Inheritance Tax and What Should be Done with It

This is the first time I am using this blog and associated website to pontificate on current affairs and political theory. It may be unique; it may be the first of many.

In recent days, Rishi Sunak - British PM… at time of writing - has apparently privately mooted the idea of reforming or even eventually abolishing inheritance tax. Simultaneously, it’s conference season in British politics and my own political party, the Liberal Democrats, are fighting our own internal fight over the direction of the party - a frankly more bitter fight than I am used to seeing from my party. These two events caused me to think about inheritance and justice and return to Thomas Paine’s pamphlet ‘Agrarian Justice’ as well as some bread-and-butter Rawlsianism. From there, I have a policy proposal for you to consider. But before I continue, I will sketch out the argument presented in Paine’s pamphlet.

Paine argues that in the ‘natural state’ (the theoretical or not so theoretical pre-civilisation state of humanity that so many enlightenment philosophers used as their starting point), before agriculture, all land was held in common. And, because the initial moral right to own something comes from the act of creation, no-one had any right to lay claim to that land. They, after all, did not create it. His view of the state of nature is not as rosy as, say, Rousseau’s, but he argues that humanity in the natural state suffers from less inequality and privation, so civilisation has downsides and a just society should ensure that all people live at least at the level they would in the natural state. That requires active policy to curb some of the privation that civilisation creates.

Civilisation as he defines it began when agriculture did. This allowed land to be used more efficiently and therefore allowed the human population to increase (the result of which is that we can never return to the natural state). The act of improving the land through agriculture was, he argues, an act of creation. It came with a moral right to the ownership of those improvements. However, it did not confer any right to own the land itself. Instead, land was and remains our common heritage. Yet, that is not how it is treated. The vast majority of people have been alienated from their common ownership of the land, are harmed by that alienation, and received nothing in return for this injustice. Meanwhile, a small number base their huge wealth upon the control of this common resource.

One solution to this might be to take land back into common ownership. However, Paine disagrees. He does think people have a right to the ownership of improvements made on the land and does not see how you could separate those improvements from the land itself. Paine argues instead that those with property should be taxed, taking back that amount of their wealth that comes from their unjust control of common property.

You might think that a land-value tax (LVT) would be the best solution here but Paine is writing a century before Henry George so, instead, his solution is an inheritance tax. Paine is also writing before the introduction of income tax (introduced in the UK about a decade later) and decided that inheritance tax would be more just than income tax as it is less disruptive. The deceased person is not harmed because they’re, well, dead and the inheritor is not harmed as they’re still benefitting from the inheritance, even if by a bit less than they would without the tax. In this way, we can call inheritance tax Pareto efficient: no-one is left in a worse off position by it. That basic truth, I think, is sometimes forgotten in discussions over the tax.

This inheritance tax would be used to create a National Fund to reduce the privation caused by civilisation. This National Fund would pay out a block sum to every citizen when they reach the age of maturity (21 in Paine’s day) and a smaller sum every year to all people above 50 years old. The first payment functions as a kind of one-time citizen’s dividend (a later but related Georgist concept), ensuring all people regardless of their familial wealth receive some money with which to build their life, and the second as a kind of pension.

Now, a cogent argument could be made that ‘Agrarian Justice’ is irrelevant today. Unlike in the 1790s, currently most property wealth does not come from land. So, even if that basic injustice that Paine sketches out still exists, it is a lot less important. A Georgist might disagree and argue that all wealth comes ultimately from the land, no matter how far removed it gets, but personally I don’t care about that argument either way.

Whereas the Enlightenment liberal-radicals consistently defended an inherent moral right to the ownership of that which you create (a right that can then be transferred and remains just as strong), I would argue that all wealth is ultimately the product of society. As such, property rights are not inherent moral rights but constructed ones that exist only so far as they are beneficial to promoting justice. Here, I am in agreement with Rawls more than Paine. As such, the claim of society at large on the wealth of the rich comes not from their infringement of a collective right to land but on the broader fact that their wealth is a product of society that could not exist outside of it.

