Taxation: Inheritance Tax
6:49 pm

Photo of Lord Burnett

Lord Burnett (Liberal Democrat)

rose to ask Her Majesty's Government what plans they have for the future of inheritance tax.

My Lords, I draw attention to my interests declared in the register.

I am grateful to be able to introduce a debate tonight on inheritance tax. Although I shall be adverting principally to that tax, your Lordships will understand that our discussions would be incomplete if we did not also discuss the interrelationship of that tax with capital gains tax. With the leave of the House, I shall say a few words about that towards the end of my remarks. I shall also refer to one or two changes made in last year's Finance Act, especially those relating to lifetime trusts.

Recent years have seen a growing clamour of disquiet and discontent about inheritance tax. The public are rightly concerned at its injustice as more and more individuals and estates are brought within its scope. Just before Christmas, a survey indicated that over 850,000 individuals in this country had assets in excess of £0.5 million, and that number was set to grow. The Institute for Fiscal Studies produced a paper last week which calculated that 3.25 million individuals and estates in this country are now potentially liable to pay the 40 per cent rate of inheritance tax. I remind your Lordships that this tax and its predecessors—estate duty and capital transfer tax—were designed to be paid by the very wealthy.

Nowadays, the greatest criticism of the tax is that the very wealthy pay, pro rata, very much less than those with far more modest means. Inheritance tax now bears disproportionately highly on what can be called "middle England", whereas those who are very rich can afford to avoid the tax, or at least most of it.

Although that is a compelling criticism of the tax, it is by no means the only one. Inheritance tax involves an element of double taxation and, in addition—this is far more pernicious—there is considerable pressure on the elderly to gift assets early to avoid the tax, and they do so far too early for their own good. This is not an argument for the reintroduction of capital transfer tax by the abolition of the potentially exempt transfer regime, although I shall come back to this point later. However, it remains a most unpleasant characteristic of the tax that the elderly often have to endure far too much pressure to gift assets early, leaving them financially and emotionally vulnerable.

Fear of the tax can drive people into making premature gifts, the effect of which can be to weaken businesses. Your Lordships will know that, in most cases, there is 100 per cent relief from the tax for business and agricultural assets, and I believe that most of us in this Chamber will support that. Nevertheless, there is a fear—some might call it irrational—that there could be changes to this regime. I have met a number of individuals who, through fear of a change in the tax regime, have been persuaded to gift business assets and have found to their horror that the donees who have inherited those assets far too early have squandered and destroyed businesses.

The tax also has an adverse macroeconomic effect. Fear of the tax often lures individuals into making rash and foolish gifts and investments. Much time and money is spent by highly competent specialists, usually employed by the most wealthy, in avoiding inheritance tax. They and their tax advisers could be far more beneficially employed in a more productive capacity.

The tax militates against investment and savings. Some middle-aged and older individuals take the view that, if the taxman is going to take the money in any event, why not spend it? But surely one of the most compelling reasons for fundamentally changing the tax is that we should encourage the entirely natural and praiseworthy ambition of most of us to work hard and save money to pass these assets and cash on to our children and grandchildren. This laudable aim should not be undermined; it should be encouraged.

There are some straightforward changes that could be made to make the tax more simple and fair. A married couple or civil partnership with combined assets, including their house, above the nil-rate band faces a dilemma. If the first dies and leaves everything, as is normal, to the survivor, there will, depending on the size of the estate, be a loss of the nil-rate band exemption, or part of it, in the estate of the first spouse to die.

That has given rise to what is known in the jargon as mini discretionary trusts. In other words, the first spouse or civil partner to die leaves the value of the nil-rate band, or part of it, in a mini discretionary trust. The objects of the trust are invariably the surviving spouse or civil partner, children and remoter issue.

My clients have found this whole process extremely bureaucratic and incomprehensible. I suggest that that goes for most of the public. They are aware that it will save the combined estates many thousands of pounds in tax, so they go along with it. HM Revenue and Customs know all about it, and it is an entirely usual form of tax planning. I hasten to add that there can be many non-tax reasons for creating such trusts. Nevertheless, people with fairly modest estates would usually prefer all their assets to pass directly and absolutely to the surviving spouse or partner without the necessity for such a cumbersome and bureaucratic mini-discretionary trust regime.

I also hazard a guess that this regime adds considerably to HM Revenue and Customs's workload. It creates extra work and complication for that department. I hope that the Government will give careful consideration to allowing the transferability of the nil rate band exemption; in other words, to enable a first spouse or partner's unused nil-rate band to pass to the survivor at its value at the date of death of the surviving spouse or partner. For example, if Mr A leaves his entire estate of, say, £500,000 to his wife, on Mrs A's death she will have not only her own nil-rate band exemption but also his, uprated to its value at the date of her death. Another example is if Mr A uses, for example, half his nil-rate band exemption on his death, then Mrs A, on her death, will be entitled not only to her full tranche of the nil-rate band exemption, but also his unused half, uprated to its value at her death.

Another change that should be made immediately is an increase in the ludicrously low nil-rate band. I suggest that it is increased to £500,000 per individual. Furthermore, unmarried siblings living together should be treated far more fairly, and so should relatives and others who give live-in care for the elderly and the infirm.

