Halving inheritance tax would give away an average of £180,000 to the top 5% of estates at death

Inheritance tax

According to a recent report from The Times, it looks like the Chancellor is thinking about reducing the rate of inheritance tax from 40% to either 30% or even 20%. There are even rumors that the tax could eventually be abolished altogether. Although cutting or getting rid of inheritance tax would be expensive for the government, as a vast majority of the tax savings would go to those with estates worth over £1 million, it wouldn't necessarily contribute significantly to inflation since wealthier people are more likely to save the extra money. However, any tax cut will still have some impact on inflation.

The tax on inherited money brings in £7 billion every year, and it's expected to increase to £15 billion by 2032-33. This is because older people have more wealth. Even though £15 billion is only 0.5% of the country's GDP, reducing the inheritance tax rate would mean either spending less elsewhere or making up the difference with higher taxes or a larger deficit. To give an idea of how significant this is, lowering the tax rate by 20% would cancel out the savings from reducing benefits by uprating them at October's inflation rate instead of September's (which might happen soon).

A small group of people would benefit if inheritance tax were cut, and this group is becoming larger. Only a small percentage of people currently pay inheritance tax, but this is expected to increase over the next 10 years, with more than 50,000 people per year affected. In some cases, the first partner to die in a marriage or civil partnership can pass on their wealth to their partner without paying inheritance tax, but their surviving partner may still have to pay it when they die. If we count both partners as taxpayers, the percentage of people paying inheritance tax is expected to be 12% by 2032-33.

The tax payment is not evenly distributed across the UK as it is geographically centered. In London, one out of every six people pays the tax which is more than twice the national average and eight times more than those in the North East. The concentration of tax payment can be seen in Figure 1 at the parliamentary constituency level. 'Home Counties' seats, which mostly voted for Conservatives in 2019, have the highest benefits (as indicated in Figure 1a). Labour-supportive seats in the North, West of London, and Edinburgh would also benefit (as demonstrated in Figure 1b).

The graph displays the quantity of estates that are eligible to pay inheritance tax per 100,000 inhabitants. The data is categorized according to the parliamentary constituency and the outcome of the 2019 election for the two most prominent political parties, Conservative and Labour. The graph is divided into two sections: (a) shows the party results for Conservative seats, and (b) presents the results for Labour seats.

The data in table 12.9 from HM Revenue and Customs (2023) was utilized to perform the calculations by the authors.

In Figure 2, it is evident that any tax cut or removal would only benefit the richest people in our society. If inheritance tax was reduced or abolished in 2024-25, 83% of the financial benefit would be received by the top 5% of the population. These individuals possess over £1 million upon their death, and with a tax rate of 20%, would be able to pass on approximately £180,000 more on average. It is important to note that the other 90% of the population would see no benefit as they do not earn enough to pay inheritance tax. Additionally, the top 1% of people would benefit the most with an average gain of £500,000 if the inheritance tax rate was reduced by half.

In this part of the blog post, there is an illustration, represented by a graph. The graph exhibits the average benefit acquired from decreasing the inheritance tax down to 20% on the left-hand side and the portion of the complete tax reduction received on the right-hand side. This is shown in relation to the wealth ventile of the donor, which pertains to the level of an individual's wealth or assets compared to other people in the same population.

Please note that every fifth of the distribution of those who pass away is equivalent to 5% and is organized by the amount of wealth they leave behind. We will not consider the first member of couples who are married or in civil partnerships and pass away, as it is assumed that they will leave all their wealth to their partner. For further information about how this data was collected, please refer to Advani and Sturrock's research (2023). All values are based on 2023-24 prices.

The data from the Wealth and Assets Survey were used to make calculations by the authors.

Looking at the advantages of inheriting money, we can see that people who went to university in the 1970s and early 1980s were more likely to have wealthy parents than those who didn't attend university. Most of the people who pay inheritance tax are from the wealthiest group of parents. This means that if inheritance tax is reduced in the future, graduates are likely to benefit 10 times more than those who only have up to GCSE level education. People who are in the top 20% of earners are eight times more likely to have parents in the top 20% of wealthy people, and therefore will benefit more from a cut in inheritance tax than those in the bottom 20% of earners.

Currently, the UK's inheritance tax rate is higher than in many other countries, but reducing it to 30% or even 20% would bring it more in line with other European nations. However, it's not just the headline rate that should be considered. The UK has a higher tax-free threshold than many other places, which means that fewer people are liable to pay inheritance tax. Additionally, there are several exemptions in place within the system that mean that those with estates valued between £3-£5 million pay a lower rate of around 25%, which drops to as low as 17% for estates over £10 million. By reducing the rate even further, to 10% or less, those with the largest estates would benefit from an even lower effective rate.

If the Chancellor intends to reduce the inheritance tax rate, it would be ideal to seize the opportunity to improve the system and make it more rational. This could be achieved by limiting the reliefs on business and agricultural assets to £500,000 per individual and including pension pots in the inheritance tax scope. A reduction in the tax rate from 40% to 30% for estates valued at £2 million or less could balance out any revenue loss. This proposal aims to make the system equitable and distribute the burden of inheritance tax towards larger estates.

The topic of inheritance tax has its fair share of advocates and critics. However, it cannot be denied that removing it from the equation would come at a steep and increasing cost, mainly benefiting the richest members of society. If the tax rate were to be reduced by half, the wealthiest 5% of inheritances would save approximately £180,000. This fact is particularly concerning given that over 90% of estates are not even eligible for inheritance tax relief, and hence, would not benefit from such a reduction.

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