Taxing inheritances.
I understand the Tories are about to discuss inheritance tax today
Many years ago I heard a suggestion, I can’t remember from whom, but probably the Liberal Party, which I found it very attractive.
The proposal was that inheritance tax should be charged not on the estate leaving the bequest but on the recipients receiving the bequests (note the plurals.) The recipients would be able to inherit modest amounts tax free, but pay tax on big bonanza inheritances, or a multitude of modest ones.
Thus, if we define a “modest amount” as, say, £50 000 (though that’s beyond the dreams of avarice of many people) then an estate of, say £1 000 000, not all that unusual nowadays, given the price of houses, would not be taxed at all if the bequests were in 20 different bundles of £50 000, but would pay the current rate (40%?) if the whole million went to one lucky recipient.
This would go some way to reducing inequality in our society, and probably increase the level of happiness. It would also probably encourage innovation, as potential entrepreneurs would have the wherewithal for start-ups.
Monetary bequests should simply be treated as income for the recipient and taxed as income at standard income tax rates.
ReplyDeleteBequests of property not be taxed at all when they are given but when they are sold they should be subject to capital gains tax on the full gain from when they were acquired to when they are sold, ignoring the transfer of ownership due to the inheritance.
So someone who bought a house for £50,000 which is now worth £1,000,000 could pass that house to their child who could live in the house and not have to pay any tax, but if they ever sold it they would pay capital gains tax on the whole increase from £50,000 to £1,000,000 (ie, no revaluing occurs when it is transferred by will).
Both these ideas are interesting addition possibilities. I'm especially interested in taxing the capital gains made through the increase in the value of houses. We really have to learn to see houses as machines for living in rather than as cash cows for the next, or next but one, generation.
DeleteI've always thought this was an idea worth looking at seriously
ReplyDeleteAs you say it might encourage a wider sharing of wealth (although I doubt it would impact much on the low income families) and also stimulate consumption and then production
I'd also like to see it applied across the board - including the so-called royal family
Now there would be a policy I'd vote for
I've long thought that out whole tax system needs a rethink
ReplyDeleteIt's grown arm and legs over the decades with various govts just finding new things to tax for revenue purposes
Income tax is one place to start.
In England there are only 3 tax bands (4 if you count 0%) with a big change when you move from to a higher one - particularly from 0 to 20 and again from 20 to 40 with potential disincentives for people marginally increasing their income
The technology today means it is entirely feasible to have a much more graduated scheme where your personal tax code can be regularly updated by HMRC rather than the once a year that usually happens
Say 5% increments every few thousand £
eg £12570 0%
up to £15000 5%
up to £20000 10% etc
Automated payroll systems would have no problem with, say, monthly or quarterly adjustments
I've long thought that out whole tax system needs a rethink
DeleteYou and everyone else.
It's grown arm and legs over the decades with various govts just finding new things to tax for revenue purposes
Indeed. We should make the tax system simpler.
The technology today means it is entirely feasible to have a much more graduated scheme where your personal tax code can be regularly updated by HMRC rather than the once a year that usually happens
Wait -- you want to introduce even more tax bands than there currently are? I thought you wanted to make things simpler -- doesn't this makes them even more complicated? And for what benefit?
its more graduated so moving to the next higher one is less of a financial shock and less of a disincentive
DeleteIf I'm on a 0% band and get a pay rise/promotion of £1000 I lose £200 of that in tax which can be a big disincentive
If I'm on a 20% band the same pay rise I lose £400
its more graduated so moving to the next higher one is less of a financial shock and less of a disincentive
DeleteBut there are more bands so moving to the next higher one (and therefore hitting the higher marginal tax rate) happens more frequently.
So the 'shock' might be less but many more people will hit it and much more often. With wide bands, you might cross a threshold once every five or ten years; with narrow bands as proposed you'd be hitting a threshold every year or two.
I don't see why that's better?
For me it's more t do with the psychology and perception
DeleteI'm aware that in terms of economic efficiency 2 bands are often seen to be optimal
However, in terms of individual worker perception, to go from 0% to 20% or 20% to 40% is perceived as a big - and disproportionate - jump
That leads to the question: is it worth me putting in the extra work/hassle/time to get the pay rise when I'm going to lose so much of it.