Of course, these changes should not prevent a complete rethink of the tax. I favour retention of business and agricultural property relief. We must assure our businessmen and farmers that the Government understand the importance of continuation and growth of the business and agricultural sectors. Tampering or lessening these reliefs is not in the best interests of the economy of this country. Foolish and inadequate businessmen will soon lose their businesses, notwithstanding the tax regime.

As I have said earlier, the impact of the tax on the very wealthy is minimal but its impact on middle England is grossly unfair. The rate of tax is too high and the nil-rate band is too low. I assure the House that it will always be open to the very wealthy to avoid the tax because they can afford to do so. To correct this imbalance, there needs to be a fundamental rethink of how the tax is levied. It may be that part of the bargain for a substantial reduction in the rate of tax is the abandonment of potentially exempt transfers. In order to justify this, however, one would retain the free capital gains tax uplift on death. Many argue that it is only fair that individuals and estates should at least bear some taxation on capital. My point is that it must be fair and be seen to be fair. If the Government were to adopt a nil-rate band of £500,000 with transferability of allowances, as I have outlined earlier, it may be that, consequent on withdrawing potentially exempt transfers, the rate of tax should be fixed at about 10 per cent or graduated up to a maximum of 20 per cent, coupled with, on death, a free uplift for capital gains tax.

Lifetime gifts, whether absolute or into trust, should all have the advantage of an election for holdover relief for capital gains tax. This might at first seem generous, but lower tax rates do not necessarily mean lower receipts. I remind the House that a Labour Government introduced tax-free inter-spouse gifts when they introduced capital transfer tax in the Finance (No. 2) Act 1975. That was a worthwhile and welcome change. Furthermore, I remind the House that the reforming Governments of the noble Baroness, Lady Thatcher, reduced corporation tax from 52 to 33 per cent, and the consequence of this change was to yield a vastly increased amount of corporation tax. Sensible tax rates encourage jobs, businesses, investment and savings.

Finally, I shall say a few words about the trust tax changes made last year. Most trusts, with the possible exception of some mini discretionary trusts, are not established for tax avoidance reasons. They are established to overcome the difficulties faced by vulnerable beneficiaries, the difficulties arising on marriage breakdown and the fragility of marriage generally. An individual is unlikely to want to make an outright gift to a recently married child or grandchild for fear of what might happen, especially in the early stages of the marriage. In January this year, HM Revenue and Customs published the results of its own market research into the use of trusts, which made it abundantly clear that most trusts were set up for reasons other than tax planning.

Last year, during the Finance Bill, the Paymaster-General was kind enough to discuss with me the Government's proposed changes to inheritance tax on trusts. Welcome changes were introduced by the Government in respect of will trusts. I hope that they will see the force of the arguments made on behalf of millions of potential taxpayers by organisations such as the Law Society and the Society of Trust and Estate Practitioners that the up-front 20 per cent charge that now applies to all new lifetime trusts is unnecessary and unfair.

7:01 pm
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Lord Campbell-Savours (Labour)

My Lords, I congratulate the noble Lord, Lord Burnett, on introducing this debate, but I make clear my total opposition to any cut in the tax take. I also congratulate the Chancellor of the Exchequer for having the courage to stand up to this national campaign for an increase in the threshold.

Lest it be thought that my position derives from some perverse tilting towards the politics of envy, let me make it absolutely clear that there are no circumstances whatever in which I would accept inherited wealth. I should add that this position, which I have taken over a lifetime, is at some considerable sacrifice to me and my family. However, it has enabled me to argue a position in principle for more than 40 years without being labelled a hypocrite.

I shall discuss the principle behind the tax. The prime question in my mind is about the impact of inheritance on the recipients. Can it alter the conduct of individuals? My case is that is does—and not always helpfully. The impact of large windfalls of cash on National Lottery winners is already well documented. I admit that a lottery win provides an exaggerated example, but it does indicate that windfalls can create problems. There are many reported cases of breakdowns in marriages, squandering of money, inter-sibling squabbling, collapse of long-standing friendships, professional lives destroyed, workplace friendships fractured through inequitable distribution of winnings, drug abuse, nervous breakdown, gambling, even the funding of crime and, most important of all, the destruction of families in a welter of recrimination and greed.

So how can inherited wealth impact on personal conduct? I argue that it devalues the value of money by undermining understanding of the relationship between effort, wealth creation and earning through work. Therefore, it can, in certain conditions, destroy incentive, innovation and ambition. I well remember that when I was a young man a number of my friends, in conditions of privilege, received early windfalls. Two of my friends lost their fortunes and to this day—we are still friends—believe that handling large amounts of money in their 20s created problems over a lifetime. The devaluing of the value of money at an early age is at the heart of the problem. It can destroy the potential for entrepreneurship and individual endeavour.

On the other hand, inherited wealth can have the reverse effect. I have another old acquaintance who inherited some tenanted property and an old quarry in the north of England. He worked hard with his inheritance and built up a huge public company. He is one of a few who start off with a modest inheritance and are successful in their own right. I ask the simple question: how many potential entrepreneurs were sidetracked by early life inheritance and thereby missed the fascinating experience of building an enterprise brick by brick through times of hardship by Herculean effort and personal sacrifice? The taste of success is particularly sweet for those who build through their own efforts and risk. I count myself among such people.

