October 24, 2011, 3:17am
AS chancellor George Osborne and his team try to simplify our over-complex tax system, they are looking at taxes whose harmful effects outweigh any good that comes from their revenue. Obviously the 50 per cent top rate of income tax must be a prime candidate, given that the Institute for Fiscal Studies has joined the Adam Smith Institute recently in arguing that it will probably reduce tax revenues instead of raising them.
Hot on its heels as a tax that distorts and damages the economy must come inheritance tax. When Dr Bracewell-Milnes wrote his classic studies in 1994 and 1995, he concluded that the tax had probably had a negative yield in every single year since it was first introduced as estate duty in 1894. To that can be added the difficulties which the tax puts in the way of entrepreneurs.
When someone starts up a new business that creates jobs and wealth, they usually want to pass it on to their children to give them a better start than they enjoyed themselves. This is what parents do; it is part of human nature, and no talk of “giving some people an unfair start” is going to change that. There is nothing unfair about parents caring for their children. They build up a business and want to pass on to their children what they have saved after taxes, only to see it taxed again.
Perversely, inheritance tax rewards spending rather than saving. The spender enjoys 100 per cent of value, whereas the saver is allowed only 60 per cent. The incentive is to dissipate the pool of capital rather than preserve it. Some unincorporated businesses that could continue as going concerns under family stewardship are sold and dissipated. Other businesses guard against this by ceasing to be entrepreneurial and growing, diverting energies instead into ways of minimising their exposure to inheritance tax rather than into expanding their activity and their markets.
The tax’s adverse effects on entrepreneurship go much further than discouraging parents from building up and passing on businesses. Several studies have shown that ordinary bequests boost self-employment. They provide capital sums to children at just the time when some contemplate branching out from paid employment into their own business. The bequest makes it possible, and by taxing bequests we are inhibiting future self-employment and the new businesses it would bring.
Furthermore, it is overwhelmingly family wealth that provides start-up businesses with lower cost and less risky capital than that available from banks. Family wealth is less demanding and more forgiving of the hiccups and cash flow crises that many start-ups experience. By taking money from families and into the Treasury, inheritance tax is taking away part of the capital stock available to fund new enterprises.
When George Osborne in 2007 announced a plan to raise the inheritance tax threshold to £1m, the move’s popularity caused Gordon Brown to postpone the election that might have re-elected him. If the tax were abolished today, entrepreneurs and would-be entrepreneurs would be among those leading the applause.