Enter Your E-mail

TaxationWeb by Jennifer Adams

The reasons for and against abolishing IHTThis is supposedly Election year and the Tories have already fired the first bullet by proposing that Inheritance tax (IHT) be abolished. Whether IHT should be abolished entirely, be replaced by some form of annual tax based on the capital transfers that a person receives rather than a tax liability on the amount given or just be kept in its present form has been debated for a number of years.



Revenue statistics show that IHT in its current form does not actually provide much incentive for a more even distribution of wealth being as it does not actually raise as much as it technically should - but for it to be abolished could be very difficult politically. The various concessions inherent in the current IHT rules mean that the tax involves only some 25,000 taxpayers per year, compared with over 25 million income tax payers. It raises only £1.5 billion, which equates to less than 1 per cent of total government revenues. It therefore does not seem unreasonable to suggest that IHT, remains a largely voluntary tax paid by those who are either believe that they are placed on this earth forever or who consider leaving money to their relatives worse than leaving it to the government!



The main arguments put forward in favour of an annual wealth tax usually centre round the concepts of horizontal equity, efficiency and the extent to which a wealth tax could be used as a method of redistribution and administrative control.



The “equity” concept is that people of a similar (or “horizontal”) taxable capacity should be taxed similarly. As the actual possession of wealth itself confers advantages over and above the amount of income received from that wealth it may be argued that an income tax on its own is insufficient to achieve horizontal equity and hence IHT is also needed. An example of this is the difference between a beggar and a rich man who keeps all of his wealth in tangible assets such as gold and jewels. Neither individual has income yet the latter clearly has the greater advantages and hence greater taxable capacity.



The advantages of wealth over income include security, power and control of resources. An individual with wealth is less dependent on earned income than someone who has no wealth; he can maintain his standard of living should earnings fall by just selling some of his assets to gain income. Wealth can also convey power to take advantage of economic opportunities that may arise. For example financial institutions are no longer interested in the “2 times earnings” rule in lending for a mortgage – they are more interested in the amount of “spare” capital per house. A person without capital may not be able to borrow to finance a venture which, if successful, could produce wealth whereas a person with wealth can always release capital borrowing from himself and then investing in the venture out of his own capital.



Wealth can also confer control over economic resources although the amount of control will vary depending upon the amount of capital or even the type of capital owned. The individual small saver has little more power than the ability to withdraw his savings from a particular institution, and sometimes, as in the case National Insurance pension rights, even that power does not exist. I am one of those who still retain their 100 Abbey National shares but although there are a number of other individual shareholders, together we were unable to stop the take over of the company by Banc Santander – the financial institutions such as the Pension Funds had already decided Abbey National’s fate and as such not need my vote. However, in other instances the situation may be quite different- an individual wealthy shareholder of a Private Limited company may well be in a position to exercise considerable influence over company policy and in a substantial number of cases the owners retain full control.



In addition to the advantages given above wealth usually yields benefits which we could classify as income but which are not considered to be so for income tax purposes. Several types of capital gain are really income in disguise. For example, the values of National Savings Certificates are increased during their life as a method of paying interest.



The final advantage of wealth is the status it confers. In the immortal words of Zsa Zsa Gabor – “No rich man is ugly”! Therefore for the reasons given above, wealth provides benefits for the owner over and above just the income it produces; hence the argument that an income tax alone is not sufficient to cover the full benefits derived from the ownership of wealth - there must be something else levied.



The main efficiency argument is that an annual wealth tax would have a less adverse effect on work incentives than an income tax of equal yield, on the grounds that the former would apply to past rather than present effort; people are less likely to be discouraged from working harder or applying for more productive and highly paid jobs if they are taxed on their past efforts (i.e. their wealth) rather than on their present efforts (i.e. income). However, this line of argument is limited by the extent to which income taxes encourage people to work hard and also the extent to which the object of work is saving rather than current consumption. In addition, a tax on income from wealth rather than on wealth itself provides an incentive for people to invest in assets with low pecuniary yields or, an income tax could be avoided altogether by investing in an asset which has no pecuniary yield at all, such as a painting for a private collection. In contrast, a wealth tax does not discriminate between assets of different pecuniary yields. A farmer with a field, for example, may be said to have an incentive to use it productively for no other reason than to pay the wealth tax; no such incentive exists with an income tax.



The administrative control argument is that a wealth tax would generate information which could be used by the administration to tighten up control of evasion and avoidance of income tax. As such any apparent inconsistency between an individual's wealth and his income could be checked by the Revenue; this was one of the reasons behind the introduction of the French wealth tax in 1982, and such specific crosschecking does take place in some countries, for example, in Sweden.



Hence, with the advantages given above why do we still not have an annual wealth tax in the UK? The main reasons put forward by opponents are mainly practical, namely, the scope of the tax (i.e. which assets to tax and which (if any) to exempt); problems of valuation; the treatment of agriculture and national heritage and which methods of administration to employ. From studies that have been made of the wealth tax imposed by foreign countries it would appear that these potential problems do not cause a great deal of difficulty in practice, normally being dealt with by a judicious combination of principle and pragmatism.



Under the heading of valuation problems, it has been said that the valuation of pension rights and life assurance policies may pose particular difficulties, dependent as they do upon a limited number of assumptions including health, history and age of taking of the rights. Other valuation problems could be associated with such items as stamps, books, coins, antiques etc. In theory the valuation should be the open market value but if the market prices of some assets are relatively volatile, conscientious valuation may lead either to high administrative and compliance costs, or to a lack of certainty regarding a current tax liability until a valuation is made. However, it would appear that the valuation of assets is not a problem overseas; neither is it expensive, perhaps because the methods are well established and generally produce conservative values. One way round such difficulties, if present, which again is commonly used abroad, is simply to exempt these assets but the disadvantage of this solution is that this dispenses with one of the original arguments for a wealth tax!



For various reasons, agriculture is a sector that receives a number of fiscal favours both here in the UK and abroad. Apart from the political power historically associated with land ownership, farmers have attracted sympathy for reasons such as the BSE crisis, the volatile price and output of agricultural products, the low rate of return associated with farming, the unstable, generally high price of land, and the fact that the farm itself often forms the vast bulk the wealth of its owner (about half of all agricultural land in the UK is owner-occupied). These problems may be less serious on the continent, as the average size of farm is smaller there than in the UK, however, whilst many countries such as Norway and Sweden do not give explicit relief for farming, agricultural land is still treated favourably in comparison with other assets.



The problem concerning 'national heritage' also does not appear to hold water. Works of art are completely exempt from wealth tax in Denmark and Sweden, not only for preservation reasons but also because of the difficulties of ensuring their disclosure and valuation. In other countries, works of art may be granted exemption if they are for artistic, historical or scientific interest.



The final reason put forward for not having an annual wealth tax is administration but again this does not hold true as the administration of wealth taxes abroad is usually at least partially integrated with the administration of income taxes.



Therefore, it would appear that the various potential problems of operating a annual wealth tax in the UK could be overcome if the operation is run along the lines of the system currently implemented abroad. Perhaps such a tax should be considered again now we are supposedly moving towards greater integration with Europe.