Inheritance too often only generates idleness. People can lose the will to succeed in the world of work; their ambition dissipated. Sometimes this demotivation can start well before the windfall as people organise their lives in expectation of inheritance. Some people spend a lifetime in expectation and so organise every aspect of their lives to ensure the trouble-free transfer of assets.

I remember as an MP some of the cases I was asked to handle. People would actually come to me and complain over the detail of a will. Such arguments invariably arose where people had factored in potential windfalls as part of their personal finances. Sometimes they had been outmanoeuvred by a relative, usually described as "greedy" or "money-grabbing". More often than not I concluded that the greed was to be found in the eye of the complainant.

People would suddenly start visiting elderly relatives, object to local authority calls on assets to pay for elderly care, isolate relatives who were rival potential recipients, contrive sibling squabbles, object to elderly relatives spending, and even manipulate the ownership of assets for personal advantage. I found this whole area of constituency work disturbing. It is as though some people out there are just waiting for other people to die.

Then there are those families whose wealth creation is justified on the basis that they are doing it for the children. No consideration is given to whether it is in the long-term interest of their children to benefit or on how it might impact on their lives. I have an instinctive suspicion of those who justify their wealth on the future needs of their children.

There is, however, a controversial issue surrounding this whole debate. It is the impact which inherited windfalls have on the housing market. We are told that property price inflation within the UK is due to four factors: the inflow of funds from overseas, city bonuses, immigration and increased demand, and housing shortages. However, there is a new factor which is having a pronounced effect on property prices particularly in the regions—inherited wealth. The mathematics are simple. The windfall-driven housing economy enables people to boost the prices they are prepared to bid and pay for houses. If on a given day purchasers in the market are competing for a house, not only on the basis of a given multiplier on income added to their savings but also on the basis of a windfall, then the windfall bidder will invariably win. Not only do they win, but their purchase influences other property values in the area by triggering further house price inflation. In fact, one inflationary house price sale feeds the next inflationary purchase. And, let me be clear, we are not talking about parental help with deposits, which even in themselves have some marginal effect, we are talking about substantial legacies which really influence local markets.

So where do we go from here? What can the Chancellor do? We all know we cannot end inheritance. People passionately believe in their right to pass on the fruits of their labour from one generation to another. Nevertheless, every generation should think through carefully the consequences for family life and wider society before accepting it, or rejecting it as I have done.

We could, however, use death and inheritance for redistribution and widen the net of beneficiaries. To do that I would abolish the tax completely, thereby removing the argument over the threshold; I would then transfer the liability to tax from the deceased to the recipient and tax the recipient at their marginal rate at the time of distribution. For reasons of fairness, I would extend domiciled inter-spouse tax-free transfer arrangements to the non-domiciled and ensure protection for working farms, family businesses, charities, the heritage and obviously a few other areas which have been referred to. I would then feed the entire additional tax take back into the system through a reduction in the standard rate of income tax. It would give a real boost to incentives in that part of the tax system, which really matters.

Finally, I would introduce an age taper, with tax penalties on younger people who receive inherited windfalls, to give weight to the transfers of wealth to older people in society. I suppose that it is strangely ironic that I should find myself arguing for that in this place, the House of Lords, which is one of the most privileged institutions on earth; for many generations, it has survived on the hereditary principle and inherited wealth to maintain its existence. Curiously, this is probably the best place to argue my case, because it is here that it is most likely to be understood.

7:11 pm
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Lord Sheikh (Conservative)

My Lords, I declare an interest as the chairman and chief executive of an insurance broking and independent financial advisory organisation. We are also involved in financial planning work for our clients.

The amount of inheritance tax revenue raised is small compared with other taxes. During 2005-06, inheritance tax was less than 1 per cent of total tax receipts. At present, only 38,000 taxpayers pay IHT, although the number of taxpayers who have to produce IHT returns is much higher.

Its proponents believe that it is somehow wrong for people to inherit large amounts of wealth and that therefore the state should take away a large proportion of it. Having said that, socially I feel prepared to accept the principle of inheritance tax. This tax used to affect the wealthy, but it is now affecting many property owners, which was not its original intention.

Since 1997, the threshold has not kept up with house prices, average earnings or inflation. There are now more people who will have to pay inheritance tax than ever before. In fact, more than 5 million households—21 per cent—in Great Britain are now valued at more than the current inheritance tax threshold of £285,000. A further 5 million are liable for inheritance tax when total household wealth is taken into account, making a total of four in 10—41 per cent—or 10 million households. Most of those cases will be the average hard-working middle-class person.

Increasing house prices are the main reason for a greater proportion of estates qualifying for inheritance tax now than a decade ago. A recent survey found that 67 per cent of homeowners felt that IHT was unfair. Increasing the threshold to £295,000—and, potentially, £300,000 later this year—will not go far enough. Some calculations suggest that the threshold would be £390,000 if it had risen in line with house price inflation during the past 10 years.

Although inheritance tax contributes only a small percentage of total tax receipts, it still makes a valuable contribution to the Exchequer. To increase the yield for inheritance tax, the Government have introduced several anti-avoidance measures. Those include pre-owned assets tax (POAT), which levies an income tax charge on benefits received from assets given away, and last year's changes to inheritance tax and trusts, which moved interest in possession trusts to the discretionary trust regime. These measures cause concern. They were introduced without consultation and, as a result, innocent transactions have been caught by the new rules.