I'd argue that some people would say "no" leading to an overall "loss" to the economy as a whole
That leads to the question: is it worth me putting in the extra work/hassle/time to get the pay rise when I'm going to lose so much of it.
DeleteI'd argue that some people would say "no" leading to an overall "loss" to the economy as a whole
Yes, I get that. But surely some people will also ask 'is it worth me putting in the extra effort if I'm going to go from 10% to 15%?'
And some of those will answer, 'no'.
Now, intuitively it seems obvious that fewer will say 'no' to a jump from 10% to 15% than will say 'no' to a jump from 20% to 40%.
But there are many more of those jump in the new system.
So: a bigger jump affects fewer people, but more of the people it does affect will say 'no'.
On the other hand, fewer of the people affected by a smaller jump will say 'no' -- but there will be many more people affected by the smaller jumps.
Which leads me to ask: how can you be certain that the two effects -- smaller jumps leading to fewer people at each jump point saying 'no', but more jump points meaning more people are faced with the question -- won't basically cancel each other out, and leave you back basically where you were before?
Because if they do cancel out, then you have just incurred the expense of complicating the system for zero gain, which is a loss.
Even if they don't cancel out, you would have to be sure that the gain you get from fewer people saying 'no' would more than cancel out the loss from the costs of making the system more complicated, in order for the policy as a whole to show a gain.
So again: how can you be sure that the 'fewer people saying "no" at each jump point' effect will be sufficiently greater than the 'more people facing jump points' effect to make the policy change worth it?
I agree that the whole tax system needs a rethink. As I understand it, it has, like Topsy, "just growed" as successive chancellors have tweaked and amended it in the light of their need for money and the squeals of the geese they decided to pluck. it is now between 17 000 and 23 000 pages long.
DeleteI believe the "rewrite" should be an all-party affair advised by umpteen Citizens' Assemblies, each one studying a different aspect, so that "the public" fully understood what was needed and the pros and cons of each proposal. I'd like to see tax directed to "bads" rather than "goods" and especially "rent" in the economic sense of "a return to a factor over and above its supply price." In this sense stand up "land" which has no supply price, and can't be shifted to a tax haven.
I believe the "rewrite" should be an all-party affair
DeleteHow can that possibly work when Labour and the Conservatives start from completely different premises about such basic things as the reason for tax existing? I don’t see how they could ever come to an agreement about how the tax system should be designed, because you can’t design something until you decide its purpose and they disagree on its purpose so they will disagree fundamentally on the design?
In this sense stand up "land"
I agree taxing land is superficially attractive because it has low deadweight cost, but isn’t there a massive problem in that it’s impossible to know the value of a piece of land unless it has been sold recently on the open market? How do you solve that? Even guessing based on nearby sales doesn’t work because two pieces of land right next to each other can differ wildly in value.
I'd like to see tax directed to "bads" rather than "goods"
Also you seem to be very confused about the purpose of tax.
There’s basically two functions of tax: either you tax to raise revenue, or you tax to change behaviour.
Taxes on employment are an example of the former; taxes on cigarettes an example of the latter.
The thing is that the same tax can’t do both. Because if a tax is successful in changing behaviour (eg, people stop smoking to avoid the cigarette tax) then it doesn’t raise any revenue. But if a tax raises significant revenue, then it can only have changed behaviour at the margins.
Saying ‘bads’ should be taxed implies you want to use tax to change behaviour (so there are less of the bads). But if you are successful in that then there will be no revenue raised to pay for all the welfare spending you want.
https://www.ippr.org/articles/the-government-should-scrap-tax-bands-to-revolutionise-income-taxes-in-the-uk
DeleteThanks. Interesting and persuasive. Well spotted.
Deletehttps://www.ippr.org/articles/the-government-should-scrap-tax-bands-to-revolutionise-income-taxes-in-the-uk
DeleteThat's an interesting idea and it has some initial attractions. But as always the first thing you should do with an idea that seems initially attractive is try to work out what bad unintended effects it might have. And in this case I would worry that by making the system less transparent -- because you have to work out a formula, rather than simply being able to see a list of rates and bands -- it would give future Chancellors greater opportunities to raise stealth taxes.
