The desire for lower taxes is a sentiment shared by many, and it’s hardly a controversial statement to make. When Australians are asked to identify the taxes they dislike the most, inheritance tax (often referred to as IHT) – levied on the estate of a deceased individual – consistently ranks high on the public’s list.
However, in a perhaps contentious view, I find myself disagreeing. If I were to prioritise which taxes to reduce, IHT would be positioned towards the very bottom of my agenda.
One of the most significant challenges governments face in managing an economy is the delicate act of balancing the public’s demand for lower taxes with the simultaneous expectation of comprehensive public services and essential infrastructure. If taxes are set too low, the funding for critical areas like healthcare, education, and welfare services can be jeopardised. Conversely, if taxes become excessively high, public dissatisfaction can grow, leading individuals to seek more elaborate strategies to minimise their tax liabilities. Elevated tax rates can also act as a drag on economic activity.
We’ve witnessed this phenomenon in recent times. For instance, consider proposals to significantly increase national insurance contributions for employers, a move that many economists argue has demonstrably hindered job creation and wage growth.
Similarly, stamp duty, a tax on property transactions, is viewed by a substantial number of economists as a disincentive to mobility. This means individuals may be less inclined to relocate for new employment opportunities. A further example is the peculiar “60 per cent tax trap” – a tax anomaly affecting individuals earning between approximately $160,000 and $200,000 AUD. This quirk can incentivise many to reduce their working hours to avoid the disproportionately high tax burden.
There are, undeniably, clear economic arguments to be made for reducing or eliminating taxes such as these, irrespective of one’s personal agreement with the underlying principles.
Then we arrive at the contentious issue of IHT. Numerous policy papers, often from right-leaning think tanks and advocacy groups, have recently advocated for the complete abolition of this tax. Commonly referred to as a “death duty,” it is typically imposed at a rate of 40 per cent on the accumulated wealth, property, and possessions of a deceased person.
Currently, there is a tax-free threshold, allowing a certain amount to be passed on without incurring any tax. Furthermore, various exemptions and allowances are available. For instance, spouses can often combine their allowances, and if the estate includes property, an additional tax-free allowance may apply, meaning that married couples can frequently transfer a substantial sum, such as $1 million AUD, to their children without incurring any IHT.
I can certainly understand the reasons behind public aversion to IHT. However, if I were tasked with compiling a list of taxes for reduction or abolition, IHT would feature very low on that list. I acknowledge that public opinion, as indicated by polling, generally favours its reduction or elimination.
Let’s, however, examine the economic rationale. Effective tax policy should aim to generate revenue while simultaneously avoiding any adverse impact on economic growth. In this regard, IHT performs relatively well when compared to other forms of taxation.
Taxes like income tax and national insurance are levied on the earnings derived from an individual’s labour and productivity – contributions that directly benefit the economy. While it may sound blunt, those who are subject to IHT are, in essence, receiving wealth that has not been earned through their own economic activity. As the tax is paid by the beneficiaries rather than the deceased, it does not represent income that has been generated. Moreover, due to the existing thresholds and allowances, the vast majority of estates do not attract an IHT charge, meaning that those who are subject to it are often from more privileged backgrounds.
One could even argue that IHT offers economic benefits. In an effort to mitigate their potential IHT liabilities, families may choose to gift wealth and assets to their children during their lifetime. This proactive approach can encourage the earlier circulation of wealth within the economy. If the impetus for such intergenerational wealth transfers were removed, it could lead to a reduction in consumer spending, including significant purchases like homes, as individuals might be inclined to retain their wealth rather than distribute it.
Some of the common arguments against IHT also warrant closer scrutiny. A frequent assertion is that it constitutes “double taxation,” as it is levied on wealth that has already been subject to taxation. While this is factually true, it is by no means a unique characteristic of IHT. When consumers pay Goods and Services Tax (GST) on clothing or excise duty on fuel, they are, in effect, being taxed on money that has already been taxed at earlier stages of the supply chain.
In my view, the most compelling argument in favour of reducing IHT is its inherent complexity. This complexity is likely to be further amplified when pensions are brought within its scope in the near future.
However, my pragmatic response to this complexity is to advocate for prioritisation. There are other complexities within the broader tax system that, due to their more significant distortive effects on the economy, warrant earlier attention. These include issues such as the aforementioned 60 per cent tax trap and the loss of free childcare entitlements, which can have a more immediate and detrimental impact on economic activity and household financial well-being.
Ultimately, abolishing IHT would necessitate either the collection of approximately $13 billion AUD in taxes through alternative means or a corresponding reduction in public spending. To pursue such a course of action primarily for the benefit of individuals who have inherited wealth through fortunate circumstances, rather than through their own economic contributions, seems fiscally questionable. Our priorities for tax reform should, I believe, be directed towards areas that offer broader economic and societal benefits.
