A no-brainer inheritance tax cut

To most voters inheritance tax is profoundly unfair, even the Fabian Society thinks the tax is too toxic to save. Worst still, rather than cutting the rate or scrapping it altogether, ministers have instead carved out exemptions for family homes distorting investment into property. Beyond being widely perceived as unfair, the tax is also much less progressive than many suppose. Greg Mankiw points out that the incidence doesn’t just fall on fortunate heirs, but also on workers who don’t receive a bequest.

“The estate tax is a tax on capital. As such, one would naturally expect it to discourage capital accumulation. Now, put this together with the fact that a smaller capital stock reduces productivity and labor income throughout the economy and the implication is clear: the repeal of the estate tax would stimulate growth and raise incomes for everyone, even those who never receive a bequest.

“The average worker has little reason to know that his weekly paycheck is smaller because of the existence of the estate tax. He may never realize that he bears part of the burden of the estate tax.”

Of course, the tax does have supporters. They worry about powerful dynasties forming and consider heirs undeserving. But there’s one inheritance tax cut everyone should support.

Under the status quo, each pound bequeathed over £325,000 is taxed at a high 40%. At the same time to avoid double taxation, capital gains are forgiven at death. This is backwards. As the Institute for Fiscal Studies’ Mirrlees Review put it “There is no case for forgiveness of CGT on death.”

This creates a powerful incentive for individuals to hold onto an asset when they would be otherwise better off selling up and putting their money in more profitable opportunities elsewhere. Taxes that reduce the number of times an asset changes hands also tend to reduce liquidity and increase volatility.

The Treasury estimated in 2012-13 that forgiving capital gains at death costs the Exchequer around £490m a year (annoyingly they haven’t calculated it lately). Since then the rate has fallen from 28% to 20% and revenue has nearly doubled.

Politicians are understandably resistant to adding further taxes on families when loved ones pass away, but forgiving capital gains at death is a terribly inefficient way to do that. The solution is a no-brainer. Scrap the exemption and plow the funds into cutting the inheritance tax rate.