A further point is that, under the current inheritance tax regime, many more individuals or their executors must complete complex forms on inheritance tax where there is no liability to tax. The administrative burden needs to be reduced. This matter needs to be taken up separately with HM Revenue and Customs.

I do not advocate the abolition of inheritance tax. I do, however, propose certain solutions that could be given further consideration. These will go a long way towards alleviating the pain to the average hard-working, middle-class person, without any major social impact on the amount paid by the really wealthy. Inheritance tax bears more heavily on the middle classes, such as people with wealth of between £300,000 and £1 million. The poor have so few assets that they will fall within the nil-rate band. The very rich can, to a large extent, avoid the tax by utilising concessions on lifetime gifts and relief for business and agricultural assets.

The effect and unpopularity of the tax could be reduced in the following ways. First, inheritance tax thresholds should be increased. They increased by 14 per cent from 2001 to 2006. However, the threshold for income tax and NIC has risen by 24 per cent over the same period, suggesting that fiscal drag has been effective at increasing the amount raised. At present, nearly every householder in the south of England will be liable to inheritance tax, as the tax threshold starts at £285,000. I suggest that there should be relief on the principal private residence—or PPR—so that the first £250,000 of the value of the deceased's principal estate can be exempt from inheritance tax.

Secondly, the rate of inheritance tax, at 40 per cent of the amount above £285,000, is very aggressive, and it would be fairer to have a graduated tax, such as 10 per cent from £285,000 to £385,000, 20 per cent on the next £100,000, and 30 per cent on the next £100,000 above that, so that the full rate of 40 per cent would not begin until £585,000. Thirdly, the number of categories of assets attracting relief should be increased, either directly or from associated tax rules such as POATs and the charges on transfers into trust. Fourthly, there should be an exemption from all periodic and exit charges for all term life assurance policies held in a trust that excludes the settlor as a possible beneficiary provided that the cash is paid out of the trust within two years of the settlor's death. Fifthly, there should be an exemption from all pre-owned assets tax and inheritance tax implications for all pure term assurance policies held in business trusts.

I reiterate that these proposals merit further consideration and, after deliberation, can be accepted, altered or rejected. I would very much appreciate the Minister's comments on my proposals.

My Lords, I, too, am very grateful to the noble Lord, Lord Burnett, for giving us a chance to have this debate. I am also very much in admiration of his altruism in doing so: not as a farmer, of course, because they long ago got out of paying any inheritance tax, but as a solicitor, because I am sure his wise advice is very highly valued in the market place, and good luck to him. However, I will be interested to hear from the noble Lord, Lord Newby, whether he too wants to see the proceeds of inheritance tax slashed. If he does, he will confirm the view that many of us have of the Liberal Democrats; it is the party which wants a lot more spending, but no taxes to pay for it.

I read only the Racing Post these days, because it is the only newspaper where the facts can mostly be trusted. I do not know whether the noble Baroness, Lady Noakes, agrees with that. But I have read some of the coverage of this issue in the Daily Express and the Daily Mail. In one of them, I saw inheritance tax referred to as a "death trap". I am afraid that I recognise only one death trap; namely, the death trap that is summed up in the shorthand phrase, "You can't take it with you". This is not a tax on the people whose estates it is paid on. I readily accept that it is a tax on their successors and for that reason, it is a rightful tax.

Given the time of night, I shall make a few observations in a somewhat staccato fashion. First, as a former member of the Royal Commission on Long-Term Care of the Elderly, I am more and more struck by how much we have become two nations in old age, despite all the endeavours of the Chancellor of the Exchequer to deal with it. Many old people are not well off, but a section of old people enjoy unparalleled prosperity in old age. They often benefit from past final salary pension schemes and can cash in now, through equity mortgages, on the values of their houses. Of course, as life expectancy goes up, they live for many more years in considerable comfort. Anyone who doubts me should pick up the holiday sections from any of our large Sunday newspapers and look at the number of holidays costing £10,000, £20,000 or £30,000 for trips around the world and so on. Of course, I do not resent people having this money, but it is reasonable to say that if anyone is deserving of tax breaks in our country, it is not these people but others who are harder pressed.

Secondly, all parties now are agreed on equality of opportunity as being a goal of our society. Substantial inheritance is an arrow through the heart to equality of opportunity. It grants some people huge opportunities that are not open to others however much they strive and try. The other day I noted the very wise words of Hank Paulson, the US Treasury Secretary. He is a former head of Goldman Sachs, so I assure the House that he is not short of a dollar or two. Very wisely, he said that he loves his children too much to give them a big inheritance. If children are given big inheritances, they lose pride in their own achievements and the incentive to succeed. I think that £300,000 between one's kids is quite enough. I certainly will take no measures to avoid paying my share of inheritance tax on my money which exceeds that threshold.

As a former practising economist, my third point is that by common consent in this country capital is taxed very lightly and income is taxed reasonably heavily, which would be a common view among economists. I will not go into every feature of it, but inheritance tax is one of our few substantial taxes on capital. We do not have, for example, wealth tax, or gift tax, to which the noble Lord, Lord Campbell-Savours, referred. Therefore, I regard it as part of redressing that balance.