Speaking of Rawls, and moving away from Paine for the moment, he also had a lot of say about inheritance. For Rawls, inherited wealth is very concerning if it leads to inherited advantages. A just society is one in which no-one is advantaged by being born into a particular family or class. A wealthy elite who inherit their wealth from their parents flies in the face of Rawls’ concept of ‘fair equality of opportunity’: a system whereby someone’s opportunities in life are determined by their natural talents and motivations, not hereditary, racial, gendered, or any other kind of privilege. For Rawls, therefore, the primary purpose of inheritance tax is not to raise money for the government; it is far more important than that. Instead, its purpose is to ‘correct the distribution of wealth and to prevent concentrations of power detrimental to the fair value of political liberty and fair equality of opportunity’ (pp. 245, A Theory of Justice, Revised Edition).

Rawls therefore proposes a radically different model for inheritance tax. To aid the further distribution of property, he would make it a tax not on the estate of a deceased person before that estate is then inherited, but on every person’s ability to receive large sums of money from others as gifts or inheritance. Each person should be able to receive a certain amount tax free and, after that point, pay a tax on any gifts or inheritance they receive. This would encourage a wider distribution of wealth and set the burden of the tax on the recipients of an estate rather than the estate itself. Including gifts in the tax would also prevent some inheritance tax avoidance whereby money is gifted in the years before death so that it is not covered by the tax (UK inheritance tax only includes gifts made in the two years before death, allowing the tax to be avoided somewhat by making large gifts before that).

To take Paine and Rawls’ ideas and put them together, I believe that inheritance tax should be formed along Rawlsian lines and that, like Paine proposes, this tax should be used to form a National Fund that would pay out a lump sum to each citizen upon reaching the age of maturity. The second use of Paine’s Fund, supplying a basic pension, would be impracticable today. First, we already have state pensions. Secondly, they require far more funding that this amount would raise. So, the National Fund will be limited to paying out a block sum to citizens upon reaching the age of maturity, 18 years old. This sum could also be paid out in instalments for, say, three years upon reaching that age instead.

To get a little personal for a moment, I had an inheritance from my grandfather that I came into when I turned 18. Not a ridiculous amount, but enough that if I moved to a country with lower tuition fees, I could put myself through university debt free (which I did). This money was a huge privilege that helped me begin my adult life and something like it - some sum of money paid to someone when they began their own separate life - used to be more normal (especially upon marriage). Today, we don’t have such a system baked into our society and the closest we have is inheritance which, with longer life expectancies, many people do not come into until they are pensioners themselves. I believe that all people should have the opportunity and that receiving money at this time provides. The opportunity to take risks, put yourself through university or take a few low-to-no paid internships regardless of familial wealth (setting yourself up for greater prosperity down the line), make a big payment early in life like a down payment on a house, marriage, or having a child, or even just set it aside for emergency use. A relatively small amount can be truly lifechanging for someone just starting out their independent life.

Now, let’s crunch some numbers. About 700,000-800,000 people turn 18 in the UK each year. Inheritance tax as it currently stands raises about £7 billion a year. If that money was put into the National Fund, it would provide for a pay-out of about £10,000 to each person upon reaching the age of maturity (sorry to those like myself who are older than that age, I’m not planning on applying it retroactively). However, here arises two problems.

First, the money raised by inheritance tax is already in use, so this would create a £7 billion blackhole in government finances on top of the current deficit, which stood at £137 billion last year. Government finances are not in a good place at the moment after the increased spending over the pandemic coming off the back of years of low investment and austerity. I would therefore prefer not to increase that deficit for this policy. My proposal would therefore be to simultaneously align capital gains with income tax, so that unearned income is taxed at the same rate as earned income. This policy is popular and would raise at least £10 billion a year, more than covering the difference.

