Paritosh Purohit is a Junior Research Associate at the Institute of Economic Affairs.
The roots of the inheritance tax lie in Edwardian attempts to tax aristocratic fortunes, starting with the Estate Duty in 1894. Rates were initially low (around 8%), but climbed sharply during the world wars, reaching 85% by 1969. While the tax was not initially unpopular, recent polling has suggested that it is widely disliked today.
Public opposition to the tax may have invited statements earlier this month indicating that the Shadow Cabinet was considering its abolition (finances permitting). Their point of view, and the argument against the inheritance tax, deserves consideration.
To begin with, a sense of inheritance is a positive incentive and one worth promoting. Thinking of property in the terms of something built up over time, that one has a duty to maintain and bequeath in better condition, lengthens the planning horizon for persons, and discourages short-termism. This sense of intergenerational stewardship would be welcome. It would be dampened by the taxation of inheritances, by introducing a middleman who tampers with what one receives from the past and gives to the future.
The ability to give to one’s descendants (or anyone else) is also a powerful incentive to engage in the creation of wealth, with all of the positive externalities that that comes with. Doing well (for oneself) considerably expands the ability to do good; the reasons for which fortunes are sought and made are varied, but a desire to apply wealth to a long-term source of livelihoods, useful goods, or charitable funds is a common one.
The ability of such goals to motivate persons to create wealth is inextricably tied to their ability to give their wealth to whoever they please (including their descendants). Inheritance tax would blunt this motivator by making clear that a portion (at times, historically, a large one) of whatever one makes will be taken away and spent per the whims of the incumbent government.
Finally, private property (as a right) implies the right to do with one’s property whatever one decides. The inheritance tax is by necessity a dictation: one has to use (some of) what one owns in the way prescribed for them by an authority (that is often removed from the creation of what is owned). The principle of private property is thus hobbled by the inheritance tax.
Of the chief concerns that might inform a practical analysis of taxation, rates are not always one: more perennial candidates are the breadth of a tax’s base, the incentives it might generate, and the character of what it will tax.
A tax base is optimally wide; if the same amount of revenue can be generated through high taxes on few people and low taxes on many, the second is typically smarter. Broad tax bases reduce what it costs to administer taxes and allows more revenue to be raised at lower rates. Inheritance taxes target a very narrow tax base: by 2032-33, around 7% of deaths in Britain are expected to result in an inheritance tax.
It is also smart to tax things that are stable and not easily moved. The taxation of things that are highly mobile risks some damaging distortions; for example, it can lead to financial capital being redirected toward ends that are less productive, and (in extreme cases) can cause capital flight and reduced wages.
The status quo for inheritance taxation in Britain makes it rather distortionary, and is thus associated with a high degree of uncertainty. It is also often arbitrary: for example, if one were to buy a piece of jewellery that one then gives to a child, one would have to face income and consumption taxes. Giving the money to the child to purchase the same piece of jewellery instead incurs a third tax.
The complexity of inheritance taxes is a further source of problems. The tax generates very little revenue; as of today, what it raises is worth around 0.3% of GDP. However, it is a burdensome tax to administer, with most of the burden falling on individual persons: while under 5% of deaths result in an inheritance tax being paid, over 250,000 families had to do the paperwork to send details to the HMRC, despite no tax being due.
This complexity - paired with a variety of carve-outs, such as reliefs for agricultural property - also makes planning around the taxeasy for the ultra-wealthy; this loophole is regressive, since it is easier for wealthier estates to plan around the tax than for poorer ones. The costs imposed by the inheritance tax may well outweigh the very small quantity of revenue they generate.
Finally, a good tax would create incentives to prefer courses of action that increase productivity, investment, and economic growth. It is unclear that inheritance taxes do this, and it is possible that abolishing them does. In Sweden, for example, an abolition of gift and inheritance taxes (in 2004/05) affected two sets of firms, ones with owners who had successors within the family, and ones without.
The abolition of the tax was found to increase growth and earnings to a greater degree for firms with generational successors, which in turn led to them paying more in corporate income tax down the line. This might confirm the aforementioned idea of a sense of inheritance being a positive incentive, and points to abolition of inheritance taxes strengthening investment and growth.
The inheritance tax is not a uniquely wicked one: there are other cuts and reforms to taxation that would generate positive incentives to a greater degree. Rather, the inheritance tax raises precious little for what it imposes, on both governments and individuals. The Shadow Cabinet’s desire to cut the tax is understandable; all else being equal, it is better off abolished.