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4 December 2015

Labour can win the argument for fairer taxes – but inheritance tax will have to go

Our new report finds that the tax is suprisingly popular on left and right - and harms the overall cause of rebalancing taxes to wealth and land, says Andrew Harrop. 

By Andrew Harrop

The British tax system is broken. It’s too complicated, with a tax code that runs to 11,000 pages. It’s outdated, with English council tax bands that were last set in 1991. Above all, it’s unfair. The poorest tenth of households pay 45p in every pound of income, while the richest pay just 35p: wealth is under-taxed but people on low incomes pay as they spend.

As the Labour Party starts to build a radical policy alternative, it must place the argument for a fairer, more progressive tax system at the heart of its agenda. But the party needs to listen first, because there are good and bad ways to argue for tax reform. New research from the Fabian Society shows that most people welcome the idea of tax reform, but only if it goes with the grain of their instincts.

We held discussions across England with people of every background and political persuasion and were buoyed by what we found. Paying tax was seen as legitimate and valuable by everyone we spoke to, and most people wanted a system where the rich pay more and the poor pay less, as a share of their incomes.

Of course everyone grumbles about paying tax, but the people we brought together did not want radically lower taxes at the cost of public service cuts. They talked about tax as a “duty of citizenship”, a “parachute to protect you” and something to take pride in: “when government does things well, we’ve all taken part in that happening”. 

But we also found that some taxes are now beyond the pale, even for Labour voters and others who want to see a fairer, more progressive system. In particular, inheritance tax is too toxic to save. It is seen as unfair and insensitive, not least because it is levied when families are at their most vulnerable.

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People simply can’t stand what they see as a tax on the dead. Our participants talked about the injustice of their parents and grandparents being taxed twice, once when they earned the money and again when they bequeathed it. One said that, even beyond the grave, “it’s still theirs and they worked and obviously paid their taxes and did everything.”

People also told us the tax was unfair because they thought the seriously rich could avoid it, but ordinary families could not. Although the truth is that only a tiny fraction of estates ever pay inheritance tax, the perception is that it penalises people who have worked hard, saved and wanted the best for their families’ future. These views were held irrespective of political inclination, occupational background and age.

Our participants acknowledged the contradictions in their views. People who believed that assets should be taxed and inequalities of wealth reduced also said estates should not be touched. “Everything else I can see the reasons for paying tax – this is the one thing I don’t see it” one said.

Both these views are the product of people’s instincts about the nature of fairness. But the left will never prevail on fairer taxes if it simply points out the inconsistences. Conflicting emotions is a recipe for inaction.

The truth is that on inheritance tax, Labour has been fighting a losing battle for decades. It’s time to give up and find new ways to tax the living, not the dead. The party needs to think about how to tax wealth “little and often” rather than in huge lump sums. That should mean proposing to scrap inheritance tax altogether and replace it with a system that taxes gifts, bequests and other cash transfers as income, at the recipient’s marginal rate. Instead of taxing dead people twice, this would be a system where the living would pay once, on the same terms, whether the money they acquired was earned or unearned. 

Surprisingly, the inspiration behind this idea is George Osborne, who is about to tax inherited pension pots in this way. This establishes an important new principle which can in future be applied to other asset classes. An obscure and technical reform could turn out to be the cuckoo in the nest for a radical and progressive approach to taxing asset transfers. Small initial sums could be excluded but as gifts mounted over time they would be taxed, by the use of a lifetime allowance. 

Scrapping inheritance tax in this way has been proposed on a number occasions by the Fabian Society, the Institute for Fiscal Studies and others. But this time it could actually happen, with the pension tax reforms provide the backdrop. The Labour Party is seeking orthodoxies to challenge and the Conservatives are after centre-ground voters. And today’s tax assessment and banking regulations make compliance and enforcement far more feasible than in previous decades.

Proposals to scrap inheritance tax while placing earned income and unearned receipts on a level playing field fits with public instincts. They show that tax reform can be both progressive and popular. The stage is set: there’s a genuine appetite for a fairer tax system and the left is keen to champion an alternative. But it has to begin by listening.