Inheritance tax: a tax on the living not on the dead

Most people don’t like tax but the tax that seems to create most moral outrage is the tax levied against fewest people: inheritance or ‘death’ tax.

On the face of it, this is odd. Tax reduces your income. No-one likes this. But as you only pay inheritance tax after you have died it cannot affect how much you have to spend. There is, after all, no ‘you’ anymore.

And while everyone should have some say in what happens to their estate, no one thinks you should be able to dispense with it in any way you choose. I know of one case in which a spouse pre-deceased his wife and stipulated in his will that she leave the family home of over 50 years within six months of his death. Unfortunately, the house was in his name only. Should his children have respected his wishes and should the state force them to? I have not yet met anyone who says yes.

‘the earth belongs to the living and not to the dead” (Thomas Jefferson in a letter to James Madison, 6 Sept 1789)

While Jefferson was talking very generally his comments apply to inheritance tax. We should certainly not dismiss the wishes of the dead but we are not required to do as they ask: it all depends how their wishes affect the living.

And it is surely unremarkable to note that, without some inheritance tax, individuals’ life-chances are likely to be determined by their lineage (possibly a talented or lucky ancestor) or by their ability to ingratiate themselves to the mighty. Such transparent unfairness is morally unacceptable and historically has not been tolerated.

According to John Rawls, who attributes the idea to John Stuart Mill, we should view inheritance tax as a tax on those who remain rather than those who die. ‘Those inheriting and receiving gifts and endowments pay a tax according to the value received and the nature of the receiver.’(Justice as Fairness, p.161)

We should do this to ensure that success in one generation does not fix the social competition for several subsequent generations and to ‘encourage a wide and far more equal dispersion of real property and productive assets.’(ibid.) Table 1 below illustrates how this might work when someone dies leaving an estate of £1 million.

In the first scenario the inheritor is a single individual and top-rate UK tax-payer (45%). In the second scenario, there are one hundred inheritors who are given £10000 each and who pay 20% income tax.

Table 1 Amount of tax Amount received by beneficiaries
Scenario 1 £450000 £550000
Scenario 2 £200000 £800000 (or £8000 each)

Table 1 shows that Rawls’s Mill-inspired idea makes inheritance tax very sensitive to the number and nature of any beneficiary.

Thinking in these terms also enables us to explain what is wrong with current UK inheritance laws. First, in most cases, inheritance tax is paid out of the deceased’s estate before any beneficiary receives anything; it is ‘not common’ for recipients to pay. Second, while no inheritance tax is paid on estates worth less than £325000 (in 2014-15 values), in most cases, anything above that amount is taxed at 40%.

Simplifying a little, under the current rules a £1 million estate is liable to a tax of £270000. It does not matter who the recipients are or how many there are. But surely we would prefer a single high earner inheriting £1 million to be treated differently from 100 average earners jointly inheriting the same amount. A tax of £270000 would reduce the average amount received in scenario 2 above by £700 each. Not a lot to a top-rate tax-payer but a reasonable amount to most people.

One worry – particularly in the UK – is unrealized assets (principally property). If I were to inherit a £1 million house would I be liable immediately for a tax of between £200000 and £400000? This seems a little tough. But any tax could be made payable when the asset is realized – although on the tax rate effective at the time the property is inherited (this will prevent attempts to delay or bring forward sales to take of advantage of any tax rate changes).

There are other issues to resolve but we must stick with the big picture: inheritance taxes are necessary but the current UK inheritance rules are a mess. Changes must occur before the baby is thrown out with the bath-water and inheritance taxes are abolished or reduced to trivial levels. The suggestion outlined here is one way of retaining a clean baby while dispensing with dirty bath-water.

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