The UK has a complicated, punitive, badly constructed, and all-around dysfunctional tax system.
The code contains over 10 million words. That is about 12.5 times the number of words in the Bible (around 800,000 words), 12 times the number in the Complete Works of Shakespeare, and 8 times as many as the longest novel ever written (Marcel Proust’s À La Recherche Du Temps Perdu).
Lots of the taxes we suffer from are double taxes (paid on money you have already paid income tax on). Think of everything from VAT to capital gains tax (which, as it is unindexed, also operates as a wealth tax). Others act as disincentives — to mobility in the case of stamp duty on house purchases, and to investment in the UK in the case of stamp duty on equity trades. And almost all have some input into our relentless sluggish productivity performance.
Among these lousy taxes, however, one stands out as particularly awful and particularly loathed — the inheritance tax (IHT).
The best taxes are low and hard to avoid (so no one bothers to try). The worst is high and relatively easy for the well-off to avoid (so the effort of doing so is well rewarded). IHT has both of the latter characteristics — plus the extra kicker of too low a threshold. It used to be for the very rich. Now it is not: More than half the estates that end up paying IHT are valued at under £1 million ($1.2 million). The allowance has been fixed at £325,000 since 2009 and will stay that way until 2028 (hello, fiscal drag). Over that level, the rate is a fairly shocking 40% on all assets held in the estate.
For context, note that since 2009 the average price of a house in London has risen from well below the threshold (£245,000) to well above it (£532,000). There is a silly loophole for the “family home,” which brings the total to most of £500,000 and hence £1 million for a couple. I say silly as there is no obvious reason for a home to be more exempt than anything else (there is no special exemption for the family art or the family classic car collection), and most heirs flog the house as soon as they can anyway.
However, there is one more element to IHT that makes it awful — the stress it causes. It is horrible for heirs in that it intrudes in both financial and bureaucratic terms into their lives at one of their most vulnerable points, the loss of a parent. But the ease at which it can be avoided by some also causes extreme anxiety to the elderly — who spend far too much time focusing on doing just that. After all, if you can avoid a 40% levy on your estate, why would you not?
You can leave the UK — it isn’t easy to redomicile and avoid IHT, but there is evidence the UK’s high taxes are driving the rich out. You can give away your assets early — and the richer you are, the easier it is to give stuff away without impacting your own lifestyle or running short of care home fees. The same goes for keeping your pension intact (defined contributions are exempt from IHT), as well as for buying IHT-exempt businesses, large portfolios of already highly valued (and hence risky) AIM-listed stocks (often IHT exempt), and farmland (also exempt — there’s a reason it is very expensive in the UK).
Start off with £20 million, mitigate, and there is a strong chance you will die with an estate worth £1.5 million. You might with some satisfaction think you have died broke, and got one over on the taxman. Start off with less — say £1.5 million — however, and, as you need the house to live in and the ISA to live off, you will also likely die with an estate worth around £1.5 million. You will not think you have died broke. Welcome to another nasty little quirk of IHT: The very rich end up paying a much lower effective rate than the merely well-off.
Some will say that all this is fine and that we need IHT. Letting some inherit large amounts of money without paying a whopping amount of tax along the way is just not fair in an increasingly unequal world. This is therefore a moral tax as much as a money-raising tax (it raises around £7 billion a year).
There is something in this. Why should some end up rich just because their parents bought a house in the right part of London at the right time? And yet, if the rich are avoiding the tax and everyone else is worrying about it, then there isn’t really very much in it. What’s the morality in grandstanding? Plus, there is an upside to the inheritance that benefits us all: Those who inherit lump sums are more likely to go on to be entrepreneurs.
The good news (such as it is in the world of taxation) is that there are easy ways to improve matters. One is to keep IHT but bring the rate down very significantly and close all the loopholes. People don’t move mountains to avoid small taxes. Another is to abolish it altogether, as not many other countries have levies like this. We could replace it with something perfectly sensible such as capital gains tax on primary homes (which would have much the same effect as a non-avoidable 20% IHT levy) or perhaps just by shifting the tax burden from the estate to the recipient — regardless of when assets are transferred.
This is not a new idea. Lots of countries have gift taxes — and pre-1889, taxes on legacies in the UK were paid by beneficiaries after the estate was distributed. We also have a starter system in the way we deal with defined-contribution pensions. There is no IHT to pay on them but heirs pay their marginal rate of income tax on withdrawals. Extend that to transfers of cash or assets between individuals (possibly at a much lower rate), add in farmland and businesses, and you might have replaced a horrible system with a perfectly reasonable one. A low and unavoidable tax, paid not by the estate of those who have built the wealth but by those who have received it free of effort. This will all feel a lot better, and it is likely to raise at least as much money.
The truth is that IHT is a bad tax. Keeping the status quo is not the moral thing to do. Replacing it is.
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