The dead constituency

24 Sep 2014

There is a widespread view in what passes for middle-England that people have a right to leave their wealth to their descendants. It seems odd that, in a country where demonising privilege has persisted as a mainstream political sport, we mostly seem to be more than comfortable with the idea that success or fortune should pass from one generation to another. But it turns out that even ideological turkeys do not vote for Christmas.

“According to May 2014 research by Skipton Financial Services Limited, 48pc of under 40s expect to receive a large inheritance from their parents. Of these people, one in five are banking on an inheritance to get onto the housing ladder, and 17pc are relying on it because they have no pension set up. Other stated reasons for hoping for an inheritance include starting a family.”

Daily Telegraph, 1 Sept 2014

Accordingly, politicians are frightened of this subject. David Cameron has called the desire to pass on your (hard-earned, responsibly saved) money to your children as “the most natural human instinct of all”. It’s parenthood from beyond the grave.

It was reported that in 2007 the opposition Conservatives scared off Gordon Brown from calling a snap general election by pledging to raise the inheritance tax threshold from £325,000 to £1 million. Although Labour pointed out that this was a policy designed to benefit a relatively few relatively wealthy families, it backed off in the face of evidence that the Conservative pledge was popular. (To this day it remains no more than a pledge – it did not survive the coalition government).

At present, the law says that an individual may leave £325,000 tax free above which level the rest of the estate is taxed at 40%. At first glance this is generous. Then one looks at UK property prices, particularly those in London and the South East. The average property price in London is now £499,000, in the rest of the South East it is £326,000 (source: ONS, June 2014). If the “family home” is worth the London average of £500,000, it will be liable to £70,000 of inheritance tax when the last exempt person (e.g. spouse or civil partner) has died. The beneficiaries of the estate will need to find that sum in cash within six months (after which interest will start adding to the bill).   

The history of inheritance tax is worth looking at because it is as much about social attitudes as financial necessity.

Death duties were introduced in 1794 and were combined into a general estate duty in 1894 by the Liberal government. The first rates of estate duty were progressive, rising from 1% to a seemingly whopping 8% on estates worth in excess of £1 million. Conservative opponents at the time objected on the grounds that 1) it was a tax on thrift, 2) that it penalised a small class of people (the very rich) who were powerless to defend themselves, 3) that future governments might make it progressive to an unlimited degree and 4) that it would encourage avoidance.  

Points 1) and 2) were and remain political but points 3) and 4) were no less than perfectly accurate predictions.

The top rate was raised and raised and raised: 20% in 1914, 40% in 1919, 50% in 1930, 60% in 1939, 75% in 1946, 80% in 1949 and 85% in 1969.

One result was to encourage the destruction of English country houses. These were (are) expensive to maintain at the best of times and family finances could frequently not stand the death of the owner. This was celebrated, if that’s the word, in popular culture in the 1930s.

In 1934, PG Wodehouse published a short story called “The fiery wooing of Mordred”. It concerns a notoriously absent-minded young poet (Mordred Mulliner) who is notorious for throwing unextinguished cigarette stubs into wastepaper baskets. The owners of Smattering Hall invite him to stay in the hope that he will cause a fire that will burn down their house, thereby allowing them to collect on the insurance and buy a nice flat in town. Unfortunately, other weekend guests, all young men hoping to win the hand of the lovely daughter Annabelle, prove equal to the task of putting out the blaze. The owner of the estate, Sir Murgatroyd Sprockett-Sprockett bemoans his ill-fortune.

I did think,” proceeded the stricken man, helping himself to a sandwich, “that when Annabelle, with a ready intelligence which I cannot overpraise, realized this young Mulliner’s splendid gifts and made us ask him down here, the happy ending was in sight. What Smattering Hall has needed for generations has been a man who throws his cigarette-ends into wastepaper baskets.  I was convinced that here at last was the angel of mercy we required.”

“He did his best, Father.”

“No man could have done more,” agreed Sir Murgatroyd cordially. “The way he upset those buckets and kept getting entangled in people’s legs. Very shrewd. It thrilled me to see him. I don’t know when I’ve met a young fellow I liked and respected more.”

Needless to say, the poet wins the girl’s hand.

In 1937 Noel Coward wrote: 

The stately homes of England

How beautiful they stand,

To prove the upper classes

Have still the upper hand.

Though the fact that they have to be rebuilt,

And frequently mortgaged to the hilt

Is inclined to take the gilt

Off the gingerbread,

And certainly damps the fun

Of the eldest son-

But still, we won’t be beaten,

We’ll scrimp and scrape and save.

