Labour is facing significant pressure to raise more in inheritance tax in order to fund the party’s social care and housing pledges.
The cross-party think tank Demos has urged the Government to prioritize changes to the tax, highlighting that inheritances are becoming "increasingly more important and valuable". Demos suggested that revising the current inheritance tax system, potentially including a higher rate and the elimination of tax breaks for farmers and family businesses, as well as reforming capital gains assessment at death, would align Britain more closely with other comparable economies.
In its report, "The Future of Inheritance Tax”, Demos noted that the UK is one of only seven OECD countries that apply a flat rate of tax on death. Currently, estates in the UK valued above £325,000 incur a 40% tax on the amount exceeding that threshold.
Although Demos refrained from making specific recommendations, their observations underscore the need for tax reform. This coincides with Rachael Reeves reportedly contemplating changes to inheritance tax and capital gains tax, though no definitive decisions have been made. The new Labour Government has already ruled out hikes on income tax and VAT.
The report emphasized, “Looking abroad shows us how the UK could have a more ambitious and hopeful vision for reforming inheritance tax – one that raises more revenue while also making it fairer.”
Demos pointed to South Korea as an example of a fairer system, where effective inheritance tax rates in 2022 were 33% for estates between £6m and £30m, and 44% for those over £30m. In contrast, smaller estates in the UK often face higher rates than larger ones, with estates worth between £2m and £7.5m paying 25% in 2021, while those over £10m paid only 17%.
The report also highlighted that few OECD countries offer full inheritance tax exemptions for owned businesses, farms, and private pensions, which the UK generally does. It noted that the UK is "unusual" in this respect.
Demos also discussed the taxation of gifts, noting that while the UK taxes estates after death, most OECD countries tax recipients of inheritance and gifts. The UK exempts gifts from tax if the giver lives for seven years after making the gift.
The report estimated that the UK could have raised an additional £680m in 2019-20 if it had taxed inheritance and gifts in the same way as in France.
Additionally, Demos proposed introducing capital gains tax on death, similar to Norway’s approach. "We could shift taxation away from inheritance per se, and towards ‘inherited capital gains’ – the growth in an asset’s value between being bought and being passed on as inheritance", the report suggested. Norway has seen public support for their system of taxing inherited assets after abolishing inheritance tax and instead taxing inherited capital gains.
Without reforms, and with thresholds frozen until 2028, the UK’s inheritance tax bill is projected to rise from £7bn today to £8.4bn by 2027-28, and to £15bn by 2032-33.
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