20 November 2023

Cutting inheritance tax is not just fiscally unsound – it’s unfair


Jeremy Hunt is under pressure from Tory backbenchers to cut taxes in the Autumn Statement. It’s been reported that Hunt believes that higher than expected tax revenues gives him the headroom to cut inheritance tax. While inheritance tax is in dire need of reform, it would be a mistake to cut it at this time.

Although stronger than anticipated tax receipts might, at first glance, make you think that the public finances are in rude health. However, it’s all an illusion. Tax revenues are high due to high inflation. Tax revenues are higher but only in nominal terms, not real terms. The Treasury doesn’t actually have a lot of actual cash for a giveaway. The Chancellor is suffering from a severe bout of money illusion.

More importantly, tax receipts are also higher due to the fact that far more people are paying tax and at higher rates due to fiscal drag. The Treasury has frozen income tax and national insurance thresholds rather than increasing them in line with inflation. In response to very high inflation, many firms increased wages for their workers in order to keep pace with the rising cost of living. In many cases this meant that they started paying income tax for the first time or even moved into a higher tax bracket. While these people have a higher salary in nominal terms, they’re not better off in real terms. Unfortunately for them, HMRC treats them as if they are richer and so they end up giving more of their money to the taxman. 

As such, using this increased revenue to cut inheritance tax would not only be fiscally unsound, it would be deeply unfair. It would represent an even greater shift away from taxing wealth and towards wages. Cutting inheritance tax at this time would therefore be a giveaway to the wealthiest funded by working people. 

Rather than cutting inheritance tax, the Chancellor should instead eliminate fiscal drag by unfreezing the income tax and national insurance thresholds. 

The main reason for this is that it will allow people to keep more of their money. While inflation is returning to target, there is still a cost of living crisis gripping the country. Millions of households across the country are struggling to make ends meet despite working hard, often in multiple jobs. Increasing tax thresholds in line with inflation will mean that they have more money to spend on themselves and their families. 

Ending fiscal drag would also boost productivity. We have seen stagnant productivity growth in the UK since the Global Financial Crisis and while the tax rate is far from being the main cause of this, it has almost certainly contributed to it. As Paul Krugman pointed out, ‘Productivity isn’t everything, but, in the long run, it is almost everything’. Productivity is the key driver of economic growth, which has been persistently low and is forecast to be non-existent over the next year. We have already experienced one lost decade in the UK and we are set to experience another if we don’t turn things around. The government should be doing whatever it takes to boost productivity, and so ending fiscal drag should be a priority.

Unfreezing tax thresholds could also help with the labour shortages facing many areas of the economy. While the labour market is loosening, it is tight by historical standards. Firms are really struggling to get staff to work for them, especially in hospitality and social care. If a person knows that they will be no better off in real terms then they are unlikely to say yes to an extra shift or take on another job. Allowing them to keep more of their money will incentivise them to work longer hours or look for another job.

Finally, the government should unfreeze tax thresholds as it is the right thing to do. If the Chancellor were to stand at the despatch box and announce that he was increasing taxes on working people then he would be rightly condemned by politicians from all parties and it would be front page news. This is effectively what is happening to households now who have seen their taxes increase and their take home pay dwindle. There was no debate in Parliament about this and it was not in any manifesto, but it is still happening. The government should reverse this injustice and unfreeze tax thresholds.

There is a nasty case of money illusion flying around Whitehall. Symptoms include a desire to help the very wealthy at the expense of working people. Hopefully Jeremy Hunt will make a quick recovery and commit to ending fiscal drag by increasing the income tax and national insurance thresholds in line with inflation. 

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Ben Ramanauskas is Research Fellow at Oxford University.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.