The playing fields of Eton

Have made us frightfully brave.

And though if the Van Dycks have to go

And we pawn the Bechstein Grand,

We’ll stand

By the stately homes of England.

Coward’s optimistic spirit was misplaced. Giles Worsley (“England’s Lost Homes”) estimates that 1200 English country houses were demolished in the 20^th century, 38 in 1955 alone.

There is now a law that allows assets that are part of the “National Heritage” to be exempted from inheritance tax and I have no doubt that most people are sympathetic to the idea that important buildings should be protected in this way. Many will accept the fact that the reported £50 million (largely house contents) inherited by Queen Elizabeth from her mother was exempt. Agricultural land in use and family businesses can also claim 100% exemptions.

It looks unfortunate that these exemptions invariably benefit the genuinely rich because the rise of property prices has meant that many estates than would not ordinarily be regarded as belonging to wealthy people are getting dragged into the inheritance tax net. One could easily incline to the view that this is unfair.

We should resist this view. If normal family houses pass from one generation to another, the UK will begin to divide into a property-owning class and a renting class. And membership of those classes will be largely determined on explicitly nepotistic grounds. We don’t want that, do we?

I have just read a brilliant book, Money, Blood and Revolution, by George Cooper which makes the point that an essential condition of a nation’s economic health is that the wealth of those at the top is recycled to fuel the growth of those at the bottom. Progressive concentration of wealth among the few at the top creates a feudal society of the kind that pre-dated democracy.  

The fact that 48% of the under-40s are looking forward to an inheritance is a depressing snapshot of our times. More pointedly, 52% clearly expect to cop little or nothing. Thus we divide into winners and losers through no merit or fault of our own.

I am sorry to say that this development, “the most natural human instinct of all” according to our Prime Minister, needs to be checked.

In 2013/14, inheritance tax receipts were £3.4 billion. According to HMRC, €23.2 billion was inherited untaxed from deceased estates due to various exemptions. These include agricultural estates, family businesses and the right of the surviving spouse to inherit everything untaxed. But by far the largest exemption (worth £19 billion) is due to the £325,000 band. Much as it pains me to say it, with such a taxation burden on those who work (not forgetting the debt-burdened students who will shortly be seeking jobs), this inheritance tax arrangement looks overly generous.

In 1999/2000, HMRC took £150 billion in income tax and national insurance (the latter, a stealth tax if there ever was one). Last tax year that total figure had grown by 76%. Over the same period the growth in receipts from inheritance tax was 57%. The descendants of dead people are doing much better than working tax payers. In 1999/2000, inheritance tax provided 0.74% of total HMRC receipts: last year this had fallen to 0.69%. And I repeat, this is not just sentimental financial generosity – this is implicit social engineering, helping to create (or arguably recreate) a property-owning class.   

The leader of the Labour party wants to introduce a “mansion tax”, a form of wealth tax aimed at properties valued at more than £2 million. As usual, politicians cannot tell the difference between gross and net assets or between net assets and income. Someone with a £1 million mortgage and a house worth £2 million clearly has net property assets of £1 million and huge outgoings in terms of interest payments. Someone else living in a house that they bought decades ago may well get caught despite the fact that they are living on a modest pension. The mansion tax is likely to pressure both of these types to sell their houses – at which point it might quickly become clear that the value of those properties could soon fall back below £2 million.

The fact that the Labour party even contemplates a wealth tax shows that it would rather pick on a targeted minority of the living than risk offending the dead.

Various commentators and institutes for this and that say either than we should give up and abolish inheritance tax altogether – because it raises so little and rich people avoid it by buying farmland – or, au contraire, that we should abolish the exemption threshold  and start charging from the first penny. Others say that inherited money should be taxed according to the income of the recipient. I have sympathy with the latter view as explain well here by Merryn Somerset Webb.

Abolishing the threshold entirely sounds lucrative but would be most unfair on people who inherited illiquid assets such as houses. Imagine inheriting a property valued at £200,000 from a deceased person who left no other assets at all. Imagine that the property market were depressed. You would find yourself facing a bill for £80,000 at current rates. If the unrealisable £200,000 were regarded as income (as suggested by Somerset Webb), your personal income tax liability for that year would explode, probably taking every penny that you earned.

So we need to be careful. Abolishing the exemption threshold for illiquid assets would be brutal. Taxing individual bequests as income is sensible.

If it were to become common for inherited properties to be sold in a controlled process, so much the better. Supply would rise, prices would go down and property ownership would be democratized. Is that prospect really so unthinkable?