Inheritance tax good economics, and the politics may be better than they seem

Tuesday, 7 August 2018

Sir Michael Cullen has said properly addressing 'intergenerational equity issues' is impossible, but he hasn't been allowed to look at an inheritance tax.

OPINION The Government had no choice but to fly blind when it instructed Sir Michael Cullen's Tax Working Group not to look at the merits of recommending an inheritance tax.

The decision was a political one.

It was made without any knowledge of how inheritances might be influencing the distribution of wealth and the economy – because in New Zealand that information simply doesn't exist.

The Government needs to record how much people earn for employment, dividends and interest, and how much they make in profits from businesses, because it taxes those sources of income.

* Tax Working Group papers highlight concerns over 'inequality'

* The Tax Working Group will end with the PM turning down a capital gains tax, expert says**

Officials have also attempted to estimate how much people make in capital gains from the sale of property, businesses and shares, given that the Tax Working Group has been asked to consider whether they should fall further under the tax net.

But neither Inland Revenue nor the country's largest administrator of wills, the Public Trust, are aware of anyone attempting to tot up the value of inheritances.

Public Trust spokesman Josh Byers says it has seen an increase in the number of people dying in debt, which he attributes to people living longer.

This might suggest inherited wealth is on the decline.

But if New Zealand is like other developed countries, the reverse is probably true.

Researchers at the London School of Economics (LSE) concluded in 2013 that inherited wealth has been on the rise in Britain and France since the mid-1970's, accounting for about 8 per cent and 11 per cent of people's income.

That was after previously plummeting from accounting for about a quarter of people's income in the late 1800s to about 5 per cent in the post-war years.

Rising house prices and the growth of the super-rich are probably behind the resurgence in inheritances.

The researchers point out 8 per cent of national income is a huge amount – equal to the sum Britons receive from private pensions – and the swings over the centuries would have fundamentally reshaped society.

'A society where each year people can expect to receive in inheritance a sum of around a fifth of total income is very different from one where the sum is around a fiftieth,' they noted.

'The repercussions are likely to be seen in the labour market, in investment opportunities, and in the housing market.'

Common criticisms of inheritances taxes are that they are easy to avoid, principally by people hiding or secretly giving away their wealth in old age.

But last year, The Financial Times reported that inheritance tax receipts in Britain exceeded £5bn for the first time and were at their highest level since the 1980s, as a proportion of national income.

The LSE researchers noted that, until the Second World War, British citizens were statistically more likely to pay estate duty at death than to pay income tax while living.

Tax expert Chris Wales suspects the Government won't press ahead with a broader capital gains tax because of the impact it could have on housing supply.

Inheritances taxes that have a tax-free threshold like Britain's of between $1.3 million and $1.8m for a married couple will be actually be very similar to a capital gains tax in terms of what they actually tax.

Chances are that the bulk of any wealth people have built up over and above that amount over their lifetime will have been from capital gains, rather than wages that they or their forebears have scrimped and saved.

But inheritances taxes also have several advantages over a capital gains tax – or over other types of wealth taxes which have not been ruled out by the Government.

From an administrative perspective, people only pay them once, rather than every year.

From the Government's point of view, the tax revenue they generate is more stable, whereas capital gains taxes mainly raise money during the good times when it is less likely to be needed.

Inheritances taxes are fairer than annual wealth taxes and capital gains taxes, because they tax the sum of the 'snakes and ladders' in life, rather than only the 'ladder' years.

Yet the disincentives they create for wealth creation are less immediate than for any other type of tax.

It would be equally possible to exclude 'the family home' from an inheritance tax or a capital gains tax.

But it would be easier to include family homes in an inheritance tax – perhaps with a separate tax-free threshold as in Britain – since homes tend to be sold when estates are settled.

An inheritance tax would also seem to better address Cullen's agenda.

Speaking in Queenstown in March, he indicated that one reason tax reforms were being considered was to address 'intergenerational equity issues'.

But he went on to say that these would require 'substantial retrospective – and thus impossible – action to address properly'.

Yet an inheritance tax is a way of taxing capital gains that have been made in the past, without being in a legal sense retrospective or indeed 'impossible'.

One small drawback is there might be a need for a few exclusions for sensitive assets such as family farms that have been in people's hands for generations.

This thinking isn't novel or left-field.

PwC tax expert and Tax Working Group member Geof Nightingale agrees there are a lot of good theoretical reasons for an inheritance tax but says 'it break downs at the politics'.

The Government made a political judgment that the Tax Working Group would honour, he says.

'Inheritance taxes are intensely disliked so if you haven't got one, it's very hard to put one in'.

Given the Tax Working Group appears highly likely to recommend a broad-based capital gains tax, and Prime Minister Jacinda Ardern and Finance Minister Grant Robertson ruled out an inheritance tax before the election, is it all just academic?

Maybe, during this parliamentary term at least.

But I agree with former Tony Blair adviser Christopher Wales, who now sits on the board of Oxford University's Centre for Business Taxation, that there may be a lot of water to go under the bridge before the Government commits to anything that the Tax Working Group recommends.

If a capital gains tax only applied to capital gains made after its introduction and that came, as seems possible, near the peak of the housing market and sharemarket boom, it is quite possible it could raise virtually no money for a decade or more – which is more than three election cycles.

That would mean a capital gains tax could entail a lot of political bother for next-to-zero political reward.

An inheritance tax might be a slightly harder sell, but only perhaps until people had a chance to look at a design, and it offers the instant reward.

Britain's Spectator, when commenting on inheritance tax, correctly observed that 'politics trumps economics'.

But you can change politics, and you can't change economics.