Listen to Adam Smith: inheritance tax is good

Spectator, The, Oct 20, 2007 by Stelzer, Irwin

Politics trumps economics. That's the best summary of the Tory and Labour competition to pander to those who until now have been threatened with paying to the Treasury a portion of the money they receive for just 'being there'.

Let's de-emotionalise this issue. An inheritance tax is not a death duty. The slogan 'No taxation without respiration' is too clever by half. Even a Chancellor of the Exchequer as powerful as the previous occupant of the office could not get a corpse to sign a cheque. It is a tax paid by the recipient of this income, the inheritor, the lucky winner in the sperm lottery.

Nor, finally, is it a tax on a lifetime of thrift. In most cases the wealth being taxed results from a rise in the value of houses -- not something brought about by the acumen and hard work of the owner, but by a decade of low interest rates and economic growth, or the good fortune of having a public amenity plunked down in the neighbourhood.

That out of the way, let's consider why the rush to appease a few voters in a few marginals is bad economic policy.

Barry Bracewell-Milnes, a student and an opponent of these taxes, concedes that 'Inheritance without taxation weakens the beneficiary's incentive to work.' Surveys by the Economic and Social Research Council show that only a very small minority of people say they work for 'enjoyment'; most work for what ESRC researchers call 'mainly instrumental reasons' -- to keep a roof over their head and food on the table. Studies by the Policy Studies Institute and the London School of Economics support this conclusion: 70 per cent of the men and half the women questioned say the main reason they work is to 'earn money for necessities'.

So it should come as no surprise that researchers at America's Syracuse University find (with appropriate caveats), 'An inheritance received by a family reduces the probability that both spouses will continue to work, and increases the probability that both will retire.' In short, Andrew Carnegie, the great Scottish philanthropist and a special Gordon Brown hero, had it right -- 'The parent who leaves his son enormous wealth generally deadens the talents and energies of the son and tempts him to lead a less useful and less worthy life than he otherwise would.' Leave inheritances untaxed, and many of the young inheritors will exit the productive workforce, not a good thing for an economy needing to encourage hard work in an increasingly competitive world.

We know, too, that inheritance taxes encourage parents to spend money enhancing their children's educational and social skills. Unable to leave a tax-free financial package, parents are more likely to pour some of their wealth into what University of Chicago economist Casey Mulligan calls 'educational and health expenditures, financial gifts, or time spent teaching or nurturing them [their children]'. It is a social misfortune that such an inheritance is not more widely available -- but that's a policy discussion for another day. What is important here is that inheritance taxes encourage parents to invest in skills during their children's formative years.

Then there is the practical question: where will the money come from to replace the revenues lost when the take from inheritance taxes is reduced? Since the Tories have promised, cross their hearts and hope to die, that they will spend as much as the Labour wastrels, it won't come from reductions in government spending. No, it will come from pensioners, whose incomes will now be capped sooner than originally planned; employees who have invested in Save As You Earn (SAYE) schemes;

higher taxes on farmers selling their farms;

the military, which forfeits any prospect of a real increase in the funds available to defend the realm; small businessmen who had been encouraged by the last Chancellor to risk their meagre capital and ample sweat equity in the hope of selling out and paying only a 10 per cent capital gains tax; non-doms (of which I am one) who will pay £30,000 per year in addition to the taxes on the money they earn and spend in Britain; and hedge-fund operators who have been pretending that their ordinary incomes are capital gains, but who will still be allowed that pretence, their tax raised to 18 per cent from 10 per cent, but not to the 40 per cent that others pay on such incomes.

The non-doms and the hedge-fund operators are reasonable targets, if equity is all there is to consider. But these financial types are the most mobile of the assets located in Britain.

Not all will flee, but some will, and others eyeing Britain as a site for new businesses will now know it is less worthwhile than it once was to brave the mean streets of London by taking up residence in a town with one of the highest costs of doing business in the world.

But if it is equity that the Labour taxmen are after, why penalise pensioners (again) and small businessmen (again), and employee-savers, and all the other innocent bystanders? All to benefit a handful of taxpayers who happen to be concentrated in key marginals.