The main way Chancellors gain extra money without making it clear to the electorate that that is what they are doing and giving the electorate a chance to object is through fiscal drag: not changing the bands as inflation increases people's wages, meaning that more and more people are caught in higher and higher tax bands. The top rate, kicking in at £100,000, for example, was meant to be for the very rich but now catches many people who aren't in fact that well off -- it should have been raised to about £150,000 by now.
By making the tax people pay less easy to understand by making it a formula rather than a simple figure for a band, I worry that that would make it both more tempting to future Chancellors to get extra money by fiscal drag by not updating the formula in line with inflation, and less easy for taxpayers to realise that is what is happening -- because who wants to try to work out the impact of a change in a complicated formula, compared to a simple band threshold change? So if the Chancellor says 'and we will be leaving the income tax formula the same' people might well say 'phew I don't have to recalculate my tax, good' instead of what they should be saying, 'hang on, that is effectively a stealth tax increase! I object!'.
I agree that transparency is important but I'd also argue that much of the current tax system in the UK isn't
DeleteTake PAYE. I doubt that everyone actually understands their tax code or can figure out if it's correct or not. Capital gains? You need an accountant.
And while some sort of land tax is favoured by many economists the complexities of calculation would leave most baffled.
I agree that transparency is important but I'd also argue that much of the current tax system in the UK isn't
DeleteOh yes, absolutely. But that doesn't mean that any particular change to it is good. That's the politician's syllogism:
1. We must do something
2. This is something
3. Therefore, we must do this
Pointless comment. So what's your proposal
DeleteSo what's your proposal
DeleteFor simplifying the tax system? Well, I’d start by combining all income tax and national insurance (both kinds) into one single tax, and dealing with the cliff-edge marginal tax rates.
that's the easy bit
DeleteOne of the difficulties is deciding on the mix of tax take from the traditional land, labour, capital split
I've not looked to the data recently but I suspect the contribution that labour makes to GDP is slowly reducing and that from capital increasing over time with implications for tax take
Land is hardly taxed at all directly hence the interest from some in some sort of land value tax
My own preference would be to focus taxes primarily on income and wealth (including land) and get rid of much of the rest
Insurance premium tax is one example
that's the easy bit
DeleteIf it were easy it would have been done by now! I think we should do the so-called ‘easy’ bit before we waste time even thinking about the hard bits!
the other easy bit is equalizing income tax and CGT
Deletethe other easy bit is equalizing income tax and CGT
DeleteNo, that’s a terrible idea. Investing in capital always involves risk: the value of investments, as we are always being told, can go down as well as up. Therefore in order to encourage people to invest, the rewards when an investment does pay off must be greater than those gained by just playing it safe and earning a steady income. That’s why it is right that tax rates on capital gains are lower than those on income: to compensate for the greater risks of capital investment compared to salaried employment.
False logic
DeleteFirst, not everything classed as an "investment" and subject to CGT is really an investment in the economics sense.
I have money put into stocks & shares funds that are classed as an "investment" with any profit subject to CGT but what I'm really doing is saving part of my income.
I could choose to put that money into a genuine savings account via a high street bank. This would attract interest on which I'd be taxed at my PAYE rate (20% or 40%)
Or I could do what I've done which is to put the money in an "investment" which if I make a profit I'm taxed at 18% or 24%
Clearly the risk is potentially higher with stocks & shares (although if I choose these carefully and wisely the risk is effectively zero) so i do expect a higher reward (through dividends and/or increase in share price)
That much is basic economics
But that's NOT a justification for the differing tax treatments of the same money
Equalise the tax treatments and the market (yes the market) will make the necessary adjustments to compensate for this at equilibrium in both the savings market and the "investment" market
Equalise the tax treatments and the market (yes the market) will make the necessary adjustments to compensate for this at equilibrium in both the savings market and the "investment" market
DeleteYes exactly. The market will make the necessary adjustments — which will result in more money going to safer investments like cash savings or tracker funds, and less to risky ventures like new companies and startups with unproven, innovative products.
