ongoing tax on an individual's total wealth. Typically, it involves assessing an individual's net worth, including properties, investments, businesses, and personal possessions.

Tax rates are then applied to the calculated net worth, often incorporating thresholds and exemptions.

Countries like France, Spain, Norway, and Switzerland have all implemented wealth taxes to varying extents.

However, the administration of a wealth tax is complex and raises challenges such as asset valuation, liquidity for tax payment, and of course compliance.

Past experiences with a more limited version, such as the UK's proposed mansion tax, indicate potential obstacles to its successful implementation. See footnote for further reading on this.

Closing Thoughts

Scrapping IHT would undoubtedly garner significant support from voters, especially among the middle class.

Many perceive the current 40% rate, which is one of the highest in the world, inherently unfair.

Additionally, from a government perspective, it would be a relatively low-cost measure, as IHT contributes only around £7 billion annually to the revenue stream.

However, its essential to consider the risks associated with scrapping IHT.

Eliminating this tax would result in reduced government revenue and while its portion in the overall tax collection is relatively small, nevertheless, its a revenue exclusively derived from the wealthiest segment of society.

When viewed in isolation, these figures present a compelling case for retaining IHT. An additional £7 billion contributed by only the top 4% of the population can be seen as a proportionally fairer approach compared to increasing taxes for other groups.

The government must carefully balance the political benefits of reforming this tax against the economic costs and potential public backlash.

It is reasonable to assume that some of those in the 58% who disagree with IHT would voice concerns if its elimination did not come with some form of relief for those with lower wealth and incomes.

Lastly, IHT is a relatively new tax compared to others, with it only being introduced in 1986. Capital Gains Tax (1965), National Insurance (1911), and Income Tax (1799)

If IHT were to be abolished, in the future we may question its why we ever had it, much like other repealed taxes such as the Window Tax, the Gin Tax, and more recently, the Poll Tax.

The Window Tax, introduced in 1696, serves as a noteworthy historical parallel to IHT and our ongoing attempts at avoidance. Its purpose was to generate revenue and deter the construction of large houses.

This period proved prosperous for bricklayers, who were in high demand for filling in windows.

The wealthy find a way. It was eventually repealed in 1851.

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Footnote on Wealth Tax proposals

Just last month, three lobby groups joined forces to propose a new wealth tax, reigniting the discussion on this subject.

The Wealth Tax Commission (WTC) released a final report two and a half years ago, which leaned towards recommending a one-off tax of 5% on wealth exceeding £500,000. The tax was envisioned to be levied annually at a rate of 1%, with the goal of raising a total of £260 billion over five years to match the expected government expenditure in response to the pandemic. At that time, Public Sector Net Debt (PSND) stood at £2,158.9 billion (99.3% of GDP). Despite garnering significant media attention, the proposals failed to gain political traction.

By April 2023, the corresponding debt figures had increased to £2,536.9 billion (99.2% of GDP). The £378 billion rise in cash terms did not result in a proportional increase in the GDP percentage due to the significant contraction of GDP caused by the impact of the Covid pandemic in 2020.

The combination of persistent high debt levels and the recent publication of the Sunday Times Rich List has spurred three groups - Tax Justice UK, the Economic Change Unit, and the New Economics Foundation - to resurrect the idea of a wealth tax. Their proposal differs from the WTC's recommendations in several aspects:

• The tax would be an annual levy instead of a one-off payment.

• It would be imposed at a rate of 2%.

• It would apply only to wealth exceeding £10 million.

Tax Justice estimates that this proposed structure could generate £22 billion per year, surpassing the WTC's 2020 estimate of approximately £17 billion for a similar format. In May 2023, Tax Justice published the results of a YouGov poll indicating that 74% of the public supported a 2% tax on wealth above £10 million.

Surprisingly, this level of support is relatively low, as it is uncommon for people to advocate for a tax that may not directly impact their own finances. According to the WTC's calculations, with a £10 million threshold, only 22,000 individuals and families would fall within the scope of the tax, a significantly higher number than the 350 families and individuals mentioned in the Rich List.

While the new proposals have captured headlines, it is unlikely that they will have a longer lifespan than those put forth by the WTC. Interestingly, the WTC provided compelling reasons in favor of a one-off tax rather than an annual wealth tax, noting potential behavioral responses and the challenges of resolving certain issues associated with an ongoing tax.

In a recent interview, Rachel Reeves, the Shadow Chancellor, stated that there were no plans for a "special FT reader tax" or any new measures specifically targeting the wealthy beyond what had already been announced.

However, if a wealth tax were secretly on the Labour Party's agenda, it would be unwise for them to disclose it, as it could provide a political advantage to the Conservatives.

Additionally, as highlighted in the WTC's report, premature disclosure could lead individuals to engage in tax planning and "forestalling" strategies ahead of the assessment date.

While wealth tax proposals attract attention, they are not commonly implemented globally in 2023.