Let’s be clear – Inheritance Tax is not double taxation

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Jason Holden is proving to be a regular, and welcome reader of this blog. But I want to pick up on something he said in a comment yesterday (and I stress, I paraphrase for emphasis):

The Aussies ... can’t understand that once you have acquired assets over your lifetime out of already taxed income that your family get hit with another tax once you die.

Well, I've got news for the Aussies who think that this is what we do in the UK (encouraged by a British media who have fueled this issue wholly inappropriately).

The tax we're talking about is UK Inheritance Tax. It's charged on estates on death worth over £285,000 but the following don't count as being in the estate:

  1. all gifts to your spouse
  2. all gifts made more than seven years before death (if they're genuine)
  3. almost all business and agricultural assets
  4. all gifts to charities
  5. all gifts to political parties.

So let's be clear, that means most things aren't covered by it.

In fact just 36,000 estates pay Inheritance Tax a year in the UK. In total they pay £3.6 billion. That's £100,000 each, which at the tax rate of 40% (in most cases) means the average estate that pays is worth around £535,000.

Let's look at two further statistics. 512,000 people died in the UK in 2005. So, one in 14 paid Inheritance Tax (7%). That's not a lot.

Using data from Inequality and the State by John Hills, which admittedly is only current for 2001 but is good enough for the current purpose, the top 5% of the UK population owned 43% of all assets in the UK, and the top 10% own 56%. That sounds pretty much like 7% own about 50% to me (the concentration is rising by the way, so I might understate this).

Now, how much is the UK worth? Well, according to National Statistics it's £6 trillion, almost exactly. Of this privately owned housing represented more than half, at £3.35 trillion. A trillion has 12 noughts after it, by the way.

But the average house price is £185,000 . So that means there are 18.1 million of them, which given that there are 59.8 million of us sounds about right. But that means the average householder has a long way to go to pay inheritance tax. And the vast majority of houseowners (maybe 90+ % of them, given that those dying are more likely to have a house than most people, since until the age of 30 most people don't in the UK now) don't pay Inheritance Tax despite that fact.

There's a way to estimate this. First of all, if we assume that of the non housing assets (that's £2.65 trillion) at least 50% is owned by those who pay inheritance tax, based on the logic above) that means these 7% of people (4.2 million people based on there being 60 million of us) own an average of £15,000 of assets each. So, assuming that they each have their own house when they die (which is probably true for estates chargeable to inheritance tax since almost all houses pass to spouses tax free on the first death) that means the average estate of these top 7% when they pay inheritance tax is made up of financial and other assets worth £315,000 and a house worth £220,000, again based on the logic noted above. All of which seems reasonable.

So, let's look at why this should be taxed. First of all, let's dismiss 93% of the population. The Aussie fear is wrong for them. They don't pay Inheritance Tax. . Nothing is taxed twice in this case. And these are, after all, the normal working people.

So what about the rest? First of all, let's deal with those very expensive houses. The Nationwide Building Society publishes some lovely data on average house prices in the UK since 1952. Now, men are dying at around 76 now and women at 81 (give or take) so let's work on the fact that given that most would have bought their most valuable house (the 'family home') sometime around the age of 40, given the average age of families when they were raising children, meaning they have owned it for 35 years. Or, they acquired it in 1970. When the average house price was £4,500. So, that's an inflation gain of £180,000. They never paid for that. They paid £4,500 out of their wages. The rest has been untaxed.

If those paying Inheritance Tax now have house prices that are 19% above average maybe they also had the same ratio in 1970. So they paid £5,300 then. Which makes their inflation gain near enough £215,000. Which means that the vast majority of what is taxed is, in fact, this inflation gain since the average value taxed is about £250,000. This can be taxed fairly for two reasons:

  1. it has not been taxed before;
  2. the person no longer needs to retain the value to buy another property, they're dead.

But that still leaves another part of the estate which will be taxed. That is the financial assets. So why is it fair to tax them? For a good and simple reason, which is that capital gains tax is not paid on death. Inheritance tax acts as a substitute subject to a massive exemption in most cases. If capital gains were charged instead it may be fair to cancel Inheritance Tax, but you really can't have it both ways. There is no God given right to pass on an estate tax free.

Which, if I'm candid suggests that almost everything written in then popular and accounting press on Inheritance Tax is nonsense, both as to fact and economic logic. I'm all for it. Not least because it fits in very well with my logic that it's not fair to tax something it's equally inappropriate to provide a means to not tax something at all which is then open to abuse. Inheritance Tax rarely charges something twice (and if it does, it will only be on the very rich who, almost certainly avoided more of their fair share in life since their overall tax rate is always lower than the 70% of the population immediately below them) but it does stop things being taxed not at all. And that's good.