The Conservatives should have stood firm on Inheritance Tax

The Conservatives have abandoned their manifesto commitment to raise the Inheritance Tax threshold as part of the coalition deal with the Liberal Democrats. This his highly regrettable.

Inheritance Tax is clearly unjust in the sense that it represents triple taxation. Tax is paid on the initial income, then on savings and then again after death, creating significant economic distortions. One result is the small army of tax advisers employed to minimise exposure to death duties; another is that resources are allocated in order to avoid tax rather to achieve the highest returns. Perhaps most importantly, the tax reduces incentives to save rather than consume, thus lowering investment and hampering the production of wealth.

Inheritance Tax raises about £3.5 billion per annum for the Treasury – a tiny proportion of the overall tax take. The Conservative plans to raise the threshold would therefore have cost relatively little. Indeed, given its impact on investment and allocative efficiency, it is probable that inheritance tax actually reduces overall tax revenues in the long term.

The Liberal Democrats’ alternative policy of raising personal allowances to benefit the low paid is worthwhile in order to improve work incentives by reducing the horrendous marginal withdrawal rates produced by benefits and tax credits. Nevertheless, given the fiscal crisis, the measure will have to be funded by tax rises elsewhere. If, as the reversal on inheritance tax suggests, this means higher taxes for the relatively wealthy, it may represent a transfer from those with low time preferences (entrepreneurs and savers) to those with high time preferences (low-income spenders). Accordingly, the economic benefits of this realignment of the tax system are far from clear.

 

The impact of Inheritance Tax is explained in Euthanasia for Death Duties by Barry Bracewell-Milnes.

“Indeed, given its impact on investment and allocative efficiency, it is probable that inheritance tax actually reduces overall tax revenues in the long term.”Do you have any empirical evidence for that bald assertion? Because I doubt Bill Gates or Warren Buffett agree.

@Giles – Perhaps there would be many more entrepreneurs like Gates and Buffett if heirs had inherited more money. Opportunities forgone are more or less impossible to measure, of course.

While I oppose IHT on moral and practical grounds, it only raises £3bn a year – about the same as the TV licence fee and has little or no impact on the wider economy. Had I been at the negotiations, I would done “you cut, I choose”, i.e. Tories are free to hike the nil rate band as much as they like, or even scrap the tax entirely, provided that the (modest)shortfall in tax revenues is made up by increasing the number of Council Tax bands, up to Z if need be, or by having a 1% mansion tax on everything above the current £325k but below the new IHT nil rate band.

@Mark Wadsworth – I’m afraid I must disagree with you on a couple of points. The impact of death duties goes far beyond the relatively small amount of revenue it raises, and, of course, the effects are compounded over the long term. A great many families would be far more wealthy today had IHT never been introduced, with positive effects on the wider economy.Increasing the number of council tax bands would be very unjust. If anything, those living in more expensive properties use council services less. For example, they may be more likely to send their children to private school and to reside in private care homes in old age.

Richard, sorry to sound naive, but why would further concentrating wealth in richer households have positive effects on the wider economy? Is there any econometric evidence to back up what sounds like yet another likeable assertion?

@Giles – if the wealthy have a lower time preference than the less wealthy then reducing taxes on the rich will tend to lengthen the cycle of production, leading to higher output in the long run. Of course, the whole ‘cake’ will then be bigger, benefiting the poor as well. The wealthy are also able to experiment and innovate more, which in turn brings benefits for the less wealthy. Hayek explains all this in The Constitution of Liberty. I would be interested to see any econometric evidence that appears to refute this argument.

How about the fact that receiving your wealth without needing to earn it reduces the need to work in the next generation? & I know you guys never really believe in/or ‘get’, the possibility of insufficient aggregate demand, but given the much lower propensity to spend of the wealthy, and the logical possibility of insufficient investment opportunities, just diverting wealth to the wealthy can hurt the economy badly. And yes there is plenty of evidence of that happening. You could argue that it is going on at present – soaring assets, insufficient demand. But to you Austrians I guess that all sounds like Greek…

One of the ways the wealthy can spend money is by investing in very high-risk new ventures to back entrepreneurs. It is difficult to argue that at present there is a surplus of such funds. Increasing the inheritance tax threshold would not cost much tax revenue (if any) and would increase the supply of badly-needed venture capital. But let’s by all means have a debate about where (first) to cut taxes, and by how much. The immediate aim should be to stimulate the supply side of the economy, not to increase government handouts to the already vast army of tax-receivers. The ‘logical’ possibility of insufficient investment opportunities sounds like an unconvincing Marxist argument.

Sorry, Professor Myddleton, but again how do you know that there is a real constraint on venture funds in this country? Why would releasing more to people who have largely accumulated this in housing equity suddenly produce investment in high-return high risk investments?Once again, I wonder where the empirical data is behind these assertionsbestGiles

Oh, and by the way, there is nothing Marxist about anticipating the possibility of poor investment opportunities. Anticipating deflation, for example, or credit-contrained customers (see 2008?) are two of thousands of easy to spot moments. It is wonderful to become aware of such optimists that think these things can’t happen …

Of course if you raise tax rates so much that it is very difficult to make an acceptable rate of after-tax return, it is possible to arrange things so that few investment opportunities are attractive. To me the solution seems rather obvious: reduce tax rates. In fact that might even end up increasing total tax revenue (the Laffer curve in action).There is now so much government interference in the economy, with government spending amounting to about half of the national income, that it must be hard to imagine what letting the market work could achieve. If you kill the geese that lay the golden eggs, in the end you won’t have much gold. What a surprise that we don’t!

Inheritance tax is expensive in terms of the avoidance measures it leads to. On a personal note, Alistair Darling’s change to allow the allowance to transfer between married couples saved me about £2K in legal fees for setting up a discretionary trust. That saving is replicated across the south east for people in modest houses (or people neglected to set up the trust so the tax became a tax on the unwary). If Giles really does want to achieve his objectives, he should call for a proper inheritance tax (ie people are taxed on what they inherit) and not an estate duty (which is what we have at present). We could probably both live with that with high thresholds.

I agree! And I think the Fabians do too. Obviously, reducing expensive avoidance issues is a good idea.David, returns on investment are not wholly determined by the government tax position (I always find it extrardinary how cowed by the government are Austrians/libertarians). Somehow Microsoft Google and General Electric have grown up through a century during which governments have generally grown, and GDP growth in larger government post War period easily exceed those of the smaller government C19. I quite agree about golden geese. Very wise words indeed.

[...] those extremes where your views are just ignored for being predictable in advance.  Consider their post asserting that inheritance tax is a tax on entrepreneurialism. I keep asking where the proof is, and I keep getting fanciful, evidence-free theories back.  [...]

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