Category Archives: tax avoidance; fair tax

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.

Is tax avoidance morally wrong? (Part II)

In a previous post (scroll down) I looked at the UK’s tax rules and suggested they might be unfair. But even if I am right, it does not follow that we should criticize people for avoiding tax. So, can people be criticized for doing something perfectly legal?

The state cannot legitimately fine or imprison lax-abiding citizens but neighbours or friends may be entitled to criticize. For instance, while the state should not mandate attendance at your children’s school plays, you should go to them and you are open to criticism if you do not. Is tax avoidance like this?

Let’s start with train fares. Is it morally wrong to avoid paying your train fare? The answer here cannot be ‘yes, because it is illegal’. I presume that most people who think that we should pay our train fares don’t believe this only because the law says so. If the law changed, they would not automatically become fare dodgers.

Surely whether others can criticize you for failing to pay your train fare depends on the circumstances. Some stations are unmanned and their ticket machines don’t work. If you travel between two such stations you have to seek out ways of paying your fare. Only the very virtuous would traipse up and down a train seeking high and low for a ticket inspector. And if you give up after a minute or two you are surely not at fault for getting a free ride.

Then there are the times in which you fully intend to pay at your destination but, at the last minute, you see open barriers. You go through. Naughty yes, but there was no plan to cheat.

Finally, there are cases that require effort: inventing a story about a conversation with a ticket inspector on the train (‘he said it would be OK…’); or crawling through a gap in a fence. We can even nuance this last possibility: you may calculate that the costs of the snags to your coat are smaller than the savings in ticket fares. Only real rotters would go this far I suspect.

It seems that our criticism of people who don’t pay train fares is dependent on the effort required either to pay or avoid the fare. We can use this analogy to think about tax avoidance. But how might we measure the ‘effort’ tax avoidance requires? It may involve little more than Gary Barlow saying ‘yes’ to his accountant. But, as Aristotle said, money is the measure of all things. How long does it take for high net worth individuals to earn the money to pay their accountants?

For instance, it might cost UK comedian Jimmy Carr a week’s gigs to pay his accountant’s fees. This makes him sound quite a lot like someone who crawls under a fence to avoid paying a train fare. Seldom do people say ‘I didn’t realize’ when told they had just done a week’s work.

We might apply a similar method to large corporations. How many extra employees could Google fund from the amount it spends on its tax advisers? How much extra growth could be expected from these additional employees?

This is quite speculative and I simply do not know how much actual tax avoidance is like crawling under a fence at a train station. But if anyone has the time and inclination I have outlined a rough method of how they might find out.

Is tax avoidance morally wrong? (Part I)

Claims that tax avoidance is morally wrong are immediately countered by claims that no-one pays more tax than they have to and, its more specific companion, we’ve all paid the builder cash-in-hand. So are complaints about tax avoidance unthinking or, even worse, hypocritical?

There are two things to look at: the tax rules and people’s behaviour. In this blog post I will focus on the tax rules. In the next I will look at whether individuals can be criticized for avoiding tax.

Unfair tax rules

If we’ve all paid the builder cash-in-hand one thing is true, we all have similar opportunities to evade tax. But not everyone can avoid PAYE by setting themselves up as a company or convince HMRC that they are Luxembourgeios. Even worse, most people who can do this are at the top end of the wealth scale. Opportunities to avoid tax are not equally available to rich and poor.

Political philosopher John Rawls argued that economic inequalities are justified only if they benefit the least well-off (his so-called ‘difference principle’). For many this is too heady an egalitarian sauce. Why should the poorest have a veto on the acceptable level of other people’s income? But our tax rules seem to be based on an even more heady principle: opportunities for tax avoidance should favour big corporations (over small businesses) and high net worth individuals (over you or I). This hardly seems fair. Of course, tax rules are not purposely designed to be unfair but they do seem to have this effect; and this is a reason to object to them.

One general reply is that it makes no sense to focus on tax avoidance when tax evasion (such as cash-in-hand payments) costs far more. But objections to tax avoidance need not based on the amount of money involved. Moral outrage about tax avoidance (whether justified or not) is shared across the political spectrum – from little Englanders who have a soft spot for Nigel Farage to dyed-in-the-wool socialists who think that Marx has just not been right yet.

These people may not agree on anything else and some will think that the money lost is not the state’s to claim anyway. But what they can agree on is that whatever the rules are they should be fair.

In addition, the debate on tax avoidance becomes confused if we focus solely on the amount of money involved. It makes it sound as if the problem is that the system is inefficient. Money is falling through the cracks! This frames the problem in somewhat dry, technical terms that should be turned over to economists or perhaps bureaucrats to solve.

But moral sensibilities are seldom provoked by technical inefficiencies; and making the tax system more efficient would not address people’s sense of injustice.

Moreover, thinking of the problem in terms of fairness – and explicitly separating fairness from economic issues – helps us to pose important questions. What would a fair tax system look like? What would be the costs – either to individuals or in terms of reduced tax receipts? It has been said that Amazon’s business-model would not survive fair competition with high-street bookshops so one cost may be more expensive books.  Are these costs worth it for fair rules?

John Rawls said that ‘laws and institutions no matter how efficient …must be reformed or abolished if they are unjust’. As unfairness is a form of injustice he was clear that a society with fair rules is more important than a society with a large tax take – even if that money is re-distributed to poorer citizens.

People disagree with Rawls but, I think, one thing is true: if a tax system and its tax rules are insensitive to fairness, it will not command the loyalty of citizens indefinitely.

So what should be done? Advice is not my purpose here but I think the tax avoidance debate would be more fruitful if it were re-framed in terms of fairness. This would require accepting the possibility that a fair tax system might have economic costs and arguing that those costs are worth it. This is not an easy task but it can be done.