Inheritance tax should be abolished due to its distortionary nature and complexity, a new report by the Institute of Economic Affairs has argued.
The report, ‘A Taxing Inheritance’ by Rory Meakin, found Britain’s inheritance tax regime ranks fifth highest among OECD countries, sitting in a “small group of high-tax outliers”.
Almost half of OECD members, 18 out of 38, levy no tax on such transfers whatsoever, and a further 10 charge preferential rates.
The report states that while Britain’s 40% headline rate sits only moderately above the OECD median, it is far more punishing than headline comparisons suggest. Most countries treat transfers from parents to their own children as a special category, taxing them at lower rates or not at all. However, Britain makes no such distinction.
The paper highlights the arbitrary nature of inheritance tax, noting that viewed through the lens of the chain from wealth creation to consumption, the tax introduces an arbitrary additional point of taxation with no justification on ‘nanny state’ or internalisation of externalities grounds.
Furthermore, inheritance tax is among the most disproportionately complex in the British system and expensive to administer.
In addition, the report argues that the tax undermines investment and international competitiveness.
It states: “Complete abolition would have beneficial effects on output, saving and investment. It would also have a disproportionately beneficial effect on the administrative cost of running the tax system, with substantial simplification benefits, freeing up significant high-quality human capital to be reallocated to more productive endeavours.”
The report says the Government should prioritise spending cuts in order to fund tax cuts. However, it also outlines a number of cheaper reforms that it believes would still deliver meaningful benefits.
These include raising the nil rate band to £2 million or more. According to Meakin, in 2022-23, £3.4 billion of the total £6.7 billion was collected from estates with a net value of over £2 million, but the £3.3 billion paid by estates worth under £2 million represented the overwhelming majority of tax-paying estates.
Meanwhile, cutting the headline rate from 40% to 20% would reduce the financial burden for all, or almost all, without removing anyone from the liability.
In addition, simplifying the gifting rules would cost the exchequer relatively little, the report says. 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, the report says.
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, added: “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.”
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