Britain’s inheritance tax (IHT) is far more punishing than headline comparisons suggest, and should be scrapped entirely, according to a new paper published today (Monday 16 March) by the Institute of Economic Affairs.
The report, A Taxing Inheritance by Rory Meakin, finds that measured on what parents can actually leave their children, the UK has the fifth highest inheritance tax in the OECD. Almost half of OECD members, 18 out of 38, levy no tax on such transfers whatsoever, and a further 10 charge preferential rates.
While Britain’s 40% headline rate sits only moderately above the OECD median, this flatters the UK’s true position. Most countries treat transfers from parents to their own children as a special category, taxing them at lower rates or not at all. Britain makes no such distinction.
Arbitrary ‘double taxation’
The paper highlights how arbitrary IHT is, challenging the common expert dismissal of inheritance tax as not being a “double tax”. Properly understood, through the lens of the chain from wealth creation to consumption, it introduces an arbitrary additional point of taxation with no justification on ‘nanny state’ or internalisation of externalities grounds.
Complex and costly to administer
The tax is among the most disproportionately complex in the British system, when compared with the revenue it brings in. The Tolley’s handbook for the tax runs to 1,000 pages, compared with the 2,500 pages for Income Tax that raises 37 times the revenue of IHT. Collecting the tax costs £66million, but the full cost will be much higher when accounting for the high-quality professional time that could be deployed far more productively elsewhere, and the distortionary economic decision making it leads to.
Undermining investment and international competitiveness
The case for abolition is further strengthened by when considering the benefits of eliminating a distortion to savings and investment on the broader economy, and the benefits of improving Britain’s competitiveness as a place for entrepreneurs and high-net-worth individuals to live and build businesses. Polls show consistent opposition to IHT by the public too.
The government should prioritise spending cuts in order to fund tax cuts, as the IEA has long argued for. However, the paper also sets out a menu of cheaper reforms that would still deliver meaningful benefits:
Raising the nil rate band significantly, to £2 million or beyond, would remove the overwhelming majority of estates from liability altogether. In 2022-23, 27,920 of the 31,500 estates that paid inheritance tax had a net value below £2 million. A higher threshold would also allow the abolition of the complex residential nil rate band and the transferable allowance between spouses, delivering real simplification alongside the tax cut.
Cutting the headline rate from 40% to 20% would reduce the burden on all estates paying the tax and, the paper argues, could be considered broadly fiscally equivalent to raising the nil rate band to £2 million, while reducing the incentive to engage in avoidance.
Simplifying the gifting rules would cost the exchequer relatively little. Reducing the period after which lifetime gifts become exempt from seven years to four, three or even two years would meaningfully cut the record-keeping burden on ordinary families, with only negligible effect on receipts.
Lord Frost, Director General of the IEA said:
“A nation serious about growth and about giving families the freedom to build something lasting, would not levy a 40% charge on wealth that has already been taxed. Nearly half of OECD countries do not tax what parents leave their children at all. Inheritance tax raises relatively little, costs a great deal to administer, and distorts the decisions of exactly the kind of wealth creators and entrepreneurs we are desperate to attract and retain. A government looking to boost growth, support families and simplify the tax system for fairness and economic competitiveness should consider abolishing inheritance tax.”
Rory Meakin, author of the report, said:
“Inheritance tax is arbitrary, complex, distortionary and drives away the entrepreneurs Britain needs. A good tax system would not have an inheritance tax and, ultimately, ours should be abolished. But even a hesitant government can reform the system now. Raising the threshold, cutting the rate, simplifying the gifting rules: any of these would be a meaningful step in the right direction. “
