The Conservatives should have stood firm on inheritance tax

February 23, 2013

The Conservatives have abandoned their manifesto commitment to raise the Inheritance Tax threshold as part of the coalition deal with the Liberal Democrats. This his highly regrettable.

Inheritance Tax is clearly unjust in the sense that it represents triple taxation. Tax is paid on the initial income, then on savings and then again after death, creating significant economic distortions. One result is the small army of tax advisers employed to minimise exposure to death duties; another is that resources are allocated in order to avoid tax rather to achieve the highest returns. Perhaps most importantly, the tax reduces incentives to save rather than consume, thus lowering investment and hampering the production of wealth.

Inheritance Tax raises about £3.5 billion per annum for the Treasury – a tiny proportion of the overall tax take. The Conservative plans to raise the threshold would therefore have cost relatively little. Indeed, given its impact on investment and allocative efficiency, it is probable that inheritance tax actually reduces overall tax revenues in the long term.

The Liberal Democrats’ alternative policy of raising personal allowances to benefit the low paid is worthwhile in order to improve work incentives by reducing the horrendous marginal withdrawal rates produced by benefits and tax credits. Nevertheless, given the fiscal crisis, the measure will have to be funded by tax rises elsewhere. If, as the reversal on inheritance tax suggests, this means higher taxes for the relatively wealthy, it may represent a transfer from those with low time preferences (entrepreneurs and savers) to those with high time preferences (low-income spenders). Accordingly, the economic benefits of this realignment of the tax system are far from clear.

12 May 2010, IEA Blog

Filed under tax Tagged with ,

Time preference, economic crisis and social decline

February 17, 2013

The last decade has been marked by a combination of low savings rates and high debt levels in both the USA and Britain. Indeed in 2005, the savings rate in the US reached zero, while 13 million adults in the UK – more than 1 in 4 – have no savings or investments.

The lack of savings, together with the readiness to take on debt, suggests that a high proportion of the population has a high time preference. In other words, the present is valued far more highly than the future.

Arguably the current financial crisis cannot be divorced from the short-term, “hand to mouth” culture that has come to dominate the USA and the UK. The widespread unwillingness to defer material gratification contributed to the debt bubble that precipitated the crash.

But the negative consequences do not end there. People with no savings are also more likely to have to rely on welfare-state safety nets when they lose their job or develop a health problem. They will also tend to be more reliant on state handouts in old age and may therefore vote for socialist political parties that promise to increase such benefits. There is also a strong association between high time preferences and criminality.

While it may be tempting to blame “cultural decline” for the phenomenon, the absence of saving in countries such as the UK may in reality be a rational response to artificial incentives created by government policy.

It is perhaps not that low saving causes welfare dependence but the prospect of welfare that causes low saving. Benefit claimants with more than £6,000 may face steep deductions in means-tested payments. If they have over £16,000 they may receive nothing. And when they reach old age, the availability of means-tested pension credits means low to middle income savers will be barely better off than their spendthrift contemporaries.

Another issue is long-term residential care for elderly. While savers will lose their assets, including their home, non-savers on state benefits will generally receive care free of charge – this is a tricky issue but, at the very least, those who do not save should not be able to expect a guarantee of the same standard of provision as those who pay for themselves.

All in all, the incentives for deferring gratification and saving are very weak. This problem should be addressed urgently through the reform of pensions and benefit systems in order to restore the social and economic benefits of a low time preference culture.

24 June 2009, IEA Blog

Filed under political economy, welfare Tagged with , ,