It is Britain’s most hated tax, yet hardly anyone pays it. Until recently, this paradox appeared to make raising more money from inheritance tax a no-go zone. Yet leading thinktanks are now talking about it as a way to deal with some of the most burning questions on the minds of middle-class families.
Baby boomers have unprecedented stashes of wealth tied up in their properties, yet their children and grandchildren are paying sky-high rents from squeezed incomes, and struggle to raise a deposit for a flat.
Families also face a social care lottery that could wipe out an inheritance if a parent or grandparent cannot look after themselves.
This month the Organisation for Economic Cooperation and Development proposed inheritance tax as a way to reduce wealth inequality and redistribute between the generations.
Next week, a report by the Resolution Foundation’s Intergenerational Commission will also put the case for raising more from this tax in the UK.
Adam Corlett, the report’s author, says: “We are going to need extra revenue in the coming years both to help the younger generation who have been screwed over in the jobs market and the housing market, and to help with their education – and also to provide the healthcare and social care people expect in their old age. We have been promoting the role wealth taxes can play, and inheritance tax should be a part of that mix.”
But inheritance tax faces entrenched hostility. An opinion poll in 2015 showed 59% opposed it, making it the UK’s least popular tax. Research by the Fabian Society that year found people from across the political spectrum disliked the levy because it was imposed at a time of grief on money on which the deceased had already paid tax.
If inheritance tax is part of the remedy for gaping inequalities and a looming tax crisis, what is needed for Britain to come round to the idea?
The first thing is to understand it. Government figures released on Tuesday showed it raised £5.1bn last year – more than double the amount in 2009-10, but the earlier figure was depressed by the post-financial crisis property slump. It makes up less than 1% of the total tax take and only about 4% of estates pay it.
It is charged at 40%, but most married couples can leave up to £850,000 to their direct descendants tax free. That figure is due to rise to £1m by 2020.
Those with assets outside their main home can make gifts tax-free up to seven years before their death, as David Cameron’s mother did when she gave him £200,000 in 2011.
The 40% rate bothers people, especially because many are unaware of how much can be left untaxed. Andrew Harrop, the general secretary of the Fabians, says many respondents in 2015 were surprised at how few estates were caught but were still “incredibly hostile” to inheritance tax.
“Our view was that it had become a toxic brand,” he says. Instead of taxing a dead person’s estate, the government should tax the receivers of all bequests and gifts at their marginal tax rate, the Fabians argue.
The OECD also favours taxing inheritances as income because it weakens the objection that the donor’s income is being taxed twice.
Corlett says the idea would feature in his report. “It opens up options for raising more money and it helps with the perception because at the moment inheritance tax is seen as a tax on giving.”
Taxing inheritance as income was floated by the Mirrlees Review of the UK tax system, carried out for the Institute for Fiscal Studies in 2011.
Stuart Adam, an economist at the IFS, says everyone could have a lifetime allowance of, say, £300,000 and pay income tax on the rest. Collecting the tax might not be easy but “no one thinks what we have now works very well”, he says.
One of the main objections to inheritance tax is that it is seen as being paid by the middle classes whereas the rich avoid it by giving assets away and paying advisers to find other ways round it.
These include investing in businesses, agricultural land and Aim shares, all of which are exempt, and putting money in trusts. The government estimates agricultural and business reliefs alone cost more than £1.2bn in 2017-18.
Corlett says closing loopholes “isn’t enough to solve long-term fiscal pressures, but it would make a big difference to health and social care in the short term. It’s possible to raise a surprising amount.”
IHT relief not claimed
George Osborne promised to send wealth “cascading down the generations” by cutting inheritance tax but his changes, which took effect last year, have made the levy even more complicated.
The headline threshold is £325,000, but married couples or those in civil partnerships can pass this on to their partner. Osborne introduced an additional “residents nil rate band” of £100,000 per person, taking the total that can be passed on tax free to direct descendants to £850,000, rising to £1m in 2020.
But the system’s complexity and various restrictions appear to have left many people out of pocket. Only about 4,000 of an estimated 24,000 estates paying inheritance tax last year benefited from the relief, according to NFU Mutual.
Sean McCann, chartered financial planner at NFU Mutual, said: “The low numbers claiming the new residence nil rate band may be the result of more executors doing DIY probate and not being aware of the new allowance or not realising that it isn’t given automatically and has to be claimed.”The allowance can be claimed retrospectively. The Office for Tax Simplification is looking at ways to make inheritance tax more straightforward.