In which I ramble on, and on, about Inheritance Tax

It's a strange tax, the Inheritance Tax. It raises, in relative terms, a vanishingly small amount of money - some £3bn of an aggregate tax take of almost £500bn. It is paid by a tiny number of people - some 16,000 per annum (3% of all estates). And yet it possesses a unique status as a kind of fiscal shibboleth, separating a 'them' and 'us.' Unique, unless of course we make the heroic assumption of a Labour victory in May, where it will be joined by a further shibboleth - someone out there will point out the plural, assuming also heroically, that a shibboleth is a notion such as can possess a plural - namely the Mansion Tax. That tax, too, will be paid by a tiny number of taxpayers. And as with the Inheritance Tax (remember Gordon Brown backing off a snap election when the Tories announced proposals to extend the nil rate band? It's tempting to speculate on how different the political and economic landscape might now look had he held his nerve, fought and lost, leaving the Tories in control during the credit crunch. Tempting, but...) it's a feature that dilutes not at all its potency. I will allow myself this speculation though: one reason why they share this political potency might be that they are both wealth taxes. They get the newspaper barons up and out. For those, like me, who would like to see income taxes on productive strivers reduced in favour of wealth taxes on (in particular) economically fallow assets, it would be nice to think of the political success of the Mansion Tax - hugely popular with the electorate - as emboldening a future Labour Government or Opposition. Sadly, or so it seems to me, this Opposition has largely taken as its motto Matthew 5:5 - that the meek shall inherit the earth. But I'm yet young. I can wait. You, on the other hand, might be less so. Where is he going, you might quite reasonably ask? I suppose it's here: why is it that the Inheritance Tax - a tax paid by the donee on wealth she has not earned - is a political liability for Labour but the Mansion Tax a success? And the answer, I'd like to venture, is a matter of design. The Inheritance Tax is badly designed. It's badly designed in technical terms. And it lacks popular legitimacy: it'll only ever be a vote loser for Labour. The Mansion Tax, on the other hand, whatever its technical failings, is popular. Poor technical design first. The cost of reliefs from Inheritance Tax is huge. The tax itself raises, as I have said, £3.1bn but the cost of the reliefs is more than seven times this at £22.4bn. Indeed, the real figure will be higher: the £22.4bn is the aggregate cost only of the 13 (of 88) reliefs from inheritance tax that HMRC publishes costs for. True it is that much of that cost reflects a modelling decision. The joint nil rate band of £650,000 accounts for all but £4bn of the £22.4bn. And the level of the nil rate band reflects a political choice. The purpose and design of other reliefs is less clearly comprehensible. Particularly difficult to understand is the privileged treatment given to agricultural property - holdings of farmland together with a 'farmhouse' on that land. The need to ensure food security might once have been advanced as a rationale for the relief. But if so, it is difficult to understand: the rationale is achieved by planning controls which limit the uses to which land can be put. However you tax the land, it cannot be used otherwise than to generate income through farming. Also ventured is the need to protect farms from being broken up on death: but I can understand neither why farmland should benefit from such privileged treatment nor how agricultural property relief achieves this goal. As things stand, agricultural property relief is merely the latest and safest iteration of a kind of fiscal polo - the game played exclusively by the wealthy of 'mitigating' inheritance tax bills. Put your money into agricultural property and you can safely escape liability to inheritance tax. Indeed, with other mechanics for avoiding liability to the tax having slowly disappeared, farmland's privileged status has seen its value - and indeed the cost of agricultural property relief - escalate sharply. The cost of agricultural property relief has tripled since 1999/00 whereas revenues from inheritance tax have remained broadly flat. This increase in the cost of the relief will partly reflect the increase in the values of farmland which have roughly quadrupled over that period (an increase itself likely to be a function of the slow loss of alternative inheritance tax avoidance mechanics). And it will also reflect the growing frequency of use of agricultural property as a token for avoiding inheritance tax - one that you buy old so that it sits, economically underproductive, in your estate for only a short period of time - and which changes hands frequently, forever being sold by younger to older hands. I pause to note that, taxed as such, agricultural property does not derive its value from its capacity to generate income; this is likely to contribute to it being utilised less than optimally; and these effects are likely to be amplified by frequent changes of ownership. Anyway. But what of popular legitimacy? The Tories, it has been widely speculated, plan to add to their raft of questionably funded tax cuts (in particular the increase in the income tax personal allowance to £12,500 and the raising of the point at which the 40p rate kicks in) by raising the Inheritance Tax joint nil rate band to a satisfyingly round £1m. Estates of a value below this figure will pay nothing, estates of a value above it may (because of the 36,000 estates valued at above the threshold, 20,000 did not have to pay inheritance tax because of the reliefs for which they qualified) pay 40% on values over it. This, they anticipate, and no doubt rightly, will be hugely popular.

A confession. Like Margaret Thatcher I am not a fan of shrinking the tax base. It might be politically expedient - everyone's favourite tax is one that someone else has to pay - but it represents bad policy, rendering the yield ever more volatile and susceptible to economic and political shocks. I believe we should all pay something: an amount both reasonable and according to our means.

And the big problem with the current design of Inheritance Tax is that it fails on both scores. Why should those with estates less than the predicted £1m pay nothing? And why should those with estates above suffer a reduction in wealth of a number as high as 40%? I'm not aware of any polling on the issue but I would hazard that the reason why changes to IHT are such a potent political weapon for the Tories is that the rate is so widely perceived to be too high. A 40% wealth tax on death is a tax set at a level as to lack legitimacy - and so to generate fiscal rebellion in the form of avoidance mechanisms. Gandhi's Salt March is our fiscal polo. Cut the confiscatory rate from 40% to 20%, lower the joint threshold to £500,000 (or lower) and fund the difference by abolishing agricultural property relief. And take a long hard look at the 87 other reliefs. There's a truly radical reform. One which will reduce avoidance, be as close to tax neutral as matters, and be hugely popular. [NB: for those interested, the distributional impacts of such changes would create a big loser of estates at £500,000 (which would see an increase in tax of £30,000). This increase would reduce until the estate hit £725,000 (at which point the changes would be tax neutral). Above this, and leaving aside the effects of abolishing APR and any other reliefs likely to fall hardest on the largest and hence best advised estates, it would generate winners.]