Sadly, however, inheritance tax has been undermined by the many avoidance measures spoken of so eloquently by the noble Lord, Lord Burnett. We have gifts inter vivos, schemes to enable couples to claim two allowances rather than one, and you can have 10 years to pay off the money inherited from the value of someone's house. All these and many more are ways of avoiding the tax. It is true that the very rich do not pay the tax unless they do not trust their children to give them the assets during their lifetimes. I regret that and should like to see an inheritance tax, whatever the threshold and the rate, that basically is payable on whatever you are worth when you die and for the methods of avoiding it before you die to be cut off.

My fourth point is one that surprised me when I did my research. This debate and the debate held in the popular newspapers are conducted as if inheritance tax is on the up, suggesting that more and more people are paying it. That is true over a very short period, but it is not true over the long term. I have checked the Inland Revenue statistics. In 1938-39, 153,000 estates were subject to inheritance tax. By 1968-69, that figure had almost halved to 81,000. By 2006-07 it has declined to 35,000 estates, though I accept that in recent years there has been some rise as a result of the house price boom. This is not a tax that is becoming increasingly onerous; it is one that is affecting fewer and fewer people over the long term. We heard in the debate last week that the Treasury predicts that it will continue to be the case that 94 per cent of estates do not pay inheritance tax.

That brings me to the theme explored by both the noble Lord, Lord Burnett, and the noble Lord, Lord Sheikh. They suggested that this is a tax that hits middle England. If 94 per cent of the population do not pay it, only 6 per cent of the population do. Perhaps it is right that they should pay it, perhaps it is wrong; but whatever that 6 per cent is, it is not middle England. It is a small percentage of those at the top. I understand that when these matters are considered in Fleet Street, that percentage is heavily represented, as it is in this House. I am sure that the noble Lord, Lord Burnett, is going to pay inheritance tax, as will the noble Baroness, Lady Noakes, despite her accountancy skills. I will pay quite a chunk, although in my case if not theirs I shall do so quite willingly. This is not a tax on middle England, it is a tax on the relatively wealthy.

I close with a final observation that might give the House some pause for thought. For every family that pays this tax, at a rough guess there are some six to eight families who have no assets at all. Something like 40 per cent of the population have no assets to their name. That is a staggering fact. Here I refer back to the previous debate. We should give more of our time to thinking about the ways we can help that 40 per cent than on thinking about getting rid of this modest impost on the very rich.

7:28 pm
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Lord Newby (Spokesperson in the Lords, Treasury; Liberal Democrat)

My Lords, I have been pleasantly surprised by this debate. When the noble Lord, Lord Burnett, tabled a Question to be held as last business at the end of the week, I feared that we would be in the same position we found ourselves in during the last business taken last week. I wondered whether the noble Lord, Lord Burnett, and the noble Baroness, Lady Noakes, the noble Lord, Lord Davies, and myself would be the sole participants. So I am most grateful to all other noble Lords who have spoken. I say that because, much as I enjoy listening to the noble Baroness, Lady Noakes, and the noble Lord, Lord Davies, it is nice to have a somewhat wider debate on a matter related to public finances. What this debate has demonstrated is one of the key features of inheritance tax. It generates a tremendous amount of heat for a relatively small amount of cash. As noble Lords have said, it represents 1 per cent or less of the total tax take. It is worth less than £4 billion compared with the £135 billion collected in income tax.

We on these Benches agree with the aim of the tax. Particularly at a time of rising inequalities of wealth, it seems appropriate to tax a proportion of the assets of the wealthy when they die, to moderate the extent to which inter-generational transfers of wealth lead to a greater concentration of wealth in the hands of a few, and to rein in the extent to which the rich get richer through death.

I am sorry to disappoint the noble Lord, Lord Lipsey, but, in regard to his crude and inaccurate description of Lib Dem tax policy in this respect, I can only suggest that for his weekend reading he studies the excellent and comprehensive policy document which we adopted at our conference last year.

The other argument advanced today about the continuation of the tax is the point made by the noble Lord, Lord Campbell-Savours, and, to a certain extent, the noble Lord, Lord Lipsey, about the effect of windfalls of large amounts of cash and wealth being passed down the generations. I can see some force in that, although it is increasingly the case as the population ages that the people who receive such windfalls are in middle age themselves. The noble Lord, Lord Campbell-Savours, described a bracket which combines inherited wealth or the hereditary principle, neither of which apply to me. I am fortunate that my mother is hale and hearty, and I suspect she will be for many years further, but even if she had a billion pounds to give me it would not have affected my life up until now. So that argument has become less relevant with the passage of the years.

It has been clear from all speeches that there are problems over how the tax works in practice. The two principal ones are, first, that it is relatively easy to avoid the tax if you are extremely rich and can employ a very good lawyer. Incidentally, the noble Lord, Lord Lipsey, significantly underestimated the powers of my noble friend Lord Burnett in this respect when he suggested that he might have to pay a significant amount of tax himself. I would be very surprised if the noble Lord allowed himself to get into that position.

The second major problem is the failure of the Government to raise the threshold for payment of the tax in line with house prices. Given that housing is by far the largest asset of most householders, even the relatively wealthy, many families who do not consider themselves wealthy have been brought within the scope of the tax. Unlike the very wealthy, because their house is their principal asset and they are not prepared to downsize their house as they get older, they are unable to reduce their tax burden as the more wealthy can.

