Should we cut the inheritance tax rate to 20%?

The impact of inheritance tax is ratcheting up.

There was a 24 per cent jump in estates hit by inheritance tax over the past year, according to recent HMRC figures, and the number affected by it will continue to rise in the years ahead.

This has been on the cards for some time, as Britain’s wealthiest ever generation start to run up against average life expectancy.

But the inheritance tax situation has been exacerbated in recent years by the pandemic house price boom that pushed average property values up 25 per cent since April 2020.

In large chunks of the country, you don’t need a mansion to end up caught in the inheritance tax net – a four-bedroom detached family home added to your lifetime’s savings will do it.

As more are affected by it, the debate around inheritance tax is likely to intensify further.

It often centres around whether inheritance tax should be abolished altogether, or the threshold should be raised substantially, to take into account inflation, rising asset values, and house price growth.

On the flipside some think the net should be tightened and inheritance targeted for even more tax.

My idea is different: inheritance tax should be cut to 20 per cent.

The best way to detoxify inheritance tax would be to radically simplify it and levy it at a much more palatable rate.

I would get rid of the complex and outdated set of reliefs, have a tax-free threshold of £1million, and cut inheritance tax to a flat 20 per cent above that.

My argument is that a 20 per cent charge feels far more reasonable than a 40 per cent tax and this greatly reduces the incentive to avoid inheritance tax and creates less of a reason to hate it.

And hate it, we do. Inheritance tax has long laid claim to the dubious title of Britain’s most hated tax, regularly winning polls of the levies people dislike the most.

A Hargreaves Lansdown survey in 2021, found it topped the pile of most hated taxes, with 24 per cent of the vote, ahead of the 17 per cent who said they disliked income tax the most.

More recent research from insurer NFU Mutual found that 57 per cent thought inheritance tax was unfair, compared to just 18 per cent of those who considered it fair.

This attitude has long been something of a curiosity, as while a very large proportion of the population pay income tax, national insurance, VAT, and even occasionally capital gains tax and stamp duty, not many people pay inheritance tax.

Even after that 24 per cent increase quoted at the start of this column, the number of estates hit by IHT last year was only 41,000.

That is going to continue to rise, but even ambitious projections only suggest an increase from one in 20 estates incurring it to one in 10 estates.

So, what lies behind inheritance tax’s villain of the piece status?

Among the complaints are that it was a tax designed for the very rich that now hits the wealthy middle classes harder, that it disproportionately hits southern England, and that the threshold and allowances have been repeatedly frozen.

These grumbles are all fair enough.

In 2018, as Chancellor, Philip Hammond tasked the Office of Tax Simplification with coming up with a plan to overhaul inheritance tax (which, of course, the government has since totally failed to see through).

The OTS inheritance tax report was a deep dive that highlighted how bonkers it has become. It’s a mess of loopholes, overly-complex rules, unfair elements, and outdated allowances.

Among other things, the OTS pointed out that: the very wealthiest estates pay a far lower rate of effective inheritance tax, as the very rich are better at tax avoidance; the unmarried are penalised compared to spouses and civil partners, non-homeowners and the childless are treated unfairly, and that annual gifting allowances are wildly out of date.

The rules only permit £3,000 to be given away per year without risking an IHT liability, which would be more than £10,000 if it had risen with inflation, while they also allow just £5,000 as a special exemption for a wedding.

The two biggest problems people have with inheritance tax, however, don’t zoom in on those details, instead they are about it being a tax on already taxed money and the high rate.

The former isn’t entirely accurate, as the wealth levied at death includes the rising value of assets such as investments and homes, which hasn’t been previously taxed.

But that’s not to say there isn’t a point to be made: the earnings that went into savings accounts, investment pots and buying homes were taxed – and so too were savings interest, dividends and capital gains along the way.

So, inheritance tax is at least partially a tax on already taxed money.

The latter moan returns us to my case for cutting the rate: 40 per cent sounds like a lot – our minds are trained to think that’s nearly half.

Cut the tax to 20 per cent on the other hand and it doesn’t sound anywhere near as bad.

It may seem mad to do this when the tax burden is rising to try to balance Britain’s books, but another vital point made in the OTS report was that despite its highly controversial and high profile status, inheritance tax doesn’t even raise that much money.

‘Inheritance tax makes up less than 1 per cent of the total tax raised by the Exchequer,’ says the OTS. ‘To put this into context, this would cover just over one week’s worth of the cost of providing UK pensions and welfare benefits that year.’ 

If a tax manages to be considered by so many to be unfair then it undermines the system, is that worth it if it barely makes a dent in the tax take? 

With an election looming and the Conservatives eager to attract voters – and not lose more than they already have – IHT looks a likely target for a potential giveaway.

It’s also long due an overhaul.

But whatever shape a inheritance tax shake-up takes will be highly controversial.

Read Tanya Jefferies’ report on what experts think should be done about inheritance tax and vote in our poll to have your say.

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