Careful what you wish for? What could happen if IHT is abolished

As a thought experiment, let’s make the assumption that before the next general election the government abolishes IHT in full. Let’s then assume that the Conservatives are not re-elected. What happens next?

What could Labour do?

The simplest approach a new government could take would be to reinstate IHT, as Labour has announced it would do for the lifetime pension allowance. But the abolition of IHT would give government a blank slate for rewriting the rules, and that might lead to something more radical.

Global alternatives

Before we look at the UK options, it may be instructive to see how other countries tax wealth. Ireland and Canada both have strong historic ties to the UK in their tax systems and are good examples.

Ireland has a combined system under which tax is payable both on lifetime gifts and on death. The system taxes the recipient rather than the estate, subject to a fixed lifetime gifting exemption. The effect is that tax is always payable on estates worth more than €335,000, unlike the current UK system where gifts made more than seven years before death are tax-free.

Canada does not charge estate taxes at all, but instead on death deems individuals to have sold all of their assets at market value. This creates a capital gain, on which the estate is taxed. Lifetime gifts of cash are not taxable, but gifts of assets are treated as sales at market value.

Options for change

Even if Labour chooses merely to reverse abolition, the residential property nil rate IHT band may not survive. And if you are legislating anyway, why not make other amendments, such as matching the rate of IHT to the top rate of income tax?

Starting from scratch could be ideologically attractive, giving Labour the opportunity to create a taxation system in line with its beliefs on equity and redistribution of wealth. Gift taxes similar to Ireland’s would make it harder to avoid estate duties and would bring forward the timing of revenue receipts, for political and fiscal benefits. A deemed asset disposal on death would simplify the current rules significantly.

And what about a wealth tax? Historically the costs and difficulties of implementation have made this option unattractive. However, with no other method in place to redistribute retained wealth, the existing calls from the left of the party for the creation of an annual charge on ‘excess’ wealth would likely grow much louder. A government looking to raise taxes to support its green agenda might well be swayed.

The current IHT system is far from perfect, but removing it would leave a big hole both in government income and ideology. If Labour chose to fill that gap, the tax burden on larger estates is likely to go up not down, and a one-off charge on death could be replaced with lifetime liabilities that are much more painful.