My noble friend Lord Burnett mentioned a number of other respects in which the tax leads to behavioural issues which may cause problems when the elderly or owners of businesses give their assets "too early", as he described it.

All these problems have led to calls for the reform—or, in some cases, the abolition—of the tax to make it less easy to avoid and to raise the threshold so that the affluent middle class, particularly in London and the south-east, are covered by it. The proposals of my noble friend Lord Burnett would be a very radical—nay, bold—way of dealing with this issue. My principal concern about them is that, to a certain extent, he is basing his arguments on the reasoning of the famous Professor Laffer, who argued, as does the noble Lord, that reducing rates could increase revenue. In this case it would reduce the incentive to evade the tax, and many more people would not take the trouble to avoid the tax if the rates fall to a quarter or, at worst, a half of what they are now. Even if that were true in the long run, the immediate effects of the Minister's changes would be to greatly reduce the revenues from the tax. I think he is proposing to reduce the rate by between a half and three-quarters and to raise the threshold by 75 per cent. I know he has other suggestions that may mitigate those two consequences, but in the absence of those or any other changes those measures would reduce the revenue from this tax by the best part of £3 billion in the first year or two.

Although there may be subsequent behavioural changes that bring the level of income back up from this tax, the short-term costs of making those changes are considerable. I still need a bit of persuading—and the noble Lord has been trying very hard to persuade me—that in the medium term we would still have the kind of behavioural change required to bring the take from the tax back up to its current level.

The second approach to reform is that proposed by the noble Lord, Lord Forsyth, in his report on reforming the tax system. He wants to go further than the noble Lord, Lord Burnett, in abolishing inheritance tax altogether and replacing it with a short-term capital gains tax on death. He would exempt the family house from this new tax altogether. He costs his proposal, as part of the other changes he makes to capital taxes, at £2.6 billion a year. I will be interested to hear from the noble Baroness, Lady Noakes, whether that is now Conservative policy, and, if so, how the party intends to make up for the lost income.

When we looked at this issue last year in the Liberal Democrat tax commission, we endorsed the principle of the tax and thought there were several ways in which it could be changed that would greatly improve its operation. First, we proposed that lifetime gifts should be included in the taxable sum. Secondly, we proposed that the tax should be levied on accessions, so that the tax paid varied to the degree that an individual benefited from a legacy. In theory, such a system would encourage testators to spread bequests over a large number of people and so spread their wealth further.

I am well aware that neither of those two proposals is straightforward to administer, and that the noble Lord, Lord Burnett, would put it more starkly than that. However, they both offer a different approach with, in principle, better outcomes than the current administration of tax, in my view, and we are looking further at them.

For my sins, I am now chairing the successor body to last year's Liberal Democrat tax commission, where we are looking not only at these possible changes to the tax, but at any other beneficial changes we could make; for example, whether we should keep all the present exemptions. It is not particularly clear to me, for example, as a major shareholder in a small business, why any value the shareholding might have on my death should not form part of my taxable estate. The suggestion that when I get up for work tomorrow morning I might think to myself, "It's really not worth working so hard today because, what I hope will be many years in the future, a proportion of the value of this business may be taxed" frankly does not enter my reckoning, and I doubt it would enter the reckoning of any entrepreneur. We will be debating our proposals at our autumn conference this year, but, whatever we decide there, I am sure it will not be the end of the arguments on inheritance tax.

7:39 pm
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Baroness Noakes (Shadow Minister, Treasury; Conservative)

My Lords, I thank the noble Lord, Lord Burnett, for giving us the opportunity to debate inheritance tax. Had the debate been at a more congenial time, I can assure him that far more of my noble friends would have been joining me to debate the subject, which is close to many of my noble friends' hearts.

Benjamin Franklin once said that nothing is certain except death and taxes. Our debate today covers the unholy alliance between the two. The noble Lord, Lord Lipsey, gave us a history lesson going back to the 1930s. We can go back even beyond that to when estate duty started, at the back end of the 1890s. By the early 1900s, estate duty raised about 18 per cent or 19 per cent of the total tax yield—an astonishingly large amount. That was done with rates that were over 10 per cent on estates over £1 million, and 15 per cent on estates over £3.5 million. In today's money, that is about £85 million and £300 million respectively, which shows that this tax was originally conceived for very wealthy estates, and it has become something quite different.

The tax does not account for the same degree of yield now, as several noble Lords have said. I think we would all say amen to that. But it is on an upward trend; the yield in 1996-97 was £1.6 billion and the current estimate for this year is £4.1 billion. That is quite a strong rising trend. As we have heard, that has been accompanied by quite a big increase in the number of estates coming within the net—from 20,000 to an estimate of nearly 40,000 this year.

My noble friend Lord Sheikh reminded us that 40 per cent of households are now estimated to be potential inheritance tax payers. The noble Lord, Lord Lipsey, said that it is paid only by the richest 6 per cent, so we do not have to worry about it. The research now shows that 40 per cent of households—and that is more people—are potentially going to have to pay inheritance tax because of their family assets.

