How to Avoid Paying Inheritance Tax

HMRC will hate you if you use this one WEIRD trick

Rishi Sunak has pledged to cut inheritance tax. This is either a political masterstroke and a truly Conservative prime minister guaranteed to win the Tories the next election as Sunak finally tackles this deeply unfair and cruel tax OR, it is just another sign that Sunak and the Conservatives are out of touch with the majority of the country and only care about helping their mates and entrenching inequality.

I actually have a lot of sympathy for those who wish to abolish inheritance tax. While far from being the most economically damaging tax, it obviously does have some distortionary impact on the economy. For example, it functions as a massive disincentive on saving and long term investment and instead incentivises less economically beneficial forms of spending, thereby hampering productivity and growth.

What is more, it is a deeply unpopular tax. This isn’t necessarily a reason to scrap it – the public is often woefully ignorant of economics – but we do live in a democracy and so what the public thinks and feels should matter. I remember being in a meeting with some mandarins from the Office of Tax Simplification (RIP) and they were sharing their shock at just how hated the tax is. Even when people understand how it works and that their own estate won’t be subject to it, they still feel that it is unfair.

It is also a tax riddled with loopholes and easily avoided by the super wealthy while those who are relatively less wealthy are forced to pay up as they cannot afford to pay for fancy lawyers and accountants. This highlights another failing with the tax. It is an inefficient way of raising revenue and reducing inequality as while it might raise a significant amount of money, it is also expensive to enforce.

Finally, while it is true that only a small proportion of the population pays inheritance tax, the number of households who do is growing. These households are predominantly located in London and the South East and although are much better off than most of us, are not really what we might consider ‘wealthy’ (more on this later).

However, there is also a good case for keeping inheritance tax. One of Adam Smith’s principles of taxation was that taxation should be fair and based on the personal circumstances of taxpayers. The government needs to get money from somewhere and it’s surely fairer to get that money from the very rich rather than those who are already struggling. Or, as the infamous bank robber Willie Sutton once put it when asked why he robbed banks: ‘because that’s where the money is’. I’m obviously uneasy about the government seeing its citizens as cash cows but if it is to do so it is fairer for them to go for the very wealthy.

An inheritance tax is also a means of tackling inequality and intergenerational wealth mobility (albeit an inefficient one). The UK is a deeply unequal country and, while I’m more comfortable about higher inequality than those on the left, this only holds if everyone is getting richer and there is also a point where it becomes politically unsustainable. What is more, the UK is really bad at social mobility. A person’s life chances should not be dictated by their parents wealth but unfortunately this is far too often the case in the UK. Taxing inheritance is a means of addressing this issue.

Given the complexity of the UK’s tax system, scrapping inheritance tax could lead to unintended consequences. For example, as tax expert Dan Neidle has pointed out, it could crash the UK’s Alternative Investment Market (AIM). This is because the majority of AIM shares are exempt from inheritance tax which means that approximately one third of AIM shares are held for the purpose of avoiding inheritance tax. It’s also a similar story with the Enterprise Investment Scheme which encourages investment in SMEs.

Finally, managing the economy is about choices and it’s difficult to make the case that abolishing inheritance tax should be a priority. This would be true at the best of times but is especially the case during a cost of living crisis and when the public finances are in a parlous state. If there is to be tax cuts then the focus should be on the most economically damaging and which cause pain for working people, not ones paid by the richest in the country.

I’m not convinced with the arguments for keeping inheritance tax and am more convinced by arguments in favour of scrapping it. However, I would probably come down on the side of keeping inheritance tax but radically reforming it. The government should simplify it by abolishing and capping many of the reliefs while using the extra revenue this would raise to lower the rate. I also think there needs to be a sensible discussion about moving away from taxing incomes to taxing wealth (I am hoping to write a long piece on this at some point).

The debate around inheritance tax has raised a number of issues such as inequality, social mobility, economic growth, and has also highlighted the fact that a growing number of people are now liable to pay inheritance tax. These are all incredibly important topics and can all actually be tackled by a simple solution: building more homes.

Take inequality and social mobility, for example. Housing is incredibly expensive which means poorer people are being priced out and so are unable to own a home of their own and are spending a significant proportion of their income on rent. Contrast this with people from wealthier backgrounds who can not only afford a home of their own, but they become even richer as they have an asset which will continue to increase in value.

Then there is economic growth. The fact that this country is experiencing stagnant economic growth is the main focus of this blog. The key driver of economic growth is productivity which is being severely hampered by the housing crisis. Our failure to build enough homes means that the most productive people cannot move to the most productive areas and so do not work in roles for which they are the best fit and so firms are deprived of their skills and experience. Meanwhile, other firms and highly productive people are also missing out from the agglomeration effects of having a large number of highly productive and organisations in the same location. If these people do accept a suitable job they often face a lengthy commute. All of this means that individuals and firms are less productive and we are all poorer as a result.

Finally, we have seen an increase in the number of people liable to paying inheritance tax. These are people who are probably living lives which are more comfortable than the majority of the country and so it is hard to muster too much sympathy for them. However, they are not really what we would consider as ‘wealthy’ and, as they like to point out, are only paying inheritance tax due to the value of their home. They are absolutely right. The housing crisis has significantly inflated the value of homes over the past few decades and has resulted in a form of fiscal drag where more and more people are forced to pay inheritance tax. Increasing housing supply will mean that house prices will remain stable and those on modest incomes no longer will get a nasty shock from HMRC.

Inequality, social mobility, economic growth, and fiscal drag are all important issues. However, if we want to solve them then focussing on inheritance tax is a distraction. Instead the government needs to liberalise the planning system to ensure that millions of new homes can be built in and around our major cities and towns.