It will result in more people taking salaried jobs instead of starting their own companies, because the potential rewards they get for creating a company that they can sell for a profit now don’t outweigh the risks that they might lose everything.
These are bad results . We need people to take risks in order to get new, innovative products and to start businesses that serve customers.
Therefore to the extent that the government intervenes in the market, it should do so to encourage risk-taking.
Taxing capital gains less than income is one way to encourage risk-taking; equalising the two would discourage risk-taking.
Therefore we should not equalise.
(Your tracker fund does reduce the risk, not quite to zero of course but nearish to it — at the cost of the potential returns being much lower than for a more risky investment, which means that for you the difference between a 24% and a 40% tax rate is unlikely to be significant. It’s only significant for investments where the potential returns are large — exactly the kind of risky investments we want to encourage)
Totally naive
DeleteWe have multiple posts from Anons commenting that govt's should just let the free markets work
And here you are saying no the govt should subsidise the risk that so-called investors are making
Utter nonsense
Profit made from "investing" should simply be seen as income in the same way that someone's salary is and taxed in exactly the same way
The market will adjust for this - or are you saying the market won't make the adjustment and doesn't work?
And here you are saying no the govt should subsidise the risk that so-called investors are making
DeleteNot taxing something is not a subsidy! In the natural state of the market, nothing would be taxed; so whenever a government imposes a tax, it impairs the ability of the market to function freely and efficiently.
Markets of course will adapt to taxes — that is what markets do. But there’s no guarantee that the market solution adapted for the tax will be as advantageous for society as the market solution without the tax would have been.
In the case of taxing capital gains, imposing high taxes in them makes risk-taking less rewarding, so the market will adapt by allocating more resources to safer places than to riskier places.
This is less bad for society, because it is from risky uses of resources that good things like innovative products come from.
The point of taxes is to raise sufficient revenue for a government to do the things it needs to do (because only a government can do them), without being too disadvantageous to society. High taxes on capital gains, that make it even more risky relative to salaried employment and other safe investments than it already is, violate this.
Taxes of course should never be used to try to shape society, eg to redistribute wealth — the purpose of taxes is only to raise revenue for the necessary functions of government.
"Taxes of course should never be used to try to shape society, eg to redistribute wealth — the purpose of taxes is only to raise revenue for the necessary functions of government."
DeleteSays who?
Redistribution is an acceptable policy goal if it's judged to be warranted
Says who?
DeleteSays me, and my vote counts as much as yours.
Redistribution is an acceptable policy goal if it's judged to be warranted
No it isn’t. Because if you believe in redistribution you are basically saying that you think everything ultimately belongs, not to the people who own it, but to the government, and therefore the government is entitled to take from one and give to another according to how the government thinks things ought to be apportioned.
That is an evil point of view.
You seem very confused over "investment"
DeleteIn economics - which is what we're talking about - investment is a tightly defined term
Investment is defined as the the addition to the capital stock of the economy
Tesco building another store is investment
Amazon building a new data centre is an investment
Rolls Royce buying new machinery if an investment
My putting money into stocks and shares is NOT an investment in economics even though the term may be used by laymen. No new capital is created, and the economy's productive capacity doesn't change.
Economics classifies my share purchase as a financial transaction hence as saving just as my putting the money into a high street savings account
So if both are the same - they're both savings why tax them differently
QED eh?
So if both are the same - they're both savings why tax them differently
DeleteSo you’re saying we solid distinguish between seed capital — someone buying shares at an IPO or other share issue, or providing venture capital or putting their own money into a business — and tax gains on that capital at an extra low rate, while taxing gains on market-traded shares at a higher rate (say equal to income rate)?
Actually I wouldn’t have too much of a problem with that in principle, as long as the practical administrative problems can be overcome.
So can we agree on that plan?