The real problem, as a number of noble Lords have suggested, is the failure of the inheritance tax threshold to keep pace with asset prices. The threshold has increased by about one-third since 1997, but average house prices have gone up by 145 per cent. The Council of Mortgage Lenders has estimated that 35 per cent of inheritance tax is now attributable to residential property. That has doubled in the past 10 years.

The total value of smaller estates, which is what we are talking about, is hugely influenced by the value of the family home. In Greater London, the average house price is now higher than the inheritance tax threshold. There is a great sense of unfairness that the values of ordinary people's homes are dragging them into the IHT net. Another perceived unfairness is that there is one national threshold but house prices and their rate of increase vary hugely across the country. Those who live in London and the south-east can see their rather modest property assets being taxed, but those who live in other parts of the country in comparable homes will come nowhere near the threshold.

The noble Lord, Lord Burnett, referred to the surviving spouse or surviving civil partner exemption, which, too, has generated a great sense of unfairness, because siblings and other close family members who may have the same emotional attachment to, and economic dependence on, the family home are not given equivalent protection. That is so much more important, because the threshold has been devalued compared with the assets that people want to protect.

Another area which I do not think has been mentioned is exemptions for small gifts up to the value of £250 and the annual exemption of £3,000. Those limits have been unchanged since the early 1980s. If they had been allowed to keep pace with straightforward RPI inflation, they would now be around £750 and nearly £8,000 respectively.

The Government have already announced that the main threshold will go up next year, but many predict that that will be wiped out by further house price increases, given the continuing strength of house prices. Do the Government have any intention of reviewing the main threshold again and will they consider revising the gifts limits? Alternatively, will the Minister confirm that it is the continuing intention of the Government to let fiscal drag drive inheritance tax yields?

It has been pointed out that inheritance tax is largely avoided by the rich, who can afford to transfer significant parts of their wealth during their lifetimes or to invest in the categories of asset that are favoured. The latest attempts by the Chancellor to tighten up the rules on trusts, to which the noble Lord, Lord Burnett, referred, have largely by-passed the better-off, but have hit middle England. We can see in revenue and customs statistics that the number of people paying inheritance tax with estates valued at less than £2 million is rising much faster than the number of those with estates of higher value, which reinforces the fact that this tax is bearing down on middle England.

There are strong theoretical objections to inheritance tax, because it involves significant double taxation; it taxes wealth which has been accumulated out of taxed income. Importantly, it does nothing to encourage savings. Unlike the Government, we believe that the savings ratio, which has virtually halved in the past 10 years, is a serious issue. In fact, if you strip pensions savings out of the savings ratio, the savings ratio is barely positive.

Stephen Byers, not normally seen as a right-wing thinker, said last year that inheritance tax was a,

"penalty on hard work, thrift and enterprise".

That is what Gordon Brown does: he attacks hard work, thrift and enterprise. He knows that the softest targets in our economy are the middle classes, who value home ownership and who save. These are the people who are being attacked by inheritance tax and are affected most by stamp duty land tax, which is now raising over £1 billion per quarter. They are the people who have been hit hardest by the Chancellor's infamous raid on pension funds. They were hit by the latest changes announced in the Pre-Budget Report, in which the Chancellor attacked alternatively secured pensions, introduced only the previous year. They are probably also the people who have been paying extra capital gains tax, because that has been yielding significantly additional amounts, with another 500,000 people paying capital gains tax since 1997. The rich can use a combination of techniques to minimise their taxes, including inheritance tax, but middle England does not have those options and is bearing the brunt of the Chancellor's redistributive aims.

The noble Lord, Lord Newby, tried to goad me into talking about Conservative tax policy, but I am sure that he knows that we have said very clearly that we would put economic stability before tax cuts, and until we are clear what scope there would be we will not talk about tax cuts. We remain in principle a party that seeks to achieve tax cuts, but not at the expense of economic stability.

I hope that the Minister today will at least recognise that inheritance tax has developed in an undesirable way and needs changes to make it fairer on the middle England that it attacks so ruthlessly. I also hope that he will say whether the views of the noble Lord, Lord Campbell-Savours, represent government policy, because I am sure that the electorate would be very interested in that.

7:47 pm
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Lord Davies of Oldham (Deputy Chief Whip (House of Lords), HM Household; Labour)

My Lords, we are all grateful to the noble Lord, Lord Burnett, for having introduced this debate. I suppose that I must respond immediately to the noble Baroness, Lady Noakes. I do not think that my noble friend Lord Campbell-Savours thought for one moment that what he was saying represented government policy, either now or in the immediate or even the likely future. Nevertheless, what he said was of considerable significance, not least in his comments on the relationship of inherited wealth and the incentive to work hard and achieve. I thought that he made an extremely valuable point in that regard.

I am grateful, too, to my noble friend Lord Lipsey, who sought to put this whole debate into some kind of context. If I repeat some of his remarks, it is because I, too, want this debate to be in context.

There has certainly been an awful lot of talk recently in this House, the other place and the mainstream media, that inheritance tax is one of the blights of our time and that middle England is subject to the aggressive forces of the inheritance tax. Out of 600,000 people who passed away last year, only 34,000 estates attracted an inheritance tax liability—one in every 17, about 6 per cent. That is a pretty narrow definition of middle England, if one also recognises that included in that 6 per cent are the extravagantly wealthy. We should not exaggerate the impact of inheritance tax. The noble Baroness, Lady Noakes, said that some 40 per cent are liable to pay the tax. These figures have percolated into the mainstream media through the latter's lack of rigour but they do not stand up to close examination.

