There’s something off-key about our approach to inheritance tax

Published on Intergenerational Commission, Tax and Welfare

It takes something to be crowned Britain’s most hated tax – a bit like being the UK’s worst ever Eurovision entry – but that is the unwanted title held by inheritance tax. It doesn’t help that it’s a tax that’s unavoidably associated with the death of loved ones. And complexity is undoubtedly a problem too. But by far the biggest issue is the sense of inherent unfairness – there’s something fundamentally off-key about inheritance tax.

Just one-in-five of us think the current approach is “fair” – somewhat lower than for any other tax. It’s viewed as a double taxation of those who have earned the wealth and who have now had the temerity to die and pass their assets onto grieving families. With a flat rate of 40 per cent (above the nil-rate band), it’s also considered high – much higher than the 20 per cent income tax rate most people are familiar with. But it’s also regarded as a tax that is ‘voluntary’ for the super-rich and well-advised, with a range of reliefs and gifting rules that make it too easy – for some – to avoid.

That’s why any proposals for reform are treated with suspicion. It’s also why the review launched this week by the Office of Tax Simplification is important but tough. It will undoubtedly uncover useful insights and offer sensible options for improvement, but our view is that we need to move beyond tinkering. As our new report for the Intergenerational Commission argues, a much better approach would be to overhaul inheritance tax entirely. Done right, there’s the potential to raise significantly more money while simultaneously making it more popular.

Because that’s the irony of inheritance tax – the disdain we have for it bears very little relationship to our chances of ever paying it. Annual gifts and inheritances total more than £125 billion a year, yet inheritance tax raises just £5 billion. That’s less than 1 per cent of the UK’s total tax take and means that, in practice, just 4 per cent of estates are subject to it. Inheritance tax manages the uniquely bad twin feat of being both wildly unpopular and raising very little revenue.

But inheritances are set to play a growing role in Britain’s living standards story over the coming years. The current value of inheritances is double what it was 20 years ago, and we expect it to double again in the next two decades – with ‘peak’ inheritance coming in 2035. That will provide a huge boost for the millennial generation which we know has struggled so much in the labour and housing markets over recent years. Yet not everyone will benefit. Those – often already lower wealth – members of the generation whose parents don’t own property, won’t get to share in the good luck.

Today’s paper calls for replacing inheritance tax with a ‘lifetime receipts tax’, which shifts the tax payment from the giver to the beneficiary. Each individual would have a lifetime allowance of £125,000, after which tax would become payable at a rate of 20 per cent up to £500,000 and 30 per cent beyond that point. That would encourage a wider spreading of bequests, in order to make best use of the individual allowances. It would also raise more money, almost doubling the potential tax take relative to the current system. And it would have the added benefit of significantly reducing the scope for the very rich to lower their tax bills by making large gifts well before passing away – limiting the scope for avoidance that explains so much of the unpopularity of inheritance tax.

Taxes are never popular (well almost never) but, like song contests, they’re a necessary feature of life. A wholesale reform along the lines proposed today might not get douze points from everyone, but it should at least mark a significant step up from the current score.