Dangerous territory, death taxes – as new Chancellor Rachel Reeves is about to find out if, in her search for more taxpayer pounds, she decides to step into this political minefield.
“The art of taxation”, declared Jean-Baptiste Colbert, Louis XIV’s finance minister, “consists in plucking the goose so as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”
However Reeves approaches it, fiddling around with inheritance tax is guaranteed to produce a particularly loud outbreak of hissing. Yet it is also one of the sources of government revenue that the new Chancellor has refused to tie her hands on, making it an odds-on favourite for the plucking.
On cue, along comes the Left-leaning think tank Demos with a 65-page report on inheritance tax reform that helpfully points out that all but one of the G7 economies raise quite a bit more from death taxes than we do here in the UK.
The exception is Italy, where the rate of tax is extremely low and is only applied to estates of more than €1m (£840,000).
All the others, including the US, manage to extract more than the UK, where only 4.2pc of the wealth passed on in the 2019/20 tax year was paid in tax. At just 0.7pc of government revenue, inheritance tax barely registers.
The temptation for Reeves must be all but irresistible. Were we to adopt the same system as South Korea, for example, the Treasury might raise £6.5bn more a year in inheritance tax than it does at the moment, according to Demos, and a further £2.5bn if we adopted the same approach to lifetime wealth transfers.
Reform becomes all the more tempting because inheritance tax as it stands is quite widely seen as unfair. For the very wealthy, it is almost entirely avoidable, but for Middle England, increasingly caught by the tax because of rising property prices, it is virtually impossible to circumvent.
Yet just because it is seen as unfair doesn’t mean it is easy to reform. For instance, there are good reasons for the exemptions on handed-on businesses and worked agricultural land, and not just because family-run businesses and farms are enterprises you want to encourage.
Much of the German economy is built around its mittelstand of small and medium-sized, family-run companies passed down from one generation to another. Would that we had something similar here in the UK.
To impose death duties on such enterprises might threaten them with breakup or otherwise render them commercially unviable. The same is true of farms, which could become uneconomic if forced to sell land to pay inheritance tax.
Some farmers have already been caught out by government-promoted rewilding schemes only to find that the rewilded land is no longer exempt from inheritance tax.
The wider point on death duties, however, is that they offend something which is deep within the human psyche: the desire to accumulate and to pass on the fruits of one’s labour or good fortune to offspring or chosen causes.
It’s in our DNA and there is no amount of political moralising or social engineering that will exorcise it. Death duties are a tax on aspiration, pure and simple. They are also a form of double taxation, since they are levied on money which in most cases has already paid tax.
Oddly, you might think, it’s one of those taxes that many people think they might have to pay even though a relatively small proportion of estates actually do so. Raising the level at which the tax becomes payable therefore tends to be politically popular even though the benefit is enjoyed only by the few.
Conversely, Reeves would undoubtedly lose votes by attempting to lower the threshold; many more people would think they had been made liable than actually are.
Ken Clarke, a former chancellor, once said that he had given up on tax reform after realising that whatever he did would create winners and losers, and that politically he would be punished by the losers while gaining no credit at all from the winners.
Reeves may be about to learn this lesson the hard way on inheritance tax. Despite the fiscal pressures to raise more tax, she would be well advised to tread warily.
There is no doubt that as currently constructed, the British system is an extremely bad tax. As Chris Sanger, EY’s head of tax policy puts it: “If designing the system from scratch, you wouldn’t start from here”.
The simplest solution would be to abolish the tax entirely, which was the eventual intention of the last Tory government – but that’s plainly not going to happen under Labour.
There are some jurisdictions, such as Singapore, which have never had the tax in the first place, but outside low-tax havens such as this thriving city state, it’s hard to find an economy with no form of inheritance tax at all.
It’s true that there is no inheritance tax as such in Canada, Australia and Norway, but in all three jurisdictions recipients of passed-on wealth are instead made liable to capital gains uplift, either when inheriting an estate or on disposal of the assets. This might reasonably be seen as much the same thing.
It’s also true that in the majority of OECD countries, the tax is levied on receipts, rather than on the estate. This has always struck me as a structurally better approach. Common to all these systems, however, is that they are incredibly complicated, subject to peculiar quirks, and quite widely seen as unfair.
Some are, however, more progressive than others; Labour’s redistributional aims will no doubt similarly instruct the redesign of the British system, which the Government could also combine with some kind of ongoing wealth tax.
If Reeves were to be truly radical, she might even replace inheritance tax with a lifelong wealth tax.
Whatever she does, she needs first to understand that all wealth taxes have often quite damaging behavioural consequences. Surprise – they tend not to be at all conducive to wealth creation, growth and therefore ultimately to growing the tax base.
Already, we see some of those consequences in the proposed abolition of the tax breaks for non-doms. Many non-doms are voting with their feet. It’ll be the same with inheritance tax. Bear down too hard on wealth and it will simply go somewhere else.
In today’s world, capital is highly mobile; plucking feathers with the minimum amount of hissing was difficult enough in Colbert’s time. Today it’s harder still.
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