As I said, in economics financial "investment" isn't seen as investment per se but as saving so it makes sense to treat it in exactly the same way - no special tax breaks, equal tax rates, threshholds etc
Delete"Real" investment - ie genuine and productive additions to the capital stock - such as provision of seed capital, venture capital, IPOs etc - is seen as "beneficial" to the economy as a whole and therefore should be seen separately for any tax (or subsidy) purposes. In practice such tax regimes become ever more complex as govts change policy aims and treated such investment differently across different industries.
"Real" investment - ie genuine and productive additions to the capital stock - such as provision of seed capital, venture capital, IPOs etc - is seen as "beneficial" to the economy as a whole and therefore should be seen separately for any tax (or subsidy) purposes.
DeleteIs that a ‘yes’, you agree with the above?
Yes. As I said, I see a big difference between real investment (in capital stock) and financial "investment" (eg share purchase) which simply transfers ownership of some asset
DeleteIf memory serves, cgt and income tax were more or less equalised under the Tories under Lawson but then - for some reason - pulled apart by Gordon brown
Odd politics with regard to the "capitalists" involved
Yes
DeleteGreat.
But — oh dear. I’ve been thinking about it some more and I think I see a flaw. Let me know if you think I’ve made any logical errors.
Investors put their money in capital because they want to see a return. They want to grow an asset that they can then sell at a profit. So the idea is that when they sell their share in that asset, after investing in the capital, they are taxed at the lower ‘investment rate’ (the current capital gains rate). But then the person who buys that share from them, when they sell it on to another buyer, they are charged tax at the higher ‘income rate’ (equal to the income tax rate).
Here’s the problem though. If I buy an asset which I know when I sell it on will be taxed at 40% instead of 24%, that makes that asset worth less to me, doesn’t it? I mean that just seems logical. So I will be willing to pay less for that asset than I would have been if it had been taxed at the lower rate. That’s just rational, right? If I buy a share for £10 thinking it will increase in value to £20 and be taxed at 25%, then I am looking at a profit of £7.50. But if that same gain will be taxed at 40% then I will only make a profit of £6. At 40% tax, to make the £7.50 profit on the £20 price that I predict I can sell at, I want I must buy at £7.50 instead of £10.
That means that the initial investor knows that when they come to sell on their share in the initial capital investment, the buyers will be not be willing to pay as much - they will only offer £7.50 where before they would have offered £10.
So this has a knock-on effect on the return that the initial capital investor can expect, doesn’t it? And that then makes them less likely to invest, especially at the margins on the most risky investments.
So in fact, distinguishing between ‘real investment’ and ‘financial investment’ in the tax system by taxing the latter higher than the former would actually have the consequence of discouraging real investment, wouldn’t it? Because the whole point of making a real investment is to produce an asset that you can then make a profit on by selling into the market to turn it into a financial investment. So if you make financial investments less valuable, by taxing them more highly, you inevitably as a knock-on effect make real investment less profitable as well, don’t you?
Have I got anything wrong?
Yes
DeleteYes
DeleteWhat, exactly?
The issue is one of timing and how the market reacts to this
DeleteYou've bought shares under the current tax regime (CGT 24%) and factored that into your decision as to whether to buy or not. That decision is now in the past
Burnham has now announced that CGT on share purchases will equate to income tax at 40%
You want to sell your shares to me now.
I know that in the future I'll have to pay 40% CGT so I'm factoring that into the price I'm willing to pay you for the shares. Logically, that price will be less than it might otherwise have been had CGT not changed.
Exactly how much will depend on supply and demand in the market
So those shares are likely to see a fall in price.
However when I come to sell those shares at some stage in the future I've already factored
CGT at 40% so there'll be no equivalent further fall in share price.
In other words the share price will take a one-off hit just as they do with Trump's attack on Iran, a new Covid outbreak, Scottish independence ....
That's the risk you take when you buy shares on the stock market
simplest way to look at it is probably through the old supply/demand chart
DeleteThe current share price is at equilibrium - the intersection of the supply curve (sellers) and demand curve (buyers)
A change in the tax regime (increasing CGT) will most likely shift the demand curve downwards as buyers factor in the new and higher CGT and will be willing to pay less for the shares as a result.
At some point a new equilibrium share price will be reached and will remain the equilibrium until some other factor "shocks" the market