The case for a progressive inheritance tax
Two months ago, Prime Minister Keir Starmer warned the public that “painful” changes were coming in the Autumn Budget. He immediately assured us, however, of his commitment to the principle that “those with the broadest shoulders should bear the heavier burden”.
This highlighted a key fact of British politics: progressive taxation – in which those with the most money contribute a higher proportion of their wealth and income – is a cornerstone of our social contract. If the public are to make sacrifices, they (rightly!) demand that the costs are distributed fairly.
With the government expected to make bold tax changes in next week’s budget, they would be sensible to echo this principle loud and clear. A repeat of the winter fuel debacle is the last thing they need. But while reports suggest inheritance tax reform could play a key role in efforts to fill the fiscal hole, the tax is currently charged at a flat rate. All inheritance over and above the tax-free allowance is charged at 40%, whether it’s given by a family just over the threshold, or by a billionaire. This makes the UK one of only seven OECD countries to charge a flat rate – and new research shows the public think that’s deeply unfair.
A bold move in the Budget to introduce progressive rates for inheritance tax – as France, Germany, Japan and many other countries have – would deliver three key benefits: for the short-term politics, the long-term politics, and the economics.
In the short-term, creating rate bands would provide a clear message from the government that the costs of their “tough choices” will be distributed fairly. As Demos recommends, this could include a rate cut for ‘working families’ (estates under £1m) and only raise the rate for the top 1% (estates over £2m). Our polling on this showed that 44% of Brits thought it would make inheritance tax ‘fairer for working people’, vs just 20% disagreeing. Such a move could give the Chancellor the political headroom for bolder inheritance tax reforms, going beyond restricting tax breaks for business assets and farms (which she is reportedly considering already).
To raise additional revenue, Reeves could start taxing capital gains on inherited assets, multi-million pound transfers during life, or inheritance between the wealthiest 0.1% of spouses – all of which currently go untaxed and are used by the wealthy to reduce tax bills. Introducing tax on these would be politically challenging. It would, however, be legitimised by a progressive inheritance tax.
In the long-term, a progressive rate would dampen calls to scrap inheritance tax based on its ‘unfairness’, as we have seen in recent years. To illustrate why, it’s useful to compare with income tax. Even though the public are highly supportive of a cut to income tax, they overwhelmingly think it is a fair tax in principle. This is because people understand the importance of income tax for public services, and progressivity is deeply embedded in it. It is seen, in other words, as central to the social contract.
The reverse is true for inheritance tax. While people are not particularly keen on cutting it, they do see it as unfair. Demos’s research has shown how the public associate inheritance tax neither with its contribution to public services, nor with progressivity. It is therefore viewed as a more cynical tax than many others, driving the emotionally charged attacks. Introducing progressive rate bands would mitigate these concerns.
The long-term survival of inheritance tax is more important now than at any point in recent decades. As house and asset prices have surged since the 1990s, the amount of wealth passed down generations has more than doubled – and this trend is expected to continue. Children of the 1980s from wealthy families (in the top fifth) are now expected to get almost a third of their lifetime income from inheritance. If we are to properly fund public services in coming decades without workers bearing an unfair portion of the tax, it is critical that these big inheritors pay their fair share – and inheritance tax must be seen as a legitimate way to enable that.
Lastly, a progressive rate would make inheritance tax (as one might expect) more progressive. Currently, estates worth over £5m tend to pay lower effective rates (the proportion of all inheritance paid in tax) than less valuable estates. This is mainly because some of Britain’s wealthiest estates benefit greatly from inheritance tax reliefs for businesses, farms, and spouses. Action should of course be taken to ensure these reliefs are fair and proportionate. But at the same time, a higher rate for top inheritances and a cut for others could make a big improvement.
We at Demos recommend increasing the top rate to 45%, but it could go even higher. The progressive rates in Germany, France, Japan, and South Korea all go to 50% or more on the largest inheritances. This would give a clear signal that those with the broadest shoulders bear the heavier burden.
After a decade of stagnant real incomes and crumbling public services, the British public voted for change, and that’s what they expect. To show that they are serious about delivering on that, the government has to be bold and ambitious. But doing so would be much easier if they can demonstrate that their decisions are underlied by progressive principles. A progressive inheritance tax would do just that.