Overview
At the upcoming Budget, the government is expected to set out its plans to fill the £22bn ‘fiscal hole’. If widespread media reports are accurate, this is likely to include changes to the inheritance tax regime. Demos' new report outlines how the government could reform the taxation of inheritance to generate £2.6bn in the current tax year - or around £16bn over this Parliament - in a way that aligns with the values and priorities of the public.
As Demos has argued through our Unlocking Inheritance programme, the UK has entered a ‘new age of inheritance’, with the value of inheritance passed on annually doubling roughly every 20 years and reaching over £120bn. The current regime for taxing these is out of date, with just 4% of inheritance paid in tax and the wealthiest estates paying lower rates than others.
Well-designed reforms could raise revenue while making the tax fairer at the same time. As a tax that is paid by fewer than one in every 20 estates, and with almost half paid by the wealthiest 1% of estates, changes will also affect very few people and only those with significant wealth. The challenge facing the government is how to unlock revenue from inheritance tax while minimising public backlash and avoiding harm to their wider objectives, such as economic growth or social mobility.
Demos' report, Plugging the black hole - reforming inheritance tax to unlock revenue and build public support, sets out proposals to meet these objectives.
Key recommendations
Drawing on insights from Demos’ multi-year Unlocking Inheritance programme - and new analysis from a deliberative exercise with the public, economic modelling, and discussion with experts - this report identified the following inheritance tax reforms as those that would simultaneously raise revenue, make the system fairer and expand public support for the tax.
Introduce rate bands
Move from flat rate of 40% to rate bands at:
• 30% for any inheritance under £1m
• 40% for inheritance between £1m and £2m
• 45% for inheritance over £2m
Reduce tax-free allowances for the top 1% of estates
Start tapering off the nil-rate band (minimum tax-free allowance) for estates over £2m, in the same way that is currently done for the residence nil-rate band (the additional allowance for people passing on homes to children or grandchildren). This would mean reducing the full allowance (the sum of the nil-rate band and residence nil-rate band) by £1 for every £2 above £2m.
Cap inheritance tax business relief
Rather than offering full tax relief for certain business assets up to any value, cap business relief, so that relief is only available on the first £500,000 of business assets in an estate.
Tax all capital gains on inherited assets
Remove the ‘uplift’ in capital gains tax for inherited assets, which currently means if an asset is passed on in inheritance, the capital gains accrued up to that point do not count towards capital gains tax when the asset is sold. Instead, when the asset is sold, apply capital gains tax to any gains since the asset was purchased.
Further reading