Overview

After the recent election, the UK has a new Labour government and they are promising change for the country. Unfortunately, given the current fiscal environment, they have very little money available to deliver that. 

Reports suggest the Labour government are looking at changes to inheritance tax as a way to unlock more public funds. Demos think this is the right place to start. For one, the tax is poorly designed and ripe for reform. But also, with inheritances becoming increasingly important in our economy, and very few inheritances - only the most valuable - charged any tax, reforms could make a big difference for the country while bearing no cost on the vast majority of people.

Alongside raising public funds, we also need to address the public’s concerns about inheritance tax. To do so, we must make it fairer, simpler and more transparent. 

To deliver these improvements, the UK can learn lessons from overseas, where the taxation of inheritances has been reformed and structured differently. This paper lays out those many lessons based on a review of UK and international evidence, and interviews with a series of policy experts.

Key findings

Analysis indicates that the UK could potentially increase revenue, progressivity, and public support simultaneously.

In particular, on the economics, we should learn from the South Korean system:
• We could raise more revenue. While in the UK, around 4.2% of inheritance passed on in 2019-20 was paid in tax, the figure in South Korea was 9.7% in 2022 (after discounting the inheritance of Samsung, which incurred an anomalously large tax bill). If taxing the same proportion of inheritance in 2019-20, the UK government would have raised around £11.6bn - an additional £6.5bn compared to what it actually raised. If also taxing the same proportion of lifetime wealth transfers as South Korea (9.1%), we would have raised an additional £2.5bn on top.
• We could make our system fairer. In the UK, the wealthiest estates tend to pay lower effective rates (the percentage of all inheritance paid in tax). Those worth between £2m and £7.5m paid 25% in 2020-21, while those over £10m only paid 17%. In South Korea, meanwhile, the effective rate reached 33% for estates between £6m and £30m, and 44% for those over £30m in 2022.

On the political challenge, the UK should learn from Norway’s reforms:
• We could shift taxation away from inheritance per se, and towards ‘inherited capital gains’ (the growth in an asset’s value between being bought and being passed on as inheritance). Inherited capital gains are ‘uplifted’ in the UK (they are not taxed by capital gains tax), as they were in Norway until 2014. Yet, Norway then began taxing these, while simultaneously abolishing inheritance tax - a popular policy. While significant revenue would be lost if the UK did the same, we could begin taxing inherited capital gains while offering a smaller inheritance tax cut.

Given the experiences of other countries, we believe the most promising opportunities for inheritance tax reform are:
1. Reworking the exemption for business property to ensure it provides value for money.
2. Introducing progressive rates, increasing the rates for the most valuable estates.
3. Consulting on hypothecation (earmarking the tax to a specific spending commitment to improve public awareness of the impact of the tax revenues).
4. Removing the capital gains uplift and charging capital gains tax when the asset is sold.
5. Clamping down on remaining non-dom avoidance opportunities

The current inheritance tax landscape 

Inheritance tax is charged on the value of someone’s estate passed on at death, plus gifts passed within seven years before death. Each estate gets a tax-free allowance of £325,000, and any inheritance over that is taxed at a flat rate of 40%. There is, however, an additional allowance of £175,000 for primary homes given to direct descendants (children and grandchildren), and couples can also combine their tax-free allowances. The available allowance therefore often totals £1m. There are also a broad range of exemptions for inheritance tax, including for business property, agricultural property, and charitable donations. Pension wealth also generally does not count towards inheritance tax.

Polling often finds inheritance tax is seen as the least fair tax. Yet, when presented with policy decisions - around which taxes to cut, whether to prioritise scrapping inheritance tax vs funding public services, and where to set the inheritance tax threshold - people express much less interest in cutting or scrapping it.

Despite this, it is clear that public concerns about the tax are widespread - as Demos explored these in 2023 through a series of 12 focus groups. Many people do not closely associate inheritance tax with public spending, and feel the money is generally wasted or not spent transparently.

Many also see it as double taxation, and a cynical way for the government to stealthily get more money. There is also widespread concern that it is easy to avoid, doesn’t do much to reduce inequality, and imposes burdens on families at times of grief. Reforms to inheritance tax should work to address these various concerns.