The house price dimension does not stand up to close examination either. House valuation accounts for about 50 per cent of the total assets of the majority of those who pay inheritance tax. Therefore, we should not pretend that a substantial number of people are trapped through rising house prices. Anyway, what are these rising house prices? The average house price in the UK in 2006 was £197,000. Noble Lords will recognise that there is a fairly generous margin between that figure and the point at which the tax is payable. The median price—the best measure we have of a typical property in England—was £175,000.

The noble Lord, Lord Burnett, emphasised that this issue is more acute in the south-east. This House is often very strong in its advocacy of south-eastern issues and interests. But we are, after all, the second House in this Parliament and we have an obligation to take things in the round across the country. I concede that there is a problem of rising house prices in the south-east. How great is that problem? Last year the median price for London was £250,000 and for the south-east region as a whole, £210,000. That is a narrower margin than applies in the rest of the country but it is nevertheless a margin of real wealth before the tax begins to bite. We need to get the matter in perspective.

The noble Lord, Lord Burnett, was rightly challenged by his own Front Bench, who are careful about the implications of reducing the potential take from inheritance tax. The total tax take is worth 1p on income tax. That is a pretty substantial figure. It behoves those who advocate a substantial reduction in inheritance tax—I think that was the burden of the remarks of the noble Baroness, Lady Noakes—to say where the resources are meant to come from.

The approach that the noble Lord, Lord Burnett, suggested in a number of other areas might minimise the significance of current reliefs. The 100 per cent reliefs for business and for agricultural assets are of great significance and play their part in building up business. That is a reflection of the obvious fact that we are concerned to sustain our productive capacity in this country. Therefore, we ensure that people can continue to invest in certain assets and that those assets will be carried on beyond their lifetime.

The noble Lord, Lord Burnett, mentioned the hoary old tale of this measure being double taxation. No Government recognise the concept of inheritance tax being double taxation. Is VAT double taxation because we all pay income tax as well? Of course not. The issue of inheritance tax cannot surely have a unique quality—

Photo of Lord Burnett

Lord Burnett (Liberal Democrat)

My Lords, I am happy to say that I did not refer entirely to the south-east of England. I wish that the Minister would advert to what I did say. It is about the prospect of high yield on this tax and many millions of people being caught by it in the future. It is not just a south-east phenomenon. In addition, the point about double taxation was a minor point. I made that clear in my speech; it was not the main thrust. It is an unfair tax, and I hope that he will deal with that.

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Lord Davies of Oldham (Deputy Chief Whip (House of Lords), HM Household; Labour)

My Lords, I understand what the noble Lord says; I was not suggesting that it was a major point of his speech. I hope that I have already addressed myself to that. He must also concede that he says that millions will come within the framework of this taxation, but the tax is at £285,000 at present. It will go up to £325,000 in 2009. That is an increase of £40,000. Does that suggest that the Chancellor, in approaching the issue, is not taking into account some pressure on house prices and the potential for house price inflation? Of course that is taken into account. The noble Lord would recognise and expect that we take full account of that factor as far as the tax is concerned.

I heard what the noble Lord said about reforms with regard to the tax and how its incidence can be eased, but he will appreciate that easing taxation costs money. I hear what he says about there being a little less avoidance of the tax. There would be an element of that, but, as he rightly says, the problem with inheritance tax is that those with very great resources are already able to deploy their advice and their strategies to reduce the burden and often to avoid it altogether. We do not think that there is a huge increased potential from graduation of the bands, but I hear what he says on that. I also heard that the noble Lord, Lord Newby, was by no means convinced of that argument.

The noble Lord, Lord Sheikh, also emphasised the house price issue. I merely indicate that I hope I have given him some satisfaction in recognising that of course we are aware of house price inflation, but we are by no means persuaded that that represents an enormous growth in the number of those who will become subject to the tax. I also heard that he said he was in favour of graduated rates. The issue with graduated rates is that costs are involved there too.

The noble Baroness, Lady Noakes, talked in general terms about the impact of the tax, but she was also concerned about the savings ratio. The savings ratio in this country at present is similar to the 1960s. No past Government have pushed people into saving in more successful ways than we ourselves have done, through the reduction in unemployment and the control of inflation—the two factors most conducive to people saying that the value of their money is safeguarded and that, if they have the security of a job, they have the ability and the incentive to save.

We have had a most interesting debate. It is a late hour. The noble Baroness, Lady Noakes, is right: we would have had a much more extensive debate had we had it at another time during the parliamentary day. I look forward to a time when we will have exactly that opportunity.

Photo of Baroness Farrington of Ribbleton

Baroness Farrington of Ribbleton (Baronesses in Waiting, HM Household; Labour)

My Lords, I beg to move that the House do now adjourn, and in moving that Motion, I place on record our gratitude to the staff who have stayed later than expected, including the Hansard writers.

Moved, That the House do now adjourn.—(Baroness Farrington of Ribbleton.)

On Question, Motion agreed to.

House adjourned at 8 pm.