A just tax on the dead

Observations on inheritance

Inheritance tax is threatened. In America, President Bush's tax cuts include the repeal of all estate taxes by 2010. Inheritance tax has fallen also in Australia and Canada. And here, the Tories have been stepping up their attacks, with Oliver Letwin, the shadow chancellor, accusing Gordon Brown recently of "clobbering" the average homeowner.

This is one of many myths about inheritance tax. Only about 4 per cent of estates in the UK pay it at all. Spouses, farms and family businesses are exempt and, after debts and funeral expenses, £263,000 can be passed on without bothering the taxman. The owner of an average home in south-east England needs around £58,000 of savings to reach the tax threshold; in Scotland, he or she needs £178,000. It is easily forgotten that the tax is levied only on the money beyond the threshold. So no estate pays 40 per cent to the Exchequer on its whole value. Even an estate worth £1m pays only 29 per cent.

Inheritance tax is a small but important counterbalance to inequality of wealth (savings, plus the value of assets such as houses) which, in Britain, is about twice as great as inequality of income. Moreover, it has been increasing steadily since 1992. Inequality of inheritance makes a significant contribution: the smallest fifth of inheritances have a mean value of £381, the largest fifth a mean of £70,000. Nevertheless, inheritance tax needs reform. If the left fails to reform it, the right will do so.

Inheritance tax is perceived as unjust because it is not a sufficiently progressive tax. On the one hand, trusts, gifts and other forms of avoidance enable the very wealthy to avoid millions in tax - as much as £40m in the case of the late George Harrison. On the other hand, those of more moderate wealth - not the poor, it should be emphasised, because the poor have no wealth - are increasingly caught in the tax net, mainly because, while the exemption threshold rose by 70 per cent between 1992-93 and 2003-2004, house prices have risen 105 per cent. If your main asset is your family home, you can't avoid tax by giving it away before death, unless you go to the expense and trouble of moving to a smaller home.

The easiest way to make inheritance tax more progressive is to introduce a banding system, similar to that for income tax. There could be a base rate of 22 per cent, with higher bands of 40 and 50 per cent. Most people who now pay inheritance tax would then be better off. About 87 per cent of the 21,000 estates that pay tax each year would pay less.

Yet, because of the higher amounts charged on the top 13 per cent, the new system would raise slightly more money - £147m. If this were earmarked for a popular cause - the child trust fund and its "baby bonds", for example - it could help inheritance tax regain legitimacy and public support. Invested for 18 years, £147m could provide an extra £700 for children from the poorest third of families, and £350 for the rest. This is money that could be used to buy a car, start a business or pay a rent deposit.

It would help kick-start a savings habit for a generation, as well as making a modest contribution to a more equitable distribution of wealth.

Dominic Maxwell is a researcher at the Institute for Public Policy Research and author of Fair Dues: towards a more progressive inheritance tax, published at www.ippr.org on 22 August