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26 February 2001

Use inheritance tax to give a fair chance to all

NS/Fabian Society Second-Term Agenda - Use inheritance tax to give a fair chance to all

By David Nissan

Setting out his vision for a second term, the Prime Minister called for Britain to become a proper meritocracy, in which all have the opportunities to succeed according to their talents. Yet this aim cannot be realised unless something is done about the inheritance of wealth.

Today, the wealthiest 10 per cent of the population own 52 per cent of all marketable wealth, while another 10 per cent have no savings or capital at all – and the gap has been widening over recent years. Wealth conveys powerful advantages: for example, in buying a house or setting up a business. Parental wealth is linked to children’s educational attainment. The inheritance of wealth perpetuates this inequality of opportunity down the generations.

People naturally want to help their children; but society has an interest in ensuring that everybody has a fair chance in life. The point is to strike a balance. The problem can thus be tackled from two directions. Those who inherit wealth can be taxed; and those without wealth can be given it.

The government has already started thinking about the second option. Labour’s forthcoming manifesto is expected to promise some form of capital grant to young people. The favoured option is apparently the “baby bond”, a payment of £1,000 invested at birth and realised at age 18, when the young person can use the money to set up a home or business or to fund higher education or training. But £1,000 is a modest sum, and its benefits would be long delayed. If the government pursued the other side of wealth redistribution, it could eventually start a much more generous scheme.

It is extraordinary that, whereas hard-earned income is taxed, most unearned inheritances are not taxed at all. It often seems that the inheritance tax system in the UK is designed principally to enable people to avoid it. It ends up being levied on a mere 3 per cent of all estates.

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This is partly because the tax has a very high starting threshold, applying only to estates worth more than £234,000. But it is also because, for the very rich, inheritance tax has become largely voluntary. By passing on their wealth at least seven years before death, people can make their legacies completely tax-free. A series of reliefs and exemptions (such as for agricultural land and private businesses), and the use of trusts, provide ample further means of avoidance.

If it is to tax unearned wealth properly, the government needs to close these loopholes. It should make three changes.

First, subject to a £2,000 annual exemption, gifts made at any time during a person’s life should be taxable.

Second, the tax should be levied on those receiving gifts and inheritances, rather than on those giving. This would encourage a wider distribution of wealth, because the larger the number of recipients the lower the tax bill would be.

Third, the tax should have a lower starting threshold and a progressive structure, instead of the existing flat rate. A tax of 20 per cent might come into effect on cumulative receipts worth £80,000, rising to 30 per cent above £160,000 and 40 per cent above £240,000. More inheritances would then be taxed, but at fairer rates.

We might call such a reformed tax a Capital Receipts Tax. It would have disadvantages: it would be administratively more expensive than the present system, and the lifetime gifts rule would no doubt be subject to some evasion. But the experience of the comparable Capital Acquisitions Tax in Ireland suggests that neither problem would be excessive. The tax would bring in considerably more revenue than the current system. Although it is impossible to be precise, Inland Revenue estimates suggest that around £30bn a year is transferred through legacies and gifts. An effective overall tax rate of 15 per cent would yield £4.5bn, £2.5bn more than at present, or around the same additional sum as a 1p increase in the basic rate of income tax. Inheritances after tax would still be sizeable, so people could not justifiably claim to be unable to look after their families.

We should not pretend that such a tax would be popular. Research for the Fabian Commission on Taxation and Citizenship found that, if anything, most people want inheritance tax abolished, seeing it as “double taxation” on income already taxed.

But that is all the more reason why the tax should be linked to the proposal for capital grants for young people. If it were earmarked, or “hypothecated”, to fund such grants, its fairness would be much more apparent. If such grants were universal (and sizeable, being worth, say, between £5,000 and £10,000 at age 18), most of those paying the tax would find a considerable part of it returning to members of their family. And they would see that the rest was being used to finance equal opportunity for others.

In this way, the reform would not only redistribute wealth and transform the life chances of many young people. It would be a powerful symbol of the government’s meritocratic ambition.

David Nissan was associate research fellow on the Fabian Society’s Commission on Taxation and Citizenship; its book, Paying for Progress: a new politics of tax for public spending (£9.95 + £2 p&p), is available from the Fabian Society, 11 Dartmouth St, London SW1H 9BN

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