Secondly, I would prefer for the pay-out to be closer to £15,000-£20,000, which would require the tax receipts from this new recipient-pays inheritance and gift tax to roughly double compared to the tax receipts raised by the UK’s current inheritance tax. Could we reach this number? I am unsure either way. I do think this tax would raise more money than the old one. It would be harder to avoid for one thing. Beyond that, how much it raises would depend on when the tax kicks in - I would propose a threshold of somewhere around £100,000 - and the rate of the tax - which I would keep at the current 40%. I would also like a higher rate above a certain level, say 80% over £1 million and I would carve out an exception on gifts and inheritance within a marriage, just as currently exists, and some leniency for the inheritance of a family home. Overall, would this set-up raise the £10-15 billion I would like it to in an ideal world? Again, I am unsure - I am not a tax expert, though I would love for one to take a look at my proposal and crunch the numbers - but I think it could probably get to the lower end of that range and, regardless, any amount it could raise over the current £7 billion would be an improvement, allowing a larger pay-out.

So far, I have sketched out what are effectively three different policies - inheritance and gift tax reform, lump sums paid out to people upon reaching 18, and capital gains tax reform - that happen to be roughly costed against one another. Why is it that I am explicitly tying the money raised from inheritance tax to the money spent on this one-time citizens’ dividend? Generally, I am opposed to specifying certain taxes to be used to fund particular policies. Here, I am making an exception for a few reasons.

One is to specifically connect the inheritance tax to the benefits it creates. Inheritance tax is, apparently, quite unpopular for reasons I have never quite understood. The ‘double taxation’ thing has never made sense - lots of money gets taxed multiple times. The idea of it being a vulture-tax, picking over someone’s financial carcass, might have something to do with it, which is somewhat fixed by changing the burden of the tax to be placed upon the receiver. But to change the public perception of the tax, I think what needs to be shown is the specific good it does. Ultimately, by tying inheritance tax to this lump sum universal benefit, I hope to improve the optics of the tax. At a basic level, as it currently stands inheritance tax doesn’t effect most people, and is a large burden to the few it does effect. With this system, most people would be able to point to a net financial benefit from the tax and its associated benefit and therefore be less susceptible to the arguments of the few who are left in a financially worse off position by it.

Another is Rawlsian reasons. Rawls saw inheritance tax, as I have said, as a way to distribute property more proportionately throughout the population. The fundamental idea behind this whole policy, then, is the transfer of the wealth that would otherwise be inherited by the wealthy onto everyone and at the time they most need it and, in doing so, distribute wealth and property more evenly. Therefore all the money raised by preventing unjust inheritance should immediately be redistributed across the population to create a more equal system and give everyone a more similar start in life, as required by the principle of fair equality of opportunity, rather than being used for ordinary expenditure. And, as Rawls said, the idea is not primarily to raise revenue for the government but to prevent the creation of a hereditary wealthy elite. Hence, both the tax and the payments funded by it should be outside of the government’s general budget. Overall, these arguments would require the policy to instead form a separate budget entirely funded by itself - the National Fund, as first conceptualised by Paine.

Lastly, because I would like the National Fund to be established as a sovereign wealth fund. The fund would pay out the vast majority of the money it takes in from inheritance tax, but any money left would be invested to increase the size of the fund and allow it to pay out even larger amounts in future. Not only would the fund growing be beneficial to those who receive money from it but it could also target its investments towards those areas in which investment is sorely needed - such as housing, infrastructure, and green energy - and have at its core a commitment to sustainable investment to promote social welfare. In other words, it could turn into the investment arm of the British state, something we currently lack.

So that is my policy proposal for inheritance and what should be done with it. Inheritance tax should be replaced by a receiver-pays inheritance and gift tax, used to create and maintain a National Fund that pays out a lump some of £10,000-£20,000 to each person upon reaching the age of maturity. The resultant hole in government finances from removing inheritance tax from the government’s general budget would be more than made up for by aligning capital gains tax with income tax. If we can do all that, Paine and Rawls will look down on us with pride and, as a liberal, what more could you want?