If you want a fair inheritance tax, make it a tax on income

Time for a tax rise? Anguskirk, CC BY-NC-ND

No one likes tax but inheritance tax (or “death tax”) is the focus of particular moral outrage. On the face of it, this is odd. The reason tax is disliked is because it reduces the money you can spend. But as inheritance tax is only payable after you have ceased to exist, you’re not actually losing out by paying it.

Admittedly, some who retain their mortal coil can object. Potential inheritors fear the loss of a windfall. But say we were to make laws without knowing whether we might benefit from an inheritance or not, then what kind of inheritance tax laws might we advocate for?

The veil of ignorance

The philosopher John Rawls famously created the concept of the “original position” – a stance where individuals agree to principles of justice from behind a “veil of ignorance”. From this position, they do not know where they would end up in society. They might be rich or poor, male or female, black or white, gifted or not. The aim: to make society’s rules fair.

The parties in the original position did not directly address the issue of inheritance tax but they did address a closely connected one: equality of opportunity. Rawls argued that if you don’t know your particular talents, or your starting point in life, you would want opportunities to be fair. For those “similarly motivated and endowed” there should be “roughly the same prospects of culture and achievement”.

This is a powerful – if hard to realise – ideal; and commitment to it is widely shared. For instance, that opportunities should be fair seems to underpin the UK Social Mobility and Child Poverty Commission’s recent recommendation that unpaid internships should be outlawed by 2020. As internships depend on your contacts and your capacity to work unpaid, they are not available to everyone who is “similarly motivated and endowed”.

And it is surely unremarkable to note that without some inheritance tax opportunities for individuals will never be fair. Your life-chances are likely to be determined by your lineage (possibly a talented ancestor) or by your ability to ingratiate yourself to those in high places.

A fairer system

Helpfully, Rawls also explained how we might realise a fair system of inheritance tax, an idea he attributes to John Stuart Mill. We should remind people that we do not tax the giver (in this case, the dead) but the receiver, based on the amount they are receiving and their economic situation:

Those inheriting and receiving gifts and endowments pay a tax according to the value received and the nature of the receiver.

In effect, this proposal treats inheritance tax as a kind of graduated income tax. If a high-earner and a low-earner inherit the same amount they should pay a different tax. This seems fair and, Rawls hopes, might “encourage a wide and far more equal dispersion of real property and productive assets”.

Current UK law

Rawls’s suggestion also enables us to explain what is wrong with current UK inheritance laws. First, in most cases, inheritance tax is paid out of the deceased’s estate before any beneficiary receives anything. Currently, it is not common for recipients to pay after they inherit. Second, while no inheritance tax is paid on estates worth less than £325,000, anything above that amount is mostly taxed at 40%.

This means that, under the current rules, a £1m estate is liable to a tax of £270,000. It does not matter who the recipients are or how many there are. But surely it would be fairer for a single high-earner inheriting £1m to pay more inheritance tax than 100 average earners jointly inheriting the same amount?

One worry – particularly in the UK – is what will happen to unrealised assets (principally property). If I were to inherit a £1m house would I be liable immediately for a tax of between £200,000 and £400,000? This seems a little tough. But any tax could be made payable only when the property is sold. If I then receive a £400,000 tax bill I still walk away with £600,000 – not a bad profit on a free gift.

Rules would be necessary to prevent people gaming the system. If you gave away an inherited property to, say, a child or partner, the tax would then be owed by them. And the amount due would be based on the relevant tax rates at the time of death rather than when the property is sold. This would prevent people delaying or bringing sales forward to take advantage of changing tax rates.

But we should avoid the detail and stick with the big picture. If you didn’t know your position in society you would want opportunities to be fair. This requires some kind of inheritance tax. Treating inheritance tax as a kind of income tax is not only fair; it also helps to explain why so many people object to current UK rules.