‘Why not fund the welfare state with a 100% inheritance tax?’ So asked Guardian columnist Abi Wilkinson in a column from July 2017. The concept of steep inheritance taxes is of course nothing new, but the idea has never had broad support in the UK. The suggestion that some elderly care could be funded by a claim on assets to be paid after death was quickly dubbed the ‘Dementia Tax’ and probably cost Theresa May a majority in the June 2017 election. But the idea enjoys some popularity. The unearned nature of inheritance makes it an obvious target for taxation as an alternative to earned wealth, where taxes have well known adverse effects on incentives. Inheritance on the other hand can discourage the recipient from working, so taxing this windfall could have positive effect on incentives. And after years of booming prices on property and other assets, more people than ever before stand to inherit life-changing sums of money when their parents pass away. This makes some worried about entrenchment of social inequality.
Different countries have very different inheritance tax codes. Japan has the highest rate in the OECD at 55%. The UK and US are both at 40%, subject to certain thresholds; France’s top rate is 45%. Fifteen OECD countries levy no taxes on property passed to lineal heirs. But this does not mean that different countries view the passing on of earthly possessions to one’s children as more or less virtuous. Wilkinson writes that ‘cultural norms teach us that the inheritance of private property is the default and any expropriation of this wealth must be justified. It should be the other way around’. This is obviously wrong – the idea of passing on your possessions to the next generation has no root in any specific culture – it is a hallmark of cultures across the world and throughout time. Milton Friedman, in a famous intervention on the subject, pointed out that our society is a family society and that individuals often seem to work and save for the benefit of their children, not themselves. In the words of Friedman, ‘almost all people value the utility which their children will get from consumption higher than they value their own’. This despite most parents recognising that their children are likely to have higher incomes and better living standards than they themselves enjoy.
There is obviously a simple moral argument against inheritance tax, rooted in basic property rights. As it is my property, I should be able to do as I choose with it, including passing it on to my children. Even if one believes in the general concept of taxation (we do not), savings is wealth that has already been taxed as income.
But there is a more utilitarian argument, which proponents of high inheritance taxes completely ignore in their exclusive focus on the recipient. The decision to bestow inheritance of course lies with the parents, not the children. It is therefore integral to the argument to examine their incentives. Inheritance taxes incentivise parents to ‘dissipate their wealth on high living’ (again quoting Friedman) instead of saving. But it is by deferring consumption (in this case deferred to the next generation) that resources become available to invest in capital goods, and it is investment in capital goods that facilitates economic growth. It Is the accumulation of capital that separates rich from poor societies.
Inheritance tax is in effect a tax on capital stock and as such a tax on society’s ability to produce wealth. This means that the revenue argument for such a tax is wrong. A study by the Tax Foundation found that ‘repealing the U.S. estate tax would lead to the creation of nearly 150,000 jobs and would eventually increase federal tax receipts by $8 billion per year’. This may be an exaggeration, but in the long run the state coffers would certainly not benefit from the introduction of inheritance tax. Unsurprisingly, Aby Wilkinson is guilt of the classic socialist mistake of failing to examine the dynamic effects of taxation. Furthermore, inheritance tax is notoriously easy to avoid and compliance costs are therefore high and revenues relatively low.
All in all, there is a strong cultural, moral and utilitarian case against inheritance taxes. This is why of all taxes this is one of the most contentious. The ideal of passing on to your children what you can and thereby offering them a better life is inherent to human nature. And though most people are ardent believers in taxation and would never articulate the arguments as we have done here, they instinctively understand that this